Scott Sumner  

More really good news

Reply to Kevin Drum... Superforecasting on Epi...

I recently pointed out that Fed officials are becoming more receptive to the market monetarist proposal for negative interest on reserves. Today there is more progress, on an even more important front. First let me provide a bit of background information. Back in late 2008 and early 2009 I argued that monetary policy was extremely tight, despite low interest rates. Most people scoffed at that claim, they'd say, "everyone knows monetary policy is highly accommodative."

A new press report (sent to me by Michael Jurka) suggests that even the Fed is coming around to the market monetarist view that low interest rates don't mean easy money:

Among the biggest questions for financial markets this year has been when the Fed would finally move away from stimulative, ultralow interest rate targets.

But what if those ultralow targets aren't actually stimulative at all? What if, instead, the Fed's current policies are actually contractionary?

That's the surprising case made by a recent paper from the San Francisco Federal Reserve.

"Monetary conditions remain relatively tight despite the near-zero federal funds rate, which in turn is keeping economic activity below potential and inflation below target," writes economist Vasco Curdia.

The insight centers around the concept of a natural rate of interest. This is the hypothetical interest rate at which money would be lent and borrowed in equilibrium, leading the economy to neither grow nor shrink. If actual interest rates are above this natural (or neutral) rate, then less money will be lent out than otherwise might be, leading economic growth to slow. Conversely, if actual interest rates are below this neutral rate, then economic expansion should result.

Seen in this context, we cannot determine whether Federal Reserve policy is expansionary simply by comparing the current federal funds rate target to historical norms. Instead, interest rate targets must be compared to that current neutral interest rate.

And according to Curdia, the neutral rate is currently below zero. Actually, he says it is currently at negative 2.1 percent, in contrast to a long-run level of 2.1 percent. If he's correct, the direct implication is that right now, even a federal funds rate target of 0 percent to 0.25 percent is high enough to slow down the economy rather than contribute to expansion.

. . .

Neil Azous of Rareview Macro points out that Curdia has worked closely with Michael Woodford, "who is widely considered to be the strongest consultant to the Federal Reserve for quite some time, and he's sort of the backbone to modern monetary policy." Further, the San Francisco Fed is "the academic arm of the entire system, and Janet Yellen came from the San Francisco Fed, so it's given additional credence."

When the paper is placed alongside recent dovish commentary from Fed Govs. Daniel Tarullo and Lael Brainard, "we have to acknowledge that the medium-term drivers of policy are shifting," Azous wrote Wednesday. Indeed, the market no longer believes that a rate hike is the base-case scenario this year, placing the chance of a move by December at just 33 percent, according to CME Group's Fed Watch tool.

This is a huge development, suggesting that market monetarism is going increasingly mainstream.

And as if that isn't enough, over at TheMoneyIllusion I have a new post that quotes some surprisingly thoughtful remarks from a key ECB official. And after posting those comments, someone sent me an additional constructive statement from another ECB official:

New instruments are needed to boost growth and inflation in the euro zone, European Central Bank policymaker Ewald Nowotny said on Thursday, suggesting it may be beyond the ECB to achieve its goals using its existing toolkit.

The bloc's economy is slowing again, with even powerhouse Germany seeing a recent string of poor data, while inflation has returned to negative territory and the euro is uncomfortably strong. That raises pressure on the ECB to make good its promise to expand or extend its trillion-euro-plus asset purchase programme if needed.

"We're clearly missing our target," ECB Governing Council member Nowotny said on Thursday. "The ECB is using monetary policy instruments available but in my view it's quite obvious that ... additional sets of instruments are necessary."

Before considering new targets they should increase the pace of monthly QE, and also sharply reduce the interest rate on reserves, which is already slightly negative. Then the ECB needs to consider switching to level targeting. Perhaps a low inflation rate, such as 1.5%, level targeting, would be a good compromise figure, acceptable to the Germans.

Again, I am seeing a rapid global sea change in the consensus view of monetary policy; people are beginning to understand the old regime isn't working. This is exceedingly good news.

Comments and Sharing

COMMENTS (22 to date)
TallDave writes:

Great news. Saw another estimate at -2.5%, apparently this is a hot topic recently.

Buy more Treasuries, Fed. The $77B returned to Congress in 2014 just gets bigger until they hit targeted inflation. No downside.

MikeP writes:
[The natural rate of interest] is the hypothetical interest rate at which money would be lent and borrowed in equilibrium, leading the economy to neither grow nor shrink.

Please please tell me this is a reporter who doesn't understand economics rather than what a Fed economist actually believes.

Justin D writes:

This is all well and good, but the Fed should simply be able to see 5 year inflation break evens showing market expectations of inflation running far below target to know that policy is tight.

Writing a paper on the hypothetical natural rate of interest (with a multiple percentage point range no less) is like taking the freeway to get to your neighbor's house.

Michael Byrnes writes:

I think you can add Lael Brainard's recent policy bomb to the list.

Dan W. writes:

The S&P is up 20% the past two years and money is "tight"? I think someone is reading wrong the state of the economy. But who?

Dan W. writes:

2015 Federal Tax receipts at an all-time high, up 7.6% from the previous year. Does this type of thing happen when money is too "tight"?

Scott Sumner writes:

Dan, The best way to think of easy and tight is relative to the policy stance required to hit the Fed's policy targets.

CMA writes:

"A 4% inflation target would greatly reduce base money demand, and there is plenty of base money in circulation. If you prefer, it would sharply boost base velocity."

Doesn't the fed lack the credibility to move inflation expectations just by increasing the target to 4%? It would have to conduct OMP's.

Bob Murphy writes:

Scott, I don't see that paper as a boon for Market Monetarism. Isn't that identical to the liquidity trap analysis Krugman was blogging as far back as 2009? He would draw the supply and demand curves and--oops!--they intersected below a 0% nominal interest rate.

That seems like what the quoted portions are saying. Is the rest of the paper more Market Monetarist than Keynesian?

B Cole writes:

BTW, if the GOP wins the White House, the "Fed is tight" view will become tolerated in right-wing circles.

Scott Sumner writes:

CMA, If you target TIPS spreads at 4%, then the credibility is there. The only remaining question is how much base money the public wants to hold.

James writes:

Whatever the merits of "market monaterism" I think the name probably holds it back. It sounds too conservative and yet it would probably offend many conservatives as well.

Left wing types will distrust anything called "market" and they will regard "monetarism" as a decades old right wing reaction to a decades old version of Keynesian macroeconomics. I suspect a lot of people would associate it with Reagan, Thatcher and Friedman with reactions varying from lukewarm to icy.

Right wing types will recoil at the use of the word "market" as well because it looks like false advertising akin to the Obamacare "marketplace." Having a committee of economists picking a target NGDP and using a NGDP futures market to see if they are hiting their target is no more "market" than the current approach of having a committee of economists picking a target interest rate and using the overnight interbank market to see if they are hitting their target.

Elwailly writes:

Great news! We'll get there. Imagine all the Phd dissertations that will come of this in 50 years. :-)

Elwailly writes:


I'm pretty left wing and don't mind Market Monetarism.

Rational Monetarism would have sounded better tho.

CMA writes:

"If you target TIPS spreads at 4%, then the credibility is there."

I don't understand how? Can someone expand on this?

Rob in London writes:

Interested to get your thoughts on Dudley vs Taylor in this recent brookings discussion.

Policy analysis aside, Dudley didn't come off well.

TallDave writes:

James -- NGPLT seems to be a much harder sell to the right, which is actively hostile to expansionary monetary policy, than to the left, which merely prefers fiscal expansion.

"Market" is accurate though, because it takes the tea leaves out of the Fed's hands and instead lets markets decide what they think NGDP growth looks like with the Fed merely reacting in predictable ways through OMOs.

ThomasH writes:

I'm certainly happy that more coming to the position that the "old regime" is not working.

I'm less sure that implies coming to the the MM position if that means targeting the price of an NGDP futures contract or even the TIPS in the sense of having that as both the target and a rule to buy or sell whatever is necessary in whatever quantities is necessary to keep the indicator exactly on target.

The change may just be in abandoning the idea that the Fed has to raise interest rates because a bunch of people have been griping about "low" rates for a long time or that "low" rates are leading toward some vague future financial disaster (that the Fed would not be able to prevent.) Waiting to raise rates until inflation actually hits or is about to hit the 2% ceiling, a big improvement over current Fed thinking, is not, I'm sure Scott will agree, MM.

This is not to deny the great work Scott has done in undermine the "old regime."

Scott Sumner writes:

Bob, Yes, that part is the same. The new part is the claim that this implies monetary policy is actually quite contractionary. That's what I claimed in 2009, and almost no one else accepted that claim. If policy was contractionary in 2008-09, then that suggests that tight money might well have caused the Great Recession.

James, You are confusing interest rate targets and NGDP targets. Even though the term 'target' is used in both cases, the term has a totally different meaning when referring to an instrument target and a policy goal. So your comment actually doesn't make sense.

Interest rate targeting is a technique that can be sued to hit an inflation or NGDP target.

I would have preferred "post-monetarism"

CMA, If TIPS spreads are 4%, then that suggests the market expects 4% inflation.

Talldave, Over the years many conservative economists have favored NGDP targeting. I think some people confuse conservatives on the internet (who are often extremists) with conservatives in government, academia and the media, who hold the power. For instance radical Austrianism (not Hayekian Austrianism) is a big deal on the internet, but almost invisible elsewhere. It's a fringe movement in the centers of power, like post-Keynesianism.

Thomas, A very BIG part of market monetarism is the claim that low rates don't mean easy money.

TallDave writes:

Scott -- I was actually thinking of the political leadership and the voting public. This is probably still an accurate picture.

James writes:


I appreciate that currently the Fed targets one variable (interest) in attempts to affect policy goals which are measured in other variables (unemployment, inflation & output). If my observation doesn't make sense to you then this is a property of your background assumptions, not my comment.

To understand, please recognize that the difference between market monetarism and the status quo is far less important than their commonality: Having a commitee of economists set a target is absolutely essential to both options. The word "market" is not appropriate to any policy which depends on economists to pick a target, no matter the specific variable. To be clear, this is not a substantive critique. I'm only taking exception to your branding here.

By the way, is there a reason why you don't propose a compromise where the Fed keeps the dual mandate but adopt a multivarate target that is strongly linked to the current policy goal? If there were futures markets in inflation and unemployment, the Fed could use the prices in those markets to minimize a quadratic loss function of the differences between the futures prices and the policy goals.

TallDave writes:

James -- there is no sovereign monetary policy that does not involve some committee setting some target. The idealized implementation of market monetarism envisions the Fed creating a market for NGDP futures and letting markets determine the level by buying or selling against the target to increase or decrease money supply -- in this scenario, there is no constant obsessing over what the Fed will do in response to economic conditions, because those conditions are already baked into NGDP.

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