Monday, August 19, 2019

Gold Oped

Now that 30  days have passed, I can post the whole July 18 gold oped in the Wall Street Journal.

Some of President Trump’s potential nominees to the Federal Reserve Board have expressed sympathy for a return to the gold standard. Conventional monetary-policy experts deride the idea—and not wholly without reason. The gold standard won’t work for a 21st-century monetary and financial system. It is possible, however, to emulate its best features without actually restoring the gold standard.

The idea behind the gold standard is simple: The government promises that if you bring in, say, $1,000 in cash, you can trade it for one ounce of gold, and vice versa. By pegging the dollar to something of independent value, it promises to solve the problem of inflation or deflation. And we don’t need central-bank wizards to run things anymore.

Yet the aim of monetary policy isn’t to stabilize the dollar price of gold; it is, rather, to stabilize the prices of all goods and services. The price of gold has varied from $1,000 to $1,800 an ounce in the past 10 years. Had the Fed fixed that price, critics say the price of everything else would have had to vary this much.

Wednesday, August 14, 2019

Geoengineering fun

Eli Dourado writes of four intriguing geoengineering schemes: (HT Marginal Revolution's incomparable links.)

1. Bring back the Wooly Mammoth



The short version: Siberia used to be grassland, maintained by wooly mammoths. Grassland is colder than forests. Our ancestors killed off the wooly mammoths, and the trees took over. The permafrost is melting, which will be a huge climate amplifier. What to do?

Nikita Zimov ... is director of Pleistocene Park, a 144 km² grassy Siberian reserve founded by his father, gonzo scientist Sergey Zimov. The Zimovs have spent the past two decades ripping up trees and reintroducing grazing herds, including bison, moose, wild horses, yaks, and reindeer.
The plan is working. Nikita Zimov says the permafrost, which is at around –3º outside the park, is 17º colder (!) inside the park. 
Better yet bring back the wooly mammoth! Or rather play with elephant and wooly mammoth DNA until we get a half way new animal that can go restore the Siberian grasslands, and let it evolve a bit.
Mammoths provided the Pleistocene with the valuable services of grazing, trampling snow and moving it around to get to the grass below, and uprooting trees. Nothing will make a mammoth happier, it is thought, than ripping a tree out of the icy ground, just as modern elephants enjoy doing the same in the warmer ground of Africa. Based on everything we know, mammoths were a critical part of the Siberian Steppe ecosystem, and their extinction at human hands is what caused the forests to take hold.
I love the image of genetically engineered half wooly mammoths playfully ripping trees out of Siberia, eating grasses, and trampling ground to save the permafrost.

2. Project Vesta.
 mine large volumes of a (usually) green mineral called olivine, crush it up, and spread the resulting green sand on beaches all over the world, especially in the tropics where the water is warmest. 
It soaks up carbon dioxide and ends up on the sea floor, and eventually subjected into the mantle. That's where carbon dioxide ends up now, just much faster. And green beaches are kinda cool.
...One ton of olivine applied in Vesta’s process removes around 1.25 tons of CO₂ from the atmosphere. Olivine is superabundant, making up about half of Earth’s upper mantle...[ calculation follows ] that works out to around $9.04 per ton of CO₂ removed from the atmosphere and ocean.
$10 per ton is a great price. Many other hot ideas are $100 per ton or more.
what if we wanted to offset cumulative anthropogenic emissions since 1751? As of 2017, that was close to 1.6 trillion tons of CO₂. 1.6T × $9.04 = $14.46T through 2017. Adding $360B for each of 2018 and 2019, we arrive at a one-time cost of $15.18T for offsetting all human emissions since the dawn of the industrial revolution, which if done over 10 years, would cost 1.7% of global GDP.
3. Prometheus fuels

Short version: a chemical process that allows you to create ethanol and then other fuels from any electricity source, including nuclear, solar, etc. Fuels can be stored and transported, so the intermittent nature of much "clean" fuel doesn't matter.

4. The billion oyster project

Bring huge oysters back to New York Harbor. Ok, not much climate action but pretty cool

*******

Cool, but like other sensible adaptation and geoengineering projects, you can tell this is going nowhere in today's environmental politics, right? Genetically engineer a new frankenspecies of mammoth and set it loose to breed? Spread green rocks on all the worlds beaches? How unsightly! You've got to be kidding right? Well, no, if the climate really is a planetary emergency.

Two little sentences from Eli are worth quoting here:
Some environmentalists don’t like geoengineering because it seems too easy: 
Indeed. Suppose we found a technical solution that did not require an uprooting of all society, "climate justice," a federal takeover of this that and the other. (Nuclear power, GMO foods, green beaches, and wooly mammoths.) How would the Green New Dealers react? Thanks, problem solved, we'll go back to other things? I doubt it.

Most deeply
 it ignores the sins of humanity, for which we must atone. 
That is indeed much of the mood on the climate left -- and the reason all sorts of technocratic solutions are going nowhere politically.

Eli makes a brave ethical argument for his GMO wooly mammoths:
..our climate impact started much earlier, during the Paleolithic era, when we hunted megafauna to extinction and therefore altered critical ecosystems. .. But in fact, using genetic engineering to revive megafauna that we wiped out to restore ecoystems that benefit the climate also atones, if that is the right way of looking it at. Hunting these magnificent creatures to extinction was our original climate sin.
Good luck with that. Maybe we should instead charge the mammoth head on: just get past the atoning for sins business and get on with solving the carbon problem in the most effective way.

Letter 2 from Argentina

Alejandro Rodrigues writes again from Argentina (previous post)


"This  graph shows the evolution of peso denominated fixed income mutual funds. On Monday (after the elections) this funds suffered withdrawals of 6% of the total shares. Net assets fell by more as prices plummeted (-5%). On Tuesday, shares fell by 6% again but prices remained constant. On Monday, Money Market funds suffered withdrawals (drop in shares) of 16% although they didn't break the buck (on average). "

I gather from other discussions that Argentinians are trying to move assets fast to dollars. That is consistent with this drop in Peso denominated fund assets. (Though of course for every seller there is a buyer -- I wonder who the private parties (non funds) are that are buying Peso fixed income assets!)

There is an interesting dynamic here. The chance of a new regime with terrible economic policies rises. It causes a rush to dollars. People suspect that the new regime will impose capital controls.  The  government has trouble rolling over its own currency debt, as interest rates rise. That makes the fiscal situation worse.

In short, the chance of a bad government taking over can provoke a crisis that makes the chance of a bad government taking over larger. Or perhaps Argentines will break the usual electoral patterns.


The Reader's Guide to Optimal Monetary Policy

The Reader's Guide to Optimal Monetary Policy is a snazzy new website created by Anthony Diercks and Cole Langlois at the Federal Reserve Board.  Screenshot: 


Who said 2% inflation is a good idea? The graph shows publication date on the horizontal axis, the optimal inflation rate on the y axis, and the size of the circle is the number of citations. 

The sizeable number of dots around -4% reflect the "Friedman rule" idea. (Sadly, the graph doesn't include Friedman. It only goes back to 1990.) The idea here is that the nominal interest rate should be zero, so you earn the same on money as on bonds. Then there is no reason to economize on holding cash. Most of these were written when real rates were thought to be around 4%, so you need 4% deflation to get a nominal interest rate of zero. Ah, the good old days. 

More dots show up around zero. These are mostly "sticky price" models. Now there are costs to changing prices. So the economy works best when people don't have to change prices at all, 0% inflation.   

Note the paucity of papers at 2%, the Fed's inflation target. This is a nice testament to the honesty of  the Fed and its researchers.

The website allows you to graph many other issues, search for papers and so on. If you hover over a paper you get a great little two-sentence summary of the paper's main idea. If you click, you get the abstract and link to the paper. Have fun. Trigger warning: you may end up wasting a good deal of time. 

Monday, August 12, 2019

Whither the Fed?

Steve Williamson has an excellent long essay, "Is the Fed Doing Anything Right?" on the current state of monetary policy.

Why is the Fed lowering rates?

(If you're impatient, skip to the ** of the most interesting and provocative points)

Steve starts with an Ode to Rules. It would be nice if the Fed acted more stably and predictably, leaving less room for the interpretation that they're just changing their minds, or panicking, or giving in to Trump tweets.

So Steve phrases the question nicely: what has changed since last September, when the Fed seemed fully on a "normalization" path? What is the "data" in a "data-dependent" policy?
They decided (with a couple of dissents) to reduce the target range for the fed funds rate by 0.25% to 2.00-2.25%. That seems to represent a change of plan, since in September 2018, the median FOMC member was thinking that the fed funds rate by the end of 2019 would be 3%. So, something important must have changed since last September. What was it?
From the FOMC statement and Powell's presser after the meeting, it seems there were 5 things bothering the committee: 
1. Weak global growth.
2. Trade policy uncertainty.
3. Muted inflation.
4. The neutral rate of interest is down.
5. The natural rate of unemployment is down.
Go see Steve's graphs. There really is not much case that the US economy is slowing down.
Typically central banks lower interest rates in the face of observed decreases in aggregate economic activity - somewhere. But we haven't seen any such thing. Must be some very weird policy rule at work here.
That's a bit overstated. Central banks do react too forecasts. But most central banks, including ours, react cautiously knowing just how unreliable forecasts are.
 I can certainly understand that there's "trade policy uncertainty." More like "Trump uncertainty," I think. But that's been with us since January 2017. And for North America, which we could argue is more relevant for the US, the trade uncertainty is actually lower than it was in September. The USMCA was signed by Mexico, Canada, and the US on November 30, 2018, though it is as yet not ratified. Brexit anxiety is with us of course, but again that's nothing new. So, I think you have to be more specific if you want to make a general case about policy uncertainty. And what's the hurry? You can't wait for resolution?
The uncertainty work is interesting (a great recent example). But if uncertainty really is an economic problem, it should be reflected in today's investment, investment plans (a great measure) hiring, durables purchases stock prices, and other forward-looking measures. Moreover, it's not clear that the Fed should offset uncertainty as trade. They are "supply" shocks. (Previous post)

The one thing that has changed a bit is inflation.
.."muted" is as a good a word as any for that, relative to the 2% inflation target. The Fed's chosen measure - headline PCE - is at 1.4%, and stripping out food and energy gives us 1.6%. Not low, certainly, and well within what you might think is reasonable tolerance, but definitely below target.
But, putting Steve's point in stronger voice, , 0.4% variation in inflation over nearly a year is tiny in historical context, certainly not the sort of things that usually reverse a steady tightening project.

**

Here though, Steve's most interesting and provocative points start.
"But, suppose we thought that the only problem here is a slightly-below-target inflation rate. What would the corrective action be?"
...
The traditional answer, of course, is, lower interest rates.
and assuming there is a stable Phillips curve, everyone knows that lower nominal interest rates imply lower real interest rates in the short run. And lower real interest rates, as everyone knows, makes "aggregate demand" go up. Further, as everyone knows, output is demand-determined, so output therefore goes up. Then, by Phillips curve logic, inflation goes up.
But, as everyone knows, I think, there are issues with the Phillips curve. AOC knows it, and Jay Powell knows it, as we can see in this exchange
The exchange  is really good on both sides. Don't underestimate AOC. She rather brilliantly and knowledgeably led Powell down the road to admit the Phillips curve has died, so unemployment doesn't cause inflation any more. Then she smoothly went right to the (false) implication that any policy previously criticized as being inflationary will not cause inflation. She mentioned minimum wages, but green new deal, free college, medicare for all and a  fiscal blowout cannot be far behind. Powell didn't take the bait, but it's wiggling on the hook.

What about the Phillips curve? Inflation seems to have nothing to do with unemployment (or is it vice versa??) Japan and Europe, as well as our own 10 years of slow growth, seem testament to the falsity of the proposition that lower interest rates spark inflation.

Powell seems to be telling AOC what his staff told him, which is that the Phillips curve is currently very flat. The Phillips curve is still there though, or so Powell seems to think, though he seems a little confused about how the whole thing works. ... 
you can see that in the presser with Powell. The reporters are trying hard to understand what the Fed is up to, Powell is struggling to explain it, and everything is coming out muddled. For example, this exchange: [JC: I edited for clarity] 
MICHAEL MCKEE. ...How does cutting interest rates lower, or how does cutting interest rates keep that going since the cost of capital doesn’t seem to the issue here.= 
CHAIR POWELL. You know, I really think it does, and I think the evidence of my eyes tells me that our policy ... supports confidence, it supports economic activity, household and business confidence, and through channels that we understand. So, it will lower borrowing costs. ... since we noted our vigilance about the situation in June, you saw financial conditions move up...You see confidence, which had troughed in June....You see economic activity on a healthy basis. It just, it seems to work through confidence channels as well as the mechanical channels that you are talking about.
Steve comments scathingly:
Well, there's no confidence channel running from Powell to me, that's for sure.... Powell started off well when he was appointed. He opted for press conferences after every FOMC meeting, reduced the wordiness of FOMC statements, and generally seemed to be communicating well. But this decision makes clear what his limitations are. Powell is an attorney whose experience with monetary policy comes from sitting on the FOMC since 2011. You may think that puts you at the center of things. Sorry, it doesn't. There's a lot Powell doesn't know, and it shows.
True, a "confidence channel'' is something of a new idea, though quite common in central banking circles. We just need to give more and better speeches. All we have to fear is fear itself. But if one accepts an "uncertainty channel" certainly "confidence" can be interpreted as "belief in the Fed put," or other beliefs about future Fed policy.

I think Steve's personal attack on Powell is unwarranted.  Here and in other speeches I see someone who does a darn good job  of digesting fancy macroeconomics, and distinguishing the nuggets of wisdom from the craziness. Many (most) trained PhD economists are no better at steering the ship. You don't necessarily want a PhD hydrodynamicist at the wheel in a storm.

Most of all "There is a lot Powell doesn't know, and it shows" seems to me totally unwarranted. Just what is there to "know" about the Phillips curve? I would much rather have Powell's healthily acknowledged uncertainty than a PhD economist who thinks he or she "knows" how the Phillips curve really works.

(As a reminder, the Phillips curve is not standard economics. It is an empirical correlation that gained causal status by its repetition. Tight labor markets should coincide with higher real wages, wages higher than prices. But there is no natural logic that tight labor markets should coincide with higher wages and prices overall.)

Steve himself goes on to prove just how little anyone "knows" about the Phillips curve and the proper direction of policy right now:
So what's going on here? The Fed announced a normalization plan.. What's that mean? Normal means that short-term nominal interest rates are high enough to be consistent with 2% inflation over the long term. ... That's just the logic of Irving Fisher, which we all learned as undergrads. But, if the nominal interest rate is too low on average, then inflation will be too low, on average. That's abundantly obvious given the post-1995 Japanese experiment. Late last year, the FOMC was thinking that a normal fed funds rate is about 2.5-3.0%. I think that's about right. Basically, they aborted normalization. And, if the FOMC thinks an important goal is hitting 2% inflation, it should have kept its target fed funds rate range constant, or moved it up. [My emphasis]
Steve acknowledges here participation in the great neo-Fisherian heresy, which I flirt with as well. The equations of our best models scream it. Japan and Europe scream it, and their comparison with the US.

Maybe yes, maybe no. But Neo-Fisherians have no business criticizing the Fed chair for uncertainty and a bit of muddiness about how the Phillips curve works, or how interest rates affect inflation!

Steve goes on to discuss the end of QE and IOER, with interesting facts. The "floor system" does seem to be falling apart. I think the answer is simple: if you want to peg rates, peg rates: offer anyone to deposit at 2.00%, and offer anyone to borrow (with treasury collateral) at 2.25%. The Fed wants only the former, to limit quantities, and to offer different rates to different institutions according to their favor with the Fed. All a topic for another day.

Letter from Argentina

My friend Alejandro Rodriguez, at Universidad del CEMA, sends the following report:
Oops we did it again. Macri (the current president) lost in the open primary elections (all parties present their candidates in an open  general election so it is like a very big poll). The formula Alberto Fernandez- Cristina Fernandez (the ex president who ruled between 2007 and 2015 is the candidate to vice president) is expected to win in October. 
The peso is falling like a rock (down 25%) and interest rates are up by 1000 bps. The Central Bank has to 1.3 trillion ARS (22 billion USD at the current FX) in short term debt (all expires in the next 5 days). Today it has to roll 250 billion ARS and in the first round it only managed to roll 14 billion ARS. Argentine. 
Argentina stocks in NY are down 50% to 60% and President Macri will adress the nation at 16:30 local time. The Central Bank has a lot of internatinal reserves (over 60 billion USD) but nearly 1/4 are the counterpart of dollar deposits at commercial banks. The remaining reserves are mostly borrowed from the IMF and China... We can surely screw over the IMF but I don't think that messing up with the Chinese is a smart move... so nobody knows how much fire power the Central Bank has to hold the FX. I don't know what can be done to stop a major currency crisis which might in turn into a debt crisis (if we are not in one already).

Wednesday, August 7, 2019

Trade and the Fed


Nina Karnaukh of Ohio State sent along this lovely graph of the 6 month Fed Funds futures around the beginning of August. Read this as the market's guess about what is happening to the Federal Funds rate over the next 6 months.

The first drop in price occurs with the FOMC announcement 2 PM July 31. The price drop is equivalent to a a rise in expected future interest rates of about 5 basis points or 0.05%. This has been read as market disappointment that the Fed did not signal more future rate cuts.

The subsequent price spike is this,


That statement caused a 10 bps rise in price, i.e. decline in expected interest rate.  The natural interpretation: The markets expect the  Fed to lower rates in a trade war, either directly or in response to the economic damage the trade war will cause.

I had read the Fed's recent actions as just a case of late expansion jitters, perhaps with a mild response  to slightly lowered inflation. But this is clear evidence that the market sees the Fed reacting to trade news.

************

Should central banks offset trade wars? I think this is a question nobody is asking but it needs to be asked. Central banks including the US Fed and ECB seem to take for granted that any reduction in economic activity demands "stimulus" to offset it. But stimulus can only provide "aggregate demand." What if the problem is "aggregate supply" -- an economy humming along at full demand, and then someone throws a wrench in the works, be it a trade war, a bad tax code, or a regulatory onslaught? (I'll stop using quotes, to signal my dislike for these terms.)

Conventional wisdom ways that central banks should not offset reductions in aggregate supply. You can fight a lack of aggregate demand, but monetary policy cannot fight a decline in aggregate supply. The first job of a central bank should be to distinguish demand from supply shocks, so it can react to the former, but not to the latter.  This standard wisdom emanates from the 1970s, where central banks kept rates low to offset the effects of oil price shocks -- supply shocks -- and ended up producing worse recessions and inflation.

Yet expressing this view at central banks these days, people stare at me with blank expressions. Distinguish... supply... from... demand... shocks....why would we do that? The view from about 1960s Keynesianism that all fluctuations in output, employment and prices come from demand, seems to have flowered again.

Now, in this conventional (i.e. 1980 Keynesianism vs 1965 Keynesianism) view the problem with offsetting a "supply" shock is that the monetary stimulus causes inflation. And now we have inflation once again drifting slightly lower. So perhaps the trade war is a "demand" shock? It's hard to see how though.

More plausibly, perhaps the policy uncertainty about the trade war is causing a decline in "demand." Why build a factory if any day now another tweet  could render it unprofitable? The prospect of a trade war -- or the kind of serious political and trade turmoil that would follow Tianamen II in Hong Kong -- is a "confidence" shock. But the uncertainty is genuine. A rise in risk premium in an uncertain environment is genuine. People should hold off building factories that depend on a Chinese supply chain until we know if there is going to be a trade war. Unless the Fed is stepping more and more into the role of psychologist in chief, to decree that such fears are irrational, it's not obvious that the Fed should try to goose investment by artificially lowering the short term rate in response to a  rise in trade fears.

A second possibility arises from more 1980s economics. A "supply" or productivity shock also lowers the expected return on investment. So the real  interest rate should decline in response to such a shock. That is another reason perhaps for some interest rate decline in response to a negative supply shock. But how much? This still does not justify the same response to all sources of output decline, or (in our case) fear of output decline that has not happened yet.

The other possibility is that the Fed is now watching the exchange rate, as most other central banks do. The one thing that still does seem to work is that raising interest rates raises the value of the currency. The trade war raises the value of the dollar, and the US clearly wants to manipulate the dollar back down again.