Monday, November 2, 2020

Sumner review of Strategies for Monetary Policy

Scott Sumner posted an excellent  Review of Strategies for Monetary Policy (Book information and, yes free pdfs here). By "excellent," I don't mean he agrees with everything, especially that I wrote! He read the whole thing, including comments, and provides a concise summary along with insightful critique. I won't try to summarize his summary -- it's all good. 

The book summarizes last year's conference on monetary policy at Hoover, which focused on the Fed and ECB policy reviews. This year's analogue is unfolding via zoom,  and has had a really interesting set of papers and discussions. More coverage will follow.  


  1. Lovely, of course, but not everything ... .

    E.g. "This might include eliminating large denomination currency notes ($50 and $100 bills), and imposing increasingly steep fees on the withdrawal or deposit of large currency hoards."

    Oh, hell, just abolish money altogether!

    1. It's lovely to theorize about it, but actually doing it would be awful (and Sumner is *far from* advocating it).

    2. Trick is knowing where to stop. :-)

    3. Frank,

      "This is why economists like Lilley and Rogoff are so obsessed with currency."

      Okay. You might want to throw short time demand deposits, short term bonds, and other highly liquid assets into the mix of money alternatives.

      "Unless something can be done to prevent massive currency hoarding, it is hard to see how the government can drive interest rates low enough to stimulate the economy in a major recession."

      Incorrect. It is not that hard to see how a government can lower the AFTER TAX cost of debt service by selling tax breaks (equity) with a rate of return and a duration.

      Private (pre-tax) cost of borrowing for 30 years is 3% nominal. Federal government sells 30 year tax break with a rate of return of 5%, 10%, 20% (pick a number). Private (after-tax) cost of borrowing for 30 years is as negative as you want to go (-2%, -10%, -20%, etc.).

  2. Reading this overview makes me lose all hope for the future. And I know many people who feel the same way.

    Virtually everybody in the central banking world seems prepared to do almost everything to debase the currency and raise the cost of living for everybody. Wage earners be damned, especially the lower 50%, who have limited wage bargaining power due to globalisation etc.

    Prudent savers nowadays get vilified as evil "cash hoarders" that have to be fought tooth and nail. They have been raped with negative real rates for a decade now.

    Can't central bankers understand that there are legitimate reasons to save? (old age etc). Is it a good idea to force people with limited ability to take risk at this stage in their lives into a vastly overvalued stockmarket, or low grade debt that pays a yield below the real rise of the cost of living, and could easily be defaulted on? Or throw your money into the property bubble? Not everybody can afford to risk losing 50% of their lifetime savings. Or do we now need to trust that the central banks are going to backstop all risks forever?

    Regarding central banks missing "inflation" targets, I have a suggestion. Why not change the inflation basket to better reflect actual cost of living increases? You know, reflecting the stuff you actually need, like healthcare, housing etc. Interest rates can then be increased to a rate way above the zero bound.

    Seriously. I know many people who are desperate now. They feel cornered. They worked hard and saved prudently. Now they experience massive cost of living increases that are not acknowledged by central banks. They see their nest egg being confiscated by negative real rates. What can they do? Cut even more expenses and pray...? Have central banks factored this into their models?

    1. Pushing on a string, regardless of how flaccid or taut it is. There's no crystal ball, even if CB magicians try to conjure them up.

    2. YuShan,

      "Can't central bankers understand that there are legitimate reasons to save?"

      I am sure they understand it very well, but here is the issue - the central bank can't force anyone (including the federal government) to borrow at a positive real interest rate. For any saver that wants a positive real return, there must be a borrower at that same positive real interest rate.

      The one thing that can be done (on a fiscal level) is for the federal government to sell discounted tax breaks (equity) to the public.

      On a first order level, this reduces the total quantity of outstanding public debt - meaning the same amount of tax revenue pays a higher interest rate on less debt.

      On a second order level, this reduces the after tax cost of servicing debt in the private sector for individuals / businesses who buy the tax breaks.

      But instead of selling tax breaks through the Treasury department, the Congress prefers to give them away to favored constituencies or worse, use tax penalties (for instance Biden's various tax penalties).

    3. FRestly,

      "the central bank can't force anyone (including the federal government) to borrow at a positive real interest rate"

      The central bank can set the rate for overnight funds at about the rate of inflation. The bond yields are then set by the market based on demand / supply.

    4. YuShan,

      The central bank can't force anyone to borrow overnight funds at any interest rate.

      This is the part that is missing from the Taylor rule - what effect does the interest rate have on the supply and demand for loans?

      The bond yield is set by agreement between the borrower and lender before it ever reaches the secondary market.

      You are missing the intermediate step - for a bond to exist, someone must borrow.

      If you want positive real interest rate debt, there is nothing stopping you from borrowing at a positive real interest rate.

    5. YuShan,

      You seem to be of the opinion that if the central bank raised the overnight funds rate, marginal buyers of bonds would be pushed out of the market forcing yields on existing bonds higher / prices lower.

      Instead what can happen is that the existing bonds being held become illiquid - an institution holding the bonds can't sell them without taking a loss, so they don't sell them.

      It's called an inverted yield curve.

  3. I would suggest the Fed focus on NGDP. People that are not economists think in nominal terms.
    2.If economists are worried about the Fed losing its independence, the fastest way for that to happen would be for a regime of negative interests; and particularly so if they steep and not of a very short duration.
    3. Am not sure why more attention not paid to real interest rates which many economists have been saying have been on the decline for quite some time. Seems to me they being low for quite some time says more about growth/investment and why monetary policy has been ineffective.
    4. Yes, IOER, etc. have been issues but not sure they just of marginal impact
    I still think of the Fisher equation and "playing" around with it in terms of what it suggests via real rates for real growth
    Right now seems to me the long term outlook given where real rates are is that real growth expected to be quite low and hence do not think monetary policy of any kind to be all that effective. Thoughts JC ?

  4. The review provides an interesting perspective on monetary policy. The principal points refer to the unobservable 'natural (neutral) rate of interest' and the 'natural rate of unemployment'. The Taylor Rule, and its variants, depend on estimates of those two 'natural' rates for its validity. If, as Dr. Sumner points out, those parameters are not in fact parameters but are variables, then the Taylor Rule must estimate two additional state variables in addition to the variables it currently estimates.

    The inflation target of 2% is an arbitrary measure. The Fed seems now to be of the opinion that this target is an absolute measure. Missing the target of 2% annual inflation is now to be 'compensated' for by pursuing a higher target rate of inflation for a period of time in order to achieve an 'average' rate of inflation equal to 2% per annum. The longer the actual (reported) rate of inflation stays below 2%, the higher the 'compensating' target of inflation must be to achieve an average of 2% per annum within the 'compensating period' (i.e., the allowed time increment to restore the economy to the control set point, 2% per annum). What isn't explained by the Fed is how it will attain this higher 'compensating' rate of inflation if it can't even now attain the targetted rate of inflation. Neo-Fisherism would likely say that if the Fed seeks a higher rate of inflation, raise the rate of interest. The Taylor Rule, on the other hand, states that if the Fed seeks a higher rate of inflation, reduce the rate of interest. Can both be right simultaneously?

    Is there anything unique about the target rate of inflation of 2% per annum? This question was not addressed by Dr. Sumner's review or by the "Strategies...". Perhaps a subtle change in the definition of the target is in order. One might be bold enough to suggest that the target be made into a range, and that the range be 0%-2% per annum. In this manner, two problems are addressed: (i) price stability, and (ii) inability of the Fed to attain the 2% target. At 0% inflation, a 1960s dollar buys what a 2020s dollar buys and vice versa, i.e., purchasing power is at parity across time. "If you can't beat 'em, then join 'em", is a doctrine for survival--perhaps the Fed should acknowledge that which is increasingly seen to be self-evident. In this move to a 0%-2% target range, the Fed can argue that it is increasing 'price stability' measures while at the same time reducing instability risk by avoiding arbitrary measures to compensate for its failure to achieve what is unachievable.

    Nominal GDP targetting is bandied about. What is it, and how does it improve the Fed's game? Let nY be nominal GDP, and let P be the current price level aggregate index. Then Y, real GDP, is nY/P. If Y is a measure of underlying economic productivity (real value added at price parity across time), then the growth rate of nominal GDP is given by dY/Y plus dP/P. If dY/Y = 0 in a period, then to achieve the targetted growth rate of nominal GDP, the rate of inflation must be increased. From the relation, dnY/nY = dY/Y + dP/P, with dY/Y=0, dnY/nY = dP/P. For targetted nominal GDP to work, the Fed has to coordinate monetary policy with the Administration and the Legislatures. How likely is it that the Fed would be able to maintain even a modicum of 'independence' under such a regimen?

    1. 2% inflation target is healthy enough to ward off the specter of deflation. Its recent symmetrical 2% target may happen if inflation gurus really think it's on the way with all the cash being pumped into markets via creative mechanisms. Also a 2% ex ante target is healthy enough to spur consistent consumption, too. Now if only demand wasn't suppressed. Not an AD issue.

    2. Old Eagle Eye,

      "For targetted nominal GDP to work, the Fed has to coordinate monetary policy with the Administration and the Legislatures. How likely is it that the Fed would be able to maintain even a modicum of 'independence' under such a regimen?"

      They wouldn't and maybe that's the ultimate objective. Whether the Fed actually succeeds in hitting it's nominal GDP target is immaterial to the goal of placing monetary policy in the hands of politicians.


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