Monday, September 28, 2015

Japan Deflation

Deflation returns to Japan. Tyler Cowen has a thoughtful Marginal Revolution post, expressing puzzlment. Scott Sumner discussion here, and Financial Times coverage.

Let's look at the bigger picture. Here is the discount rate, 10 year government bond rate and core CPI for Japan. (CPI data here if you want to dig.)
If you parachute down from Mars and all you remember from economics is the Fisher equation, this looks utterly sensible. Expected inflation = nominal interest rate - real interest rate. So, if you peg the nominal interest rate, inflation shocks will slowly melt away. Most inflation shocks are individual prices that go up or down, and then it takes some time for the overall price level to work itself out.


The recent experience looks a lot like 1998. As of 2001, it would have been reasonable to think that the dreaded deflationary vortex was going to break out. But it didn't. Inflation came trundling back. As of 2008, you might have thought that low rates would finally spark inflation. But they didn't. In 2014-2015 you might have thought that the latest in a 20-year string of fiscal stimuli, bond purchases, bridges to nowhere and xx-onomics programs were finally going to produce inflation. But, so far at least, no.

It's tough to make predictions, especially about the future,  as the late great Yogi Berra reminds us. Still, this is the third strike.

The long term bond market continued its linear trend throughout the recent episode, a strong sign that expected inflation had not moved. And the sharp jump up and then back down again exactly a year later smacks of data errors, or one specific component. I hope a commenter has more patience for wading through the data than I do to find it. 

To be sure, Tyler emphasizes a central puzzle. Even if you accept the view that the Fisher equation is a stable steady state, that ties down expected inflation, but not actual inflation. There are troublesome multiple equilibria. The fiscal theory of the price level can tie down one equilibrium in theory, but not yet in practical application. But I wonder if we're not overblowing this problem. If we interpret the shocks not as shocks to individual prices that take time to melt away, but as expectational shocks, we still get a pretty good view of the data. Nominal interest rates plus a slowly time-varying real rate tie down expected inflation, little multiple equilibrium shocks let actual inflation vary, but such shocks melt away.

And the earthquake fault under all of this: Even the theory that says pegs can be stable warns they can only be stable if bond investors think they will be paid back. At some point -- 250% debt to gdp, slow growth and no population growth? 300%? What does it take? -- they change their minds. And then Japan gets the inflation it has so long desired, and a bit more to boot.

In the meantime, perhaps rather than worry-worry, we should celebrate 20 years of the optimum quantity of money, achieved at last.

Update David Beckworth on the same topic. I'm less of a NGDP target fan. It's like saying all the Chicago Cubs need is a "win the world series" target. OK, but what do you want them actually to do differently? What 3 trillion of QE wasn't enough, but 6 will do the trick? I know the answer, that talk alone tweaks some off equilibrium paths to generate more "demand" today. And monetary policy does seem to be just talk these days. But still... I'm also less of a fan of looking at monetary aggregates. At zero rates, money = bonds, and MV=PY becomes V = PY/M.  But it's a well stated analysis in these terms, and nice coverage of the fiscal theory at the end.

47 comments:

  1. The sharp jump up and then down again is likely the consumption tax increase Japan implemented in April 2014 (and then that increase falling off the back end a year later).

    www.bbc.com/news/26830486

    Btw the October 2015 increase mentioned in the first paragraph has been postponed.


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  2. John, you wrote:

    > And the sharp jump up and then back down again exactly a year later
    > smacks of data errors, or one specific component. I hope a commenter has
    > more patience for wading through the data than I do to find it.


    I think this is just the 3% increase in consumption tax in April 2014 rolling into consumer prices, and then, if you look at consumer prices year-over-year on a monthly basis, it appears that inflation is 3% higher for exactly 12 months and then drops right back down again.

    i.e., I think this little burst in apparent inflation is just an illusion.

    -Ken

    Kenneth Duda
    Menlo Park, CA

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  3. Valter Buffo, Recce'd, MilanoSeptember 28, 2015 at 11:14 AM

    About the "sharp jump": that is the effect of the introduction of a "consumer" or VAT tax. About the "bond investors": as you say, "at some point" they will doubt about the solvency of the debtor. I just would prefer NOT to see that happening: I still hope someone will act to anticipate such a "change of mind". But as you say, if we proceed along this way, it would become inevitable.

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  4. Prof. John Cochrane, the recent spike in Japan inflation data is due to the increase in consumption tax from 5% to 8% in April-2014. A similar VAT increase had been implemented in April 1997.

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  5. "Even the theory that says pegs can be stable warns they can only be stable if bond investors think they will be paid back. At some point -- 250% debt to gdp, slow growth and no population growth? 300%? What does it take? -- they change their minds."

    Government bond investors are not paid out of GDP, they are paid out of tax revenue - sheesh. Suppose government debt was only 10% of GDP, but tax revenue was only 0.0001% of GDP, would bond investors suddenly feel a lot better?

    Why do you consistently ignore what should be obvious?

    ReplyDelete
    Replies
    1. Annual GDP sets an upper limit to tax revenue,that is why its an importnat concept.

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    2. In 1713-1795 Holland paid 70% of taxes to interest, and it was priced as prime investment (4% to 6%), but near the edge. Public debt was about twice GDP. The Wealth of Nations reports taxes high; take it almost 15%, and NL had 45% GDP for taxes, and we have lower interest rates now, so the point can be somewhat further, but the point was, that there is a point, and in that prof. Cochrane has a point.

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    3. Baconbacon / Yope,

      My point was that bond investors don't use debt to GDP as a reliable measuring stick to gauge the government's fiscal position. Instead they use interest expense as a percentage of total tax revenue (as Yope describes for Holland).

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    4. Neither works on its own. To get a good sense you need to be able to look at risk over the life of the bond and that means knowing the IR exposure. Debt to GDP is good enough to give a quick and dirty answer to the tail end of "how long can this last?"- while current interest payments/tax revenue gives a quick a dirty to the front end of that question. Unless you are only playing very short term bonds you need the answer to both to make a good decision.

      I am sympathetic to the notion that a country like Japan (with a long term quality track record of repayment) it is more relavent to discuss debt to gdp. Tax revenue to interest can be moved signiicantly in a much shorter time frame, but high debt to gdp levels imply that the ptential for a crsis exists over a very long time frame.

      Delete
    5. "Even the theory that says pegs can be stable warns they can only be stable if bond investors think they will be paid back. At some point -- 250% debt to gdp, slow growth and no population growth? 300%? What does it take? -- they change their minds."
      ---------------------
      Like the U.S and U.K, etc., Japan has its own free floating currency and no foreign denominated debt. My understanding is that for such countries debt can be paid off (unprinted) in exchange for bank deposits created out of thin air (printed). Such a transaction would be a "neutral" swap, similar to QE, with no ramifications for inflation, etc. The debt would be gone and no taxpayers would be in sight! Thus, bond investors will never "change their minds" - at least with respect to "receving their money". Japan also does not have a debt ceiling so that pointless game is not played. .

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    6. Baconbacon,

      "Debt to GDP is good enough to give a quick and dirty answer to the tail end of how long can this last?"

      You don't know what GDP will be in the future and so how can you determine the tail end of how long can this last?

      Also, while interest expense (in dollars) divided by tax revenue (in dollars) is a unit less percentage reflecting what percentage of tax revenue is directed toward servicing debt (more than 100% means you are in trouble), debt (in dollars) divided by annual GDP (in dollars per year) gives you a answer in years.

      For instance, $10 Trillion in debt divided by $5 Trillion per year in nominal GDP gives you a ratio of 2 years. What does the 2 years even mean?

      Delete
    7. Charles,

      From John's article:

      "Even the theory that says pegs can be stable warns they can only be stable if bond investors think they will be paid back. At some point -- 250% debt to gdp, slow growth and no population growth? 300%? What does it take? -- they change their minds. And then Japan gets the inflation it has so long desired, and a bit more to boot."

      Suppose bond investors do change their minds but instead of spending their investment on goods they simply swing their positions - instead of being long Japanese bonds they are now short those same bonds with the same level of investment.

      There is no guarantee that bond investors will generate aggregate demand or inflation simply by abandoning their long positions. They can just as easily take short positions.




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    8. Agreed. The bond positions should not impact aggregate demand. And I see my comment was not really addressing the point. I was just saying that there is never a solvency issue (absent self imposed limits) for a country with its own currency and no foreign debt But John's point was that there could be an inflation issue at some point - with which I agree.

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  6. Dr. Cochrane,

    1) The difficulty with using the Equation of Exchange is assuming that it is made up of four independent variables and than any of them can be changed which the influence the others. There are really only one driving variable, y. The total volume, or rather the rate of change of the total volume of goods and services is what drives an economy. M is a variable that central banks can influence but not really control. No one can control velocity or prices. When an economy expands, dy>0, velocity and prices will rise, the degree to which is influenced by dM. So long as dM = k (dy) prices and velocity will rise proportionately. When dy < 0, prices and velocity will fall, i.e. deflation, UNLESS central banks vastly increase the volume of money. Then dM can counter balance dy producing minimal deflation or even a small amount of inflation. This is precisely what the Federal Reserve Bank has done during the last four recessions[1]. Normally, the M1 Money Stock (M) tracks weakly but significantly Gross Domestic Product (y) and Personal Consumption Expenditure Price Index (P). However in 1983, 1991, 2001, and 2009 M1 went in the opposite direction from GDP and PCE as the FRB increased the M1 money stock. If the data from these four events are removed, the M, y, and P track much more strongly and significantly. This relationship does hold as well for M2 or MZM.

    2) The choice of money stock is critical in assessing the relationship between velocity and other variables. For example there is no relationship between the Effective Federal Funds Rate and M1 or M2 but there is for MZM[2].

    3) In regards to Japan, the central bank, the Bank of Japan, has been trying to forestall the inevitable dP<0 that follows form dy<0 as capital, manufacturing capital in particular has fled the island nation by increasing the supply of money dM>>0. This is what Quantitative Easing is all about.

    [1] http://m1currencygdppcecimonpol.tumblr.com/

    [2] http://effrvelocity19592014.tumblr.com/

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  7. John,

    Scott Sumner has a more recent post than the one you linked to responding to Tyler Cowen. It's called:

    "Deflation has not returned to Japan"

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  8. "OK, but what do you want them actually to do differently?" In other words, "Show me the concrete steppes"!

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  9. If what Dr. Cochran says is true, the Bank of Japan can evidently eliminate Japanese national debt in the next 10 years or so. There is already talk the Bank of Japan is running out of 10-year JG bonds to buy.

    What does monetization of Japanese national debt be a good thing?

    On the other hand the typical Japanese resident has $6,000 in cash paper money outside of banks. The economic figures we see on Japan may or may not be accurate. There may be a very large off-the-books economy. This is the result of the length of the era of deflation in Japan which has made cash a perfectly good way to save money. Once a population has large amounts of cash, then transactions can be conducted in cash as well.

    It strikes me that a nation in which cash is legal, but in which there is no inflation, will inevitably develop a very large off-the- books economy.

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  10. Can monetary policy work? I copied this from a Roger Farmer blogpost:

    "From January of 2007, through September of 2008, expected inflation fluctuated between two percent and three and a half percent. When Lehman Brothers declared bankruptcy in September 2008, expected inflation fell by nearly eight hundred basis points in the space of two months and by October of 2008 it reached a low of negative four and half percent.

    Immediately following the Federal Reserve purchase of one point three trillion dollars of new securities, expected inflation went back up into positive territory."

    Why did expected inflation drop? Partly it was because of deregulation and fraud by the banks. Rating agencies were passing off bad investments at AAA ratings. That's analogous to Volkswagon designing software to get around emissions testing. Outright fraud. Banks didn't trust one another. Market failure. Panic.

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  11. It was most likely Niels Bohr, not Yogi. Although some contend he was quoting Markus Ronner, Piet Hein or Robert Storm Peterson.

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  12. John, you wrote:

    > I'm less of a NGDP target fan. It's like saying all the
    > Chicago Cubs need is a "win the world series" target.

    As a big supporter of market monetarism, I must protest.

    If the Fed announced "full employment and stable prices targeting", *that* you could rightfully mock as "win the world series targeting".

    There is no reason whatsoever to think the Fed couldn't hit an NGDP target if it tried. The Fed rules the nominal universe. It's the monopoly creator and destroyer of dollars. As long as there is a dollar-denominated economy, the Fed can get any level of NGDP it wants.

    I am always confused when smart economists don't see it that way. Why do you think the Fed would miss its target? Is it:

    (A) the Fed's instruments are too blunt. Sure, it could drive NGDP really high or really low, but hitting a target accurately is hopeless.

    (B) the Fed's instruments are not powerful enough. No matter what the Fed did (within its legal authority) could it have hit a 5% NGDP level target in 2008, 2009, or 2010.

    (C) the Fed could do it, but never will due to political and/or cultural constraints (either the governors love their arbitrary discretion too much, or they fear it will reflect badly on their careers if they try something like NGDP level targeting, etc.)

    From your comment, I assume it's B. Really? The Fed can't generate enough spending? Let's suppose the Fed said:
    (1) we have an NGDP level target of $19T in 2014;
    (2) we will expand the monetary base as much as needed to hit that target;
    (3) if we miss, next year's target will be all that much higher;
    (4) we are pegging the yen to the dollar, 1Yen = USD1, until we hit that target.

    What do you think would happen?

    -Ken

    Kenneth Duda
    Menlo Park, CA

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    Replies
    1. Ken,

      Let's suppose the Cub's say to win the World Series they are going to feed Kris Bryant megadoses of fluoride tablets. Where is the causality between fluoride ingestion and World Series success?

      Likewise, where is the causality between monetary base and nominal GDP? From the equation of exchange:

      MV = PQ

      Increase M by 50%, what stops V from falling by 50%?

      "What do you think would happen?"

      What do you think would happen if the Cubs tried the fluoride route to the World Series?

      Delete
    2. Frank,

      > Increase M by 50%, what stops V from falling by 50%?

      Nothing. If the markets believe the increase in M to be temporary, and future monetary policy will be even tighter, V could fall by more than 50%.

      I am not arguing for any particular level of or rate of change in M. I'm arguing for NGDP level targeting, which relies on the markets to tell the Fed what instrument settings will hit the Fed's desired level of NGDP.

      Expectations really, really matter. Nick Rowe has some great posts explaining how a given central bank action can have a wide variety of effects depending on the market's understanding of what the action means about future monetary policy.

      http://worthwhile.typepad.com/worthwhile_canadian_initi/2015/07/wtf-and-neo-fisherianism-as-one-social-construction-of-reality.html

      http://worthwhile.typepad.com/worthwhile_canadian_initi/2015/04/var-vs-wtf.html

      Frank, you and John are making the same mistake in looking for some direct causal connection between monetary base expansion and rising NGDP. The markets are smarter than that. That's why the key to NGDP level targeting is that the monetary authority promises to hit the target, or, if it misses, to *not change the target level path in the future*, and try even harder to hit the (unchanged) future target. If the Fed vacillates, hedges, hems, and haws, tells us it's all data dependent, etc., then the markets are left guessing about future policy and V becomes much harder to predict.

      The last 8 years have been very unkind to people who think doubling of M will have some specific effect, like doubling the price level, or doubling NGDP, or collapse of the value of the dollar in forex markets. What matters is not just M today, but also expectations of the future path of M. Sadly, current Fed policy keeps us all guessing. Why do we put up with this? It doesn't have to be this way.

      -Ken

      Kenneth Duda
      Menlo Park, CA

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    3. Ken,

      "Frank, you and John are making the same mistake in looking for some direct causal connection between monetary base expansion and rising NGDP."

      If there is no direct causal connection between monetary base expansion and rising NGDP then why increase the monetary base?

      I am a simple guy asking simple questions - if I can't use a grape fruit to drive home a nail, then why would I keep buying grape fruit?

      "Frank, you and John are making the same mistake in looking for some direct causal connection between monetary base expansion and rising NGDP."

      And you and the rest of the market monetarists seem to forget that legally binding contracts (including debt) help to fix expectations. Okay, so the central bank literally prints tens of trillions of dollars with no binding legal obligation attached to them - and then they sit there, and sit there, and continue to sit there. And you continue to wonder why?

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    4. > If there is no direct causal connection between monetary base expansion
      > and rising NGDP then why increase the monetary base?

      I have no idea why the Fed is increasing the monetary base. Neither does anyone else. Did you read the Nick Rowe links I sent? That's the whole problem. Presumably the Fed is hoping that monetary base increases will help the economy somehow, but we know specifically, because they won't tell us.

      > then they sit there, and sit there, and continue to sit there.
      > And you continue to wonder why?

      No, I don't wonder why and never have. There's no puzzle here. The dollars are not going anywhere because the market expects the Fed to suck them right back out of the economy the instant inflation brushes up against the Fed's 2% inflation "target". While the Fed's statements are mostly incomprehensible, the one thing the Fed has been extremely clear about is that it regards its "credibility" on inflation to be sacrosanct and will not sacrifice it. I put "credibility" in quotes because the Fed has not actually hit its target in years, i.e., its target is not actually credible, but that's not what the Fed means --- they mean their credibility in keeping inflation low, which they have obviously been very successful at, at the expense of the real economy unfortunately.

      Do read Nick Rowe. He's very good. Here's another post on what is wrong with the "concrete steppes" thinking that you and John are displaying here.

      http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/10/engdp-level-path-targeting-for-the-people-of-the-concrete-steppes-.html

      Kenneth Duda
      Menlo Park, CA

      Delete
    5. Kenneth,

      Yes, I read it, and Nick's argument boils down to this:

      "The Fed makes a threat. On the first day the Fed will print $1 billion and use it to buy assets." And Nick continues with the Fed buying more and more assets.

      Except the Fed can't force the holders of assets to sell them. Which makes the Fed's "threat" really a choice - I can choose to sell assets to the Fed or I can hold onto the assets. And even if I choose to sell assets to the Fed, I can choose to buy them right back.

      Nick does make a solid argument here:

      "You want me to tell you a story in which the central bank pulls a lever, and that lever causes another lever to move next, followed by another lever, then another, spelling out a causal chain from beginning to end, where the end is a higher level of NGDP. But economics isn't like that. Because people aren't like that."

      But then he resorts to the "Chuck Norris" metaphor. When Chuck Norris beats someone up - they don't have a choice in the matter. When the Fed tries to buy assets, the holder of assets does have a choice.

      It all boils down to choice. No amount of NGDP targeting or monetary base manipulation is going to change that.

      If instead you want to constrain or steer choices toward a desired result, the legal / fiscal system is where the action is.

      Delete
    6. if you believe that the only way to influence behavior is coercion, this argument is incontrovertible
      if, however, economic agents react to incentives *on the margin*, then of course a credible risk of the (fiat) currency being debased will increase V
      both empirically and theoretically this can't even be doubted. Why, then, is reality not a clear-cut growth story without demand shocks? The Market Monetarist answer is that
      a) central banks follow a sub-optimal model (targetting inflation instead of the aggragate demand)
      b) show an abysmal performance in implementing their own model

      This is not circular reasoning: central banks have *not* done what it takes for years/decades to bring inflation up (they have done better bringing it down), even at times when there was no observable disconnect between their actions and monetary reactions. Now they would need to regain their credibility in that direction.

      Have central banks tried to regain credibility to achieve above 2% inflation? No, they haven't even claimed they wanted to

      Would they be unble *if* they tried? The burden of proof would be on you to show how people suddenly stop reacting to incentives. And note, my point is, they *have* reacted to incentives so far, just the incentives were disinflarionary (mostly)

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    7. Michael,

      "If, however, economic agents react to incentives on the margin, then of course a credible risk of the (fiat) currency being debased will increase V.
      Both empirically and theoretically this can't even be doubted."

      Sure it can. Even if people react to incentives, and even if the central bank members attempt to debase the currency, the people's reaction might be to have the central bank members removed from office (see G. William Miller - Fed Chair 1978-79).

      I don't confess to be a mind reader / soothsayer capable of predicting what people will do and neither should you.

      Delete
  13. Frank,
    So the Fed buys all the US national debt and forgives it, rescinding any claim on it. What happens? National debt goes to 0 and V drops a lot? Let's go for it.

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    Replies
    1. Dustin,

      The Fed (central bank) cannot forgive the U. S. national debt. It can buy the debt and remit the interest payments back to the Treasury, but the debt (as a legal obligation) still exists. The federal government and only the federal government can retire it's own debt.

      See:
      http://www.federalreserve.gov/aboutthefed/section14.htm

      "To buy and sell in the open market, under the direction and regulations of the Federal Open Market Committee, any obligation which is a direct obligation of, or fully guaranteed as to principal and interest by, any agency of the United States."

      If the central bank tries to forgive the principal and interest on a government bond that it has purchased, then it has violated section 14 of the Federal Reserve Act since the principal and interest are no longer guaranteed.

      "Let's go for it." I don't work for the central bank and you are free to pursue your own agenda. I am just telling you how the regulations are written.

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    2. Dear Secretary Lew,

      I am pleased to announce that I have several trillion-dollar platinum coins for sale - discounted by 99%! Hurry! At these prices they won't last long!

      Act now and I will send you 6 coins for the price of 5, PLUS a Popeil Pocket Fisherman.

      Sincerely,

      JB

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    3. The Fed could buy all the debt - i.e., keep going with QE. These Treasury securities would then be as asset of the Fed and a liability of the Treasury. That is, the debt would be effectively gone as far as the private sector (the sector which counts) is concerned. This result would reveal that the "National Debt" is a phony issue - and the most misunderstood issue in the history of the nation. In this sense, we could "go for it". .

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    4. Charles,

      For the Fed to buy all the debt, someone else would have to sell all the debt. Convince me that everyone that currently holds Treasury securities would be willing sellers.

      "This result would reveal that the National Debt is a phony issue"

      Phony compared to what - debt owed by General Electric or Joe on his mortgage? Even when the central bank buys the debt, the legal obligation still exists for the federal government to make payments on it.

      If the "National Debt" is such a phony issue then why should the federal government continue to make payments on it? No need for the central bank to get involved, Congress / Supreme Court simply declares that all Treasury securities are worthless, done.

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    5. Frank,
      Yes, to use your example, the National Debt is phony compared to the debt of General Electric or Joe on his mortgage. That is, you and I, Illinois, Greece, General Electric, etc. must pay off our debts with private sector money (or get help). This is a real burden (a bank deposit debit) upon the private entities involved. We must come up with the money!.In contrast, my understanding is that Federal government pays off its debt in exchange for bank deposits created "ex-nihilo" (out of thin air). . This is a burden on no one. No taxpayers are involved.
      Viewed this way, the "National Debt" is just a large private sector savings account. It is a private sector asset. The "phony issue" in that this "savings account" is viewed by "everyone" as some kind of burden on the future.
      I admit my ignorance on whether "all" of the Treasuries could be readily purchased with, say, a continuation of QE. It was just a hypothetical way to demonstrate that the debt is "not a burden on the future" - as it would be effectively eliminated.
      Yes, when the central bank buys the debt, the legal obligation to make payments on the debt continue. The Treasury pays the Fed. Then the Fed ships most of this interest back to the Treasury at the end of the year
      While this shell game exists, this debt is effectively gone as far as the private sector (the sector which counts) is concerned. To your point, all this "debt" at the central bank could just be cancelled (we're talking economics not legalities).
      Whoops. Had another thought but have to go.

      Delete
    6. Charles,

      "We must come up with the money!.In contrast, my understanding is that Federal government pays off its debt in exchange for bank deposits created "ex-nihilo" (out of thin air)."

      Your understanding is incorrect (at least from a U. S. standpoint). U. S. federal government uses tax revenue to make the interest payments on it's debt - this is not controversial and the interest on the debt is part of any government budget discussion.

      Delete
    7. Frank, thanks for the comments. Yes, interest payments on the debt assume must come from either tax revenue or from the proceeds of further debt issuance (deficit spending). Agreed.
      However, with respect to the principal, the government is paying off debt every day as it matures. In terms of the nuts and bolts, a securities account at the Fed , which holds the Treasury securities, is debited while a reserve account (think of it as a checking account) is credited "ex-nihilo". I believe that upwards of $50 trillion has been "paid off" in this manner in just the past year. Obviously, this is not tax money. .
      It is true that additional Treasury debt is then issued to replace the "paid off" debt - but that is a legal, not an economic, requirement. Without the legal restriction that the debt must equal the cumulative value of the deficits, there would be no need to replace the "paid off" debt and therefore it would be gone - no taxpayers involved. That's my understanding as at least two leading monetary economists have told me that my description is accurate. Does this make sense to you?

      Delete
    8. Charles,

      "Yes, interest payments on the debt assume must come from either tax revenue or from the proceeds of further debt issuance (deficit spending)."

      It's true that a government could attempt Ponzi finance - pay off existing bond holders principle and interest with new bond issuance - I just don't think it would be very sustainable, and I think interest rates under a Ponzi finance scheme would become very unstable. In essence I, as bond holder, would be paying myself and so I can charge myself whatever interest rate I feel is appropriate. With interest paid from tax revenue, interest rates (on government debt) are constrained by the amount of tax revenue available to make the payments.

      "It is true that additional Treasury debt is then issued to replace the paid off debt - but that is a legal, not an economic, requirement."

      I don't think you can separate an economic system from it's legal underpinnings so easily. Ultimately, those bonds represent a property asset that the owner can choose to retain until maturity or sell at his / her discretion. Without the protection of property rights granted by a legal system, economic systems do not go very far.

      "Without the legal restriction that the debt must equal the cumulative value of the deficits, there would be no need to replace the paid off debt and therefore it would be gone - no taxpayers involved."

      Without the legal restrictions on theft, I could care less what the central bank did with it's money, anything that I would want I could just steal it.

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    9. Frank in terms of paying the interest on the debt, I wasn't necessarily implying Ponzi finance. I was just saying that right now the U.S. is running a fiscal deficit. This means that some of our spending is coming out of taxes and the remainder from issuing securities. As to what expense (interest, defense, medicare, education, etc) the deficit is "paying for" is, I guess, an arbitrary decision. But, to keep it simple, you could assume all the interest in being paid for with taxes and some part of "other spending" is being covered by the deficit. So I agree
      I also agree that you can't separate an economic system for its legal underpinnings. All I was saying is that, operationally, the National Debt could be paid off in exchange for bank deposits created "ex-nihilo" - and the debt would be gone. No taxpayers involved. These transactions would be similar to QE -only the debt would be retired instead of remaining (with QE) as both as asset (for the Fed) and a liability (for the Treasury) which, it seems to me, is the "same" as retirement.

      I agree with your sentiments. I am explaining this "retirement transaction" as an operational nuts and bolts fact -without regard to economic theory, or moral or political judgment. I would be happy to be proven wrong - one reason for my posting - that is,I don't want to be spreading misinformation.
      So, bottom line, I agree with your sentiments that this transaction might be unsettling but I have heard nothing to indicate that it's description is incorrect. As I noted, not beng sure myself, I have shared with some monetary economists for their critique. Leaving aside political and moral concerns, they agreed it was "all accurate" . As a friend of mine joked the other day "we've actually "paid off" $800 trillion (not a typo) over the past 20 years - what's another $19T?" So that's where I am. Your thoughts have been and are appreciated.

      Delete
    10. Charles,

      "All I was saying is that, operationally, the National Debt could be paid off in exchange for bank deposits created "ex-nihilo" - and the debt would be gone. No taxpayers involved."

      And what I am saying is that the debt is not gone with QE purchases by the central bank. If the debt were truly gone, the central bank could not reverse the process of QE - selling securities back into the market - and we know that it in fact can. Hence, the taxpayer is still on the hook because the Fed remittances back to the Treasury can be suspended at any time. If the debt were truly gone, there would be no remittances at all.

      "I am explaining this retirement transaction as an operational nuts and bolts fact -without regard to economic theory, or moral or political judgment."

      The nuts and bolts of it are pretty simple - the federal debt as a legally binding obligation of the federal government (and thus the taxpayer) still exists even when the central bank purchases the debt. The central bank can choose to remit / not remit interest payments back to the Treasury just as the Treasury can choose to accept / reject those remittances.

      Delete
    11. Frank I agree. The debt is not gone with QE purchases by the central bank. I think I was describing a hypothetical situation where the debt is retired and therefore it is not on the Fed's balance sheet. In terms of the nuts and bolts, a securities account at the Fed , which holds the Treasury securities, is debited while a reserve account at the Fed (think of it as a checking account) is credited "ex-nihilo". Just bookkeeping entries. So the debt would be gone with there being no future private sector tax liability.
      To my (limited) mind this seems straightforward to me. Am I still missing something from your standpoint? Thanks.

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    12. Frank regarding the "nuts and bolts" of retiring the debt I forgot to note that also Treasury liabilities (securities) are reduced (obviously) with the offset on the Treasury's balance sheet being a reduction in the Treasury's deposits at the Fed. The Fed, as noted, experiences a decrease in Treasury deposits and an increase in reserves. The banking system also reflects this increase in reserves. At least that is my detailed understanding. Hope helpful.

      Delete
  14. Frank,
    I'm not familiar the reg but will look into it. Anyway, and as others have point out, the Fed could relieve the national debt in kind by committing to its QE purchases as permanent injections (i.e., it will issue future QE to cover the principle repayment).

    The US government (or anyone or entity for that matter) could then could issue unlimited debt and be comforted in knowing that the debt would be covered by the Fed into perpetuity. If QE cannot cause inflation, then we could be effectively debt free, forever, with with a really low V.

    I can't prove it, but I've a hunch the result wouldn't be a really low V. Rather, the result would be a low interest rate policy with hyperinflation, and the Neo-Fisherian claim that inflation follows the nominal rate would be a distant memory.

    ReplyDelete
    Replies
    1. Dustin,

      But the causal inflationary link would not be the purchase of debt by the central bank, it would be the purchase of goods using money "borrowed" from the central bank by the federal government.

      Suppose the US government did issue unlimited debt and burned the borrowed dollars in the White House furnace. How inflationary would that be?

      The Neo-Fisherian result is arrived at with an important requirement - fiscal (government) restraint.

      Delete
    2. The causal link would be the creation of money that fuels the unlimited debt that in-turn fuels purchases. Even if demand for real goods remained constant, unlimited new money could drive prices toward infinity. The Fed could conntrol inflation by so many mechanisms. Suppose the Fed just grossly overpays for a T security? Or MBSs? Fiscal policy isn't even required as the transmission mechanism.

      As has been pointed out, the Fed's QE programs were overtly temporary injections of new money, which combined with an IOR, effectively sterilized the new money. Unfortunately the result is that folks seem to assume QE is ineffective, or worse, that the Fed cannot control inflation / NGDP.

      In other words, if I can make a boat sink, it doesn't follow that boats don't float.

      Delete
  15. A number of the comments here are above my pay grade, so please bear with my simpler view of the world.

    On QE as Prof Cochrane pointed out in an earlier post what has effectively happened is that the Fed has borrowed from banks short term (with loans rolled over at the discretion of the Fed) and invested it in MBS and Treasuries. It looks more like a highly levered investor doing this or a dealer maintaining inventory financed in the short term market.
    Banks have funded this purchase by taking deposits from the asset managers who sold these treasuries to the Fed. Now the asset managers (representing all agents who earned a surplus in the real goods economy) are holding a safe asset (collectively) in bank deposits and the risk premium (term and mortgage) is earned by the Fed. A conspiracy theorist would see through the trick- government is borrowing long term by paying short term overnite rates once you square of the interest it pays on these bonds and the income that the Fed remits.
    This is Fed providing some financial intermediation in the market for balances (surplus and deficits earned by economic agents and a inter mediated by the financial system) or asset markets. This is a role as a dealer rather than as an intermediary in the credit markets (lender of last resort). So may be when we talk multipliers for example we should distinguish these two very different roles performed by the Fed. And then we may find that the multiplier has not fallen as much.

    And why should QE be expected to cause inflation in goods market other than through the interest rate channel (consumption behavior and investments) when arbitrage considerations do not create the expected "yield curve" or reasonable "risk premiums"

    I am also not sure how extinguishing debt works. If Fed writes off the debt, it's balance sheet has a big hole equal to the write off which has to be funded by the government (equity) bringing that obligation right back. Otherwise the Fed can never balance its books. The other option is to make fresh loans to create a new asset on its balance sheet to repay the old loans but you get the drift. The Fed is just another bank with a more reliable "liability" than a commercial bank "deposit". But they work on the same principles.
    In my opinion the only way to evaluate QE is that it brought in an optimistic marginal buyer of government paper when others were shying away; and if appetite for this risk resumes, the Fed should just replace one safe asset (reserves and through it bank deposits) with government paper having acheived its goal to influence these prices.

    ReplyDelete
  16. A number of the comments here are above my pay grade, so please bear with my simpler view of the world.

    On QE as Prof Cochrane pointed out in an earlier post what has effectively happened is that the Fed has borrowed from banks short term (with loans rolled over at the discretion of the Fed) and invested it in MBS and Treasuries. It looks more like a highly levered investor doing this or a dealer maintaining inventory financed in the short term market.
    Banks have funded this purchase by taking deposits from the asset managers who sold these treasuries to the Fed. Now the asset managers (representing all agents who earned a surplus in the real goods economy) are holding a safe asset (collectively) in bank deposits and the risk premium (term and mortgage) is earned by the Fed. A conspiracy theorist would see through the trick- government is borrowing long term by paying short term overnite rates once you square of the interest it pays on these bonds and the income that the Fed remits.
    This is Fed providing some financial intermediation in the market for balances (surplus and deficits earned by economic agents and a inter mediated by the financial system) or asset markets. This is a role as a dealer rather than as an intermediary in the credit markets (lender of last resort). So may be when we talk multipliers for example we should distinguish these two very different roles performed by the Fed. And then we may find that the multiplier has not fallen as much.

    And why should QE be expected to cause inflation in goods market other than through the interest rate channel (consumption behavior and investments) when arbitrage considerations do not create the expected "yield curve" or reasonable "risk premiums"

    I am also not sure how extinguishing debt works. If Fed writes off the debt, it's balance sheet has a big hole equal to the write off which has to be funded by the government (equity) bringing that obligation right back. Otherwise the Fed can never balance its books. The other option is to make fresh loans to create a new asset on its balance sheet to repay the old loans but you get the drift. The Fed is just another bank with a more reliable "liability" than a commercial bank "deposit". But they work on the same principles.
    In my opinion the only way to evaluate QE is that it brought in an optimistic marginal buyer of government paper when others were shying away; and if appetite for this risk resumes, the Fed should just replace one safe asset (reserves and through it bank deposits) with government paper having acheived its goal to influence these prices.

    ReplyDelete
  17. How is this difficult to figure out? Old people don't spend money. They don't buy new TV's and computers every 3 years. They don't buy cars. They don't buy new phones every year and they don't buy the latest electronic gadget. They don't spend their savings because nothing really excites them anymore. The producers have an ever shrinking market to sell to and are continually cutting prices to do so.

    ReplyDelete

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