Economics, Monetary Policy, Pethokoukis

5 market monetarism-QE questions in 5 days (Part 3): ‘Why no inflation?’

Image Credit: jaci starkey (Flickr) CC

Image Credit: jaci starkey (Flickr) CC

Most folks who identify as market monetarists have been in favor of the Fed’s bond-buying, or “quantitative easing,” program. They don’t think it’s been executed perfectly, however. If the Fed’s actions had been accompanied by a stated intention to target the level of nominal GDP, there’s a strong case that QE could have been far smaller yet far more effective. Still, as I write in my new National Review column, QE has likely helped the economy and thus been worth doing.

Every day this week, I will present answers to some common QE criticisms from a market monetarist perspective. 

Question #1 on Monday: “QE is doing nothing since banks are just sitting on the money. Look at the huge increase in excess reserves! What’s the point? How is this boosting growth, exactly?”

Question #2 on Tuesday: “Maybe the Fed is having a positive economic impact, but isn’t it just a sugar high, papering over or propping up a bad economy with easy money?”

Here is #3:

Why hasn’t QE been inflationary?

Scott Sumner, economist at Bentley University and blogger at The Money Illusion:

 It hasn’t been inflationary because demand has been rising very slowly (NGDP).  In addition, the economy is currently depressed so when demand does rise it mostly leads to more real GDP.  The reason demand has not risen faster is that with interest rates low, and the Fed paying interest on reserves (big mistake) banks have more incentive to sit on the extra reserves..

Michael Darda, chief economist at MKM Partners:

The Fed has boosted the supply of [the monetary base] dramatically but there’s a very high demand for base when rates are low or expectations of future growth and inflation are subdued.

David Beckworth, economist at Western Kentucky University and blogger at Macro and Other Market Musings:

Because liquidity or money demand remains so elevated. The Fed could quadruple the size of its balance sheet and have no effect on inflation if money demand quadrupled.

Josh Hendrickson, economist at the University of Mississippi and blogger at The Everyday Economist:

First, I would argue that QE has been inflationary to some extent as it has caused inflation to rise back to the Fed’s target from where it was during 2008.  Second, if people like Scott, David, and I are correct that there is an excess demand for money problem, then a successful QE policy shouldn’t cause inflation.  Inflation is caused by an excess supply of money.  If there is an increase in the demand for money and the Federal Reserve does nothing, we should expect disinflation if not deflation.  On the other hand, if the Fed was to increase the money supply in conjunction with the increase in money demand, then inflation should remain relatively constant.

 

Pethokoukis, Economics, Taxes and Spending

‘Our 60% probability that the U.S. will not enter into technical default is based on nothing more than blind faith’

Credit: The Washington Post

Credit: The Washington Post

“The path forward on the debt ceiling remains a total mystery and our 60% probability that the U.S. will not enter into technical default scenarios is based on nothing more than blind faith.”

Some more alarming commentary from Chris Krueger, political analyst with Guggenheim Washington Research Group, who sees — do the math — a 40% chance of a technical default. A few thoughts:

1. Here’s your trouble: The White House strategy is a) don’t negotiate, b) don’t blink, c) remember not to negotiate or blink. The GOP, on the other hand, doesn’t really have a plan and is far from unified on what they want to get from Obama — Keystone pipeline, entitlement reform, tax reform — or how exactly the battle should play out. Who is going to blink?

2. A “technical default” refers to a temporary delay in US debt interest payments. During the last debt ceiling crisis, legendary investor Stanley Druckenmiller raised eyebrows when he told The Wall Street Journal: “I think technical default would be horrible, but I don’t think it’s going to be the end of the world.”

3. A technical default would not be good. As JPMorgan said back in 2011: “Any delay in making a coupon or principal payment by Treasury would almost certainly have large systemic effects with long-term adverse consequences for Treasury finances and the US economy.”

4. Among those potential nasty “effects”:  a) a run on money market funds, b) new reluctance by foreigners to hold US federal debt causing interest rates to spike, c) at least a 1% hit to GDP growth.

5. Bond investors are not a forgiving lot. In 1979, a word processor issue caused a check issuing problem which resulted in the US Treasury failing to pay $120 million to investors holding maturing debt. This was not a default, merely delay. From the Daily Telegraph:

 A much-referenced academic paper, The Day the United States Defaulted on Treasury Bills, says the result of the technical default was a “one-time, permanent ratchet upward of yields” – the rates of return demanded by investors to hold the US’s debt. … The authors calculated the ultimate impact was a 0.6 percentage point rise in the interest rates the US government had to pay on its debt. While that sounds tiny, that would signal that a $120m mistake – paltry compared to the total government debt even then – meant the US had to pay billions more each year in interest. The US public may also have taken a more direct hit. Since yields on government debt and interest rates within the wider economy tend to move together, the professors have argued the pick-up in yields contributed to the painful interest rates the US faced in the Eighties.

Pethokoukis

Ba-Boom! Suddenly investors think the US more likely to default on its debt

Credit: The Washington Post

Credit: The Washington Post

As this chart (via Jim Tankersley of The Washington Post) shows, investors have suddenly become more worried about the soundness of US debt. Recall from yesterday these words from a research note by Chris Krueger, ace political analyst at Guggenheim Partners’s Washington Research Group:

There is no evidence to suggest that the debt ceiling will be raised in time.

Pethokoukis

So what exactly is driving the increase in food stamp spending?

Cutting food-stamp spending wouldn’t be my top policy choice right now. But separate from that is the issue of what has driven the more than doubling of Supplemental Nutrition Assistance Program spending over the past six years.

Looking first at enrollment, researchers Peter Ganong and Jeffrey Liebman find that state adoption of relaxed income and asset limits and automatic waivers of time limits raised enrollment by 3 million between 2007 and 2011 out of roughly 19 million new enrollees, or 18%. People who previously would not have been eligible became eligible. And what about the other 16 million? Unemployment raises SNAP spending by increasing the number of people who are eligible and increasing need among eligibles. Ganong and Liebman determine that one-third of that 16 million jump is attributable to increases in the number of eligible individuals (holding program rules fixed), and two-thirds is attributable to increases in the take-up rate.

But what about SNAP paying fatter benefits to enrollees? Economist Casey Mulligan finds that new benefit formulas “would have increased SNAP spending more than 25 percent even without any new enrollment.”

But of course there was new enrollment. So what share of increased total spending from 2007 to 2011 was caused by a) more generous benefit formulas and more inclusive eligibility rules, and what share was caused by b) a depressed economy increasing the number of eligible individuals and need (the take-up rate)? Milligan calculates it thusly (spending is in 2007 dollars per American per year and spread over all Americans):

Credit: The New York Times

Credit: The New York Times

The total increase is $112 per person per year. Part, but not all, of the $112 can be attributed to more generous benefit formulas and more inclusive eligibility rules. That part is shown in red. My estimates say that, without a depressed economy, inflation-adjusted SNAP spending per capita would have increased $77 because SNAP rules changed. Using the enrollment estimates of Mr. Ganong and Professor Liebman together with the changes in benefit formulas suggests the increase would have been $53.

Mulligan’s bottom line: Most of the SNAP spending growth from 2007 through 2011 was due to more generous benefit formulas and looser eligibility requirements. On the other hand, a slight majority of SNAP participation growth was the economy rather than new rules expanding eligibility.

 

Economics, Monetary Policy, Pethokoukis

Market monetarism and quantitative easing: 5 questions in 5 days (Part 2)

Image Credit: jaci starkey (Flickr) CC

Image Credit: jaci starkey (Flickr) CC

Most folks who identify as market monetarists have been in favor of the Fed’s bond-buying, or “quantitative easing,” program. They don’t think it’s been executed perfectly, however. If the Fed’s actions had been accompanied by a stated intention to target the level of nominal GDP, there’s a strong case that QE could have been far smaller yet far more effective. Still, as I write in my new National Review column, QE has likely helped the economy and thus been worth doing.

Every day this week, I will present answers to some common QE criticisms from a market monetarist perspective. Question #1 was Monday. Here is #2:

Maybe the Fed is having a positive economic impact, but isn’t it just a sugar high, papering over or propping up a bad economy with easy money? Even the hint of pulling back on QE causes markets to tank. That can’t be healthy.

Scott Sumner, economist at Bentley University and blogger at The Money Illusion:

If it were causing a sugar high, it would be leading to high inflation, but it isn’t.  When the economy is depressed, higher nominal spending will tend to boost RGDP.  The main problem in the US economy is too little demand, too little nominal spending.  Monetary policy cannot fix many problems, but one problem it can fix is too little demand.

Michael Darda, chief economist at MKM Partners:

If nominal GDP is growing at a slow rate (too slow) and inflation is low (perhaps too low), by definition, there’s no sugar high. Yes, equities have responded to the Fed’s QEs. But that’s not the whole story since profits have grown significantly during his cycle even though output and employment (so far) have grown slowly. Moreover, expectations of Fed tapering were fully in the market before the September Fed meeting, with stocks close to cycle highs.

David Beckworth, economist at Western Kentucky University and blogger at Macro and Other Market Musings:

Again, the Fed is buying a lot of treasuries but relative to the total stock it is not holding much more than it did during the pre-crisis. Similarly, the amount of monetary base it is creating is modest compared to the demand for it. In other words, if the Fed were truly creating too much monetary base relative to the demand for it, we would be seeing inflation expectations taking off and interest rates rapidly rising. All of this means the Fed has not been adding that much stimulus relative to the slump state of the economy.

Recall that unemployment is still elevated and the economy is operating below potential.  The US economy is still weak, sick, and lethargic. And just like giving a  weak, sick, and lethargic person given a sugar shot really wouldn’t make much difference the same is true for the US economy now. Sugar highs really do something (in a pejorative manner) when the economy is healthy and running a full capacity. That is when distortions on a large scale emerge. Another way of saying this is that sugar highs come when the Fed lowers its target interest rate below the natural or neutral interest rate level. Right now, this is not the case. It is more plausible the opposite is true: market interest rates are above the natural interest rate.

Josh Hendrickson, economist at the University of Mississippi and blogger at The Everyday Economist:

 I think that this “sugar high” view of policy comes from the experience of stop-go monetary policy that Milton Friedman highlighted throughout his career. Historically, the Federal Reserve has tended to overreact to fluctuations in the economy and fail to take into account the various leads and lags associated with monetary policy.
What would basically happen is that the Fed would see rising unemployment, for example, and decide to conduct expansionary monetary policy. After a few months, they would continue to expand because of the little observed improvement in unemployment. Unemployment would begin to decline, but inflation would start to rise substantially and the Fed would immediately reverse course  to lower inflation.
However, due to the lag in policy, they would continue to contract until they saw changes in the inflation rate.  By failing to take into account the lags of policy, they would tend to overreact to their indicators thereby generating wild swings in the monetary aggregates and ultimately, nominal income and real economic activity.
This experience seemed to create the view that all monetary policy does is create a “sugar high”, a temporary improvement in the economy followed by a quick contraction.  In reality, the “high” of this scenario was the over-expansionary policy and the “crash” was over-contractionary policy. This is not an inherent feature of monetary policy.  It is an inherent feature of bad monetary policy.
Pethokoukis

Who really lost the recovery? A second look at America’s stagnant new normal

Credit: Michael Bordo

Credit: Michael Bordo

Here’s how the business cycle is supposed to work: the worse a recession, the stronger the recovery. Like plucking on string attached to an upward sloping board was Milton Friedman’s famous analogy. After the nasty 1981-82 recession, it took just five quarters for economic growth to return to prerecession trend.

The Obama recovery has been far weaker. Now 52 months into the expansion and there’s still a huge output gap as growth has averaged just over 2% since mid-2009. Democrats say the president is a victim of circumstance, pointing to research suggesting recessions accompanied by financial crises produce unusually weak recoveries. But this recovery, notes Rutgers University and former Federal Reserve economist Michael Bordo, is slower than every preceding recession with a financial crisis in American history.

Republicans often counter by blaming uncertainty generated by big budget deficits and sweeping new regulation such as the Affordable Care Act. Bordo has his own theory, outlined in a new paper, The Recovery of Housing and the End of the Slow Recovery? Blame the housing collapse rather than the financial crisis, he says:

The recent recovery is much slower than historical averages after deep recessions, largely attributable to the unprecedented housing bust that accompanied the financial crisis. … The shortfall attributed to problems in the financial sector was not able to account for the recovery’s slow pace.

However, when residential investment was taken into account, the improvement was particularly noticeable in the recent recovery. Residential investment is not a large component of national expenditure but it is closely linked to the purchase of consumer durables and other housing-sensitive sectors, which stimulates consumption.

The good news here is that the rebounding housing sector should accelerate GDP growth in the coming quarters. Bordo: “If the recovery pattern in residential Investment from the last few quarters continues to follow its trajectory then the current recovery should soon return to a more normal pace.” New housing price data out Tuesday shows the sector’s turnaround continuing. Consultancy IHS Global Insight thinks housing inventory shortages mean home-price gains “are likely to remain strong for some time.”

So if Bordo is correct, the Obama White House really was dealt a uniquely terrible hand. But that does not mean they or Republicans played it well. Indeed, Bordo mentions as possible headwinds to his bullish forecast “uncertainty in the U.S. over fiscal and regulatory policy and the new health care system.” Along those lines, San Francisco Fed research find that without policy uncertainty such as the 2011 debt ceiling crisis, the unemployment rate by late 2012 would have been close to 6.5%. Also, a new paper from AEI’s Stan Veuger and Harvard’s Daniel Shoag documents “the tight link between increased levels of economic and policy uncertainty and unemployment at the state-level during the 2007-2009 recession.”

Moreover, perhaps the 2009 stimulus would been more effective as a giant investment tax credit, as Harvard economist Greg Makiw and Google economist Hal Varian have suggested. And we could have done without the 2013 hikes, too.

Then we have the Fed, whose passivity in 2008 played a huge role in exacerbating the emerging downturn. Bordo credits the housing turnaround to “the operation of normal market forces aided by low policy interest rates and the Federal Reserve’s [bond buying] policies. If the Fed had been more aggressive earlier — combining quantitative easing with a clear policy rule — the economy would likely be far stronger today.

In short, there seems to be plenty of blame to go around for the New Normal.

Pethokoukis, Economics, Taxes and Spending

No reason to make a snap decision on cutting food stamp benefits

(Wikimedia Commons)

(Wikimedia Commons)

There’s been an 80% rise since 2007 in the number people on food stamps, officially the Supplemental Nutrition Assistance Program. University of Chicago economist Casey Mulligan thinks the bulk of the 135% cost increase comes from more generous benefit formulas and eligibility rules rather than a weak economy.

Liberal groups are aghast that House Republicans want to cut $40 billion over ten years from the $80 billion a year program. The Center on Budget and Policy Priorities calls the House GOP bill ”harsh.” The CBPP notes that many of the 3 million to 4 million Americans losing benefits are unemployed, childless adults in high unemployment areas and “low-income families who have gross incomes above the federal SNAP limits but disposable income below the poverty line.”

Now SNAP could certainly use reform. Some research has found that food stamps reduce work incentives, suggesting the program should be abolished with its funding redistributed to other antipoverty programs such at the Earned Income Tax Credit. I agree with Reihan Salam who advocates a broader rethink of how we support low-income households beyond just “rolling back” SNAP. I worry we don’t have a good feel for the dynamics of the US labor market right now, and how exactly the labor force — the low-skill bit, especially — is being affected by technology as it intersects with rising hiring costs. Certainly market income for the bottom 20% in recent decades has fallen sharply.

Economist Tyler Cowen thinks there are a growing number of Americans who business would not want at almost any price. As he writes in his new book, Average is Over, “I believe these ‘zero marginal product’ workers account for a small but growing percentage of our workforce. At the very least, they make it unlikely that we will return to 4 percent unemployment in the foreseeable future.”

Indeed, long-term unemployment remains abnormally and persistently high more than four years after the recession’s official end. A recent study on America’s back-to-back-to-back jobless recoveries has more questions than answers. If GOPers are looking for budget savings, Cowen suggests “more wasteful targets, including Medicare and also defense spending, not to mention farm subsidies.”

 

Pethokoukis

Why has FA Hayek rather than Milton Friedman been resurgent since the Great Recession?

Photo Credit: Ellen Meiselman (Wikimedia Commons)

Photo Credit: Ellen Meiselman (Wikimedia Commons)

Center-right debate about monetary policy and recessions often turns into a Friedrich Hayek vs. Milton Friedman debate. Which are always fun. But as my pal Russ Roberts correctly noted on a recent EconTalk podcast episode, Hayek rather than Friedman has been more the go-to guy on the right since the Great Recession. And here is an explanation as to why from guest Angus Burgin, author of The Great Persuasion: Reinventing Free Markets since the Depression:

An essential difference between Hayek and Friedman here was that Hayek was in many ways a dark thinker. If you read Hayek in the 1930s and 1940s, the thinks the world is coming apart. Certainly Hayek’s response to the Great Depression was not one that imbued with a great deal of optimism. He thought that to a certain extent you just have to wait things out; if you try to intervene to solve the problem you’ll only exacerbate it.

Whereas Friedman was this tremendous optimist. Friedman was always emphasizing–he said that what Hayek and Robbins got wrong when they were responding to the Great Depression was precisely that: that they said you shouldn’t do anything. He thought that part of what he was doing in monetary theory was to try to come up with a way to say that there was a solution, something that could be done that would prevent this kind of problem. A kind of counternarrative to Keynes. And he always emphasized–instead of dwelling on the catastrophic situation that the world was in, he always emphasized the ways in which those catastrophes could be solved by the market.

And so when you reach this moment of deep pessimism that I think a lot of people associated with organizations like the Tea Party felt, Hayek in many ways feels more consonant with that set of views. His chiliastic tones align with the perspective that a lot of market advocates have in the present day. In that sense it’s not surprising at all that there’s kind of a revival of Hayek.

At the same time, I would say to them that precisely what made Friedman so influential in the public sphere was that sense of optimism. I make an argument in the book that Friedman was in many ways the rhetorical underpinning of Reaganism, that a lot of Reagan’s messages about the benefits of the market were derived from rhetoric that Friedman had developed. And so in emphasizing this dark perspective that can be very powerful among subsets of people who agree with that perspective but in the end can limit the public influence of a group in a broader political environment that in difficult times is looking for optimistic solutions rather than expressions of despair.

Pethokoukis, Economics, U.S. Economy

‘There is no evidence to suggest that the debt ceiling will be raised in time’

Image Credit: Shutterstock

Image Credit: Shutterstock

Scary words from today’s research note by Chris Krueger, ace political analyst at Guggenheim Partners’s Washington Research Group:

There is no evidence to suggest that the debt ceiling will be raised in time.

Now you can sort of see an end-game over the budget and continuing resolution. Eventually the House passes a “clean” CR thanks to a promise from GOP leaders that they will take the Obama White House to the mat over the debt ceiling. Something like that.

Then it gets real. The White House strategy has three parts: 1) don’t negotiate, 2) don’t blink, 3) remember not to negotiate or blink. The GOP, on the other hand, doesn’t really have a plan and is far from unified on what they want to get from Obama or how exactly the battle should play out.

Who is going to blink? The non-scary options — Obama offering a quid pro quo, raising the debt ceiling by congressional disapproval and an Obama veto, a straight hike in the debt ceiling — require someone to blink.

Then you have the unilateral options where Obama just flat out bypasses Congress, both of which would likely freak out markets. Krueger:

Constitutional Option. The debt ceiling forcing mechanism could be demolished if Obama invoked the “constitutional option” and unilaterally raised the debt ceiling. Among other things, the 14th Amendment of the Constitution states the validity of the public debt shall not be questioned. Under this option, Obama would invoke the 14th Amendment and unilaterally raise the debt ceiling – a move that was encouraged by former President Clinton during the summer of 2011 in the height of the debt ceiling stare down. This option would trigger a wave of lawsuits and a likely Supreme Court decision. The biggest problem with going this route would be to – in effect – set up two tranches of Treasuries. Those that are not subject to a legal challenge (issued under the old debt ceiling) and treasuries that are subject to a legal challenge, which would likely trade at a discount. This is an unlikely end result, but one that could happen if we get past the X-date without Congressional action.

Platinum Coin Option. This is even more theoretical than the Constitutional Option, though some argue that it is a stronger legal option. There are limits on how much paper money the U.S. can circulate and rules that govern coinage on gold, silver, and copper. BUT, the Treasury has broad discretion on coins made from platinum. The theory goes that the U.S. Mint would create a handful of trillion dollar (or more) platinum coins. The President would then order the coins deposited at the Fed, who would then put the coin (s) in the Treasury who now can pay all their bills and a default is removed from the equation. The effects on the currency market and inflation are unclear, to say the least. You would also likely trigger a wave of lawsuits similar to the Constitutional Option and create two tranches of treasuries. We do not see the platinum coin option as a viable solution.

At this point Krueger sees a 40% probability the US enters “technical default scenarios” in late October or early November due to a debt ceiling impasse.

Economics, Financial Services, Pethokoukis

Market monetarism and quantitative easing: 5 questions in 5 days (Part 1)

800px-federal_reserve

Most folks who identify as market monetarists have been in favor of the Fed’s bond-buying, or “quantitative easing,” program. They don’t think it’s been executed perfectly, however. If the Fed’s actions had been accompanied by a stated intention to target the level of nominal GDP, there’s a strong case that QE could have been far smaller yet far more effective. Still, as I write in my new National Review column, QE has likely helped the economy and thus been worth doing.

Every day this week, I will present answers to some common QE criticisms from a market monetarist perspective. Question one:

QE is doing nothing since banks are just sitting on the money. Look at the huge increase in excess reserves! What’s the point? How is this boosting growth, exactly?

092313reserves

Scott Sumner, economist at Bentley University and blogger at The Money Illusion:

It boosts growth through higher asset prices and also through the expectations channel.  We know it boosts asset prices, because stock and bond and commodity prices fall on rumors it will be stopped.  It also makes future expected policy more expansionary (when rate are not stuck as zero) and that expectation of higher future NGDP tends to boost current spending.

Michael Darda, chief economist at MKM Partners:

This is true, but if banks want to hold reserves and households want to hold cash, the central bank has to satiate this demand to prevent a deflationary slump. That is basically what the Fed has done. Slow, steady growth is the result of the Fed only partially offsetting a huge velocity (demand for money) shock. Had they done less the slump surely would have been worse.

David Beckworth, economist at Western Kentucky University and blogger at Macro and Other Market Musings:

Is the economy growing too slow? Yes. Do we conclude from this fact that monetary policy is ineffective? No. The right way to think about whether QE is working is to consider where the economy would be in its absence.  One way to do that is to compare the US economy with the Eurozone. Both have fiscal austerity. But in the United States, real GDP has grown about 1.8% over the first half of the year. In Europe it has grown about 0%. The difference is QE in the United States. Now compare these outcomes to Japan where an even more aggressive QE is taking place. It has managed to generate about 3.5% during the first half of 2013. And it has far worse structural problems than the US economy.

The way QE is working is by addressing the ongoing, elevated demand for liquidity. The Fed is partially accommodating this demand which then leads to more spending.  Evidence of this demand can be seen by the fact that about 85% of US marketable debt—the most liquid asset other than US dollars—is held by individuals, their financial intermediaries, and foriegners. In other words, about 85% of the largest run in public debt continues to be supported by entities other than the Fed. Now, interest rates on treasuries have gradually risen over the past year indicating some of the liquidity demand is easing (i.e. less demand for treasuries lowers their price and raises their yield), but there is still a long ways to go.  Other evidence for this ongoing demand for liquidity is that households still hold a relatively large share of their assets in liquid form.

Josh Hendrickson, economist at the University of Mississippi and blogger at The Everyday Economist:

It is true that banks are sitting on a large amount of reserves. However, this is largely the result of the fact that they are paying interest on reserves. This hinders the monetary transmission mechanism, which means it is harder to translate changes in the monetary base to changes in broader aggregates and therefore nominal income.

To illustrate my point, suppose that the Fed had a monopoly over apples rather than currency. If they wanted to reduce the price of apples, they could just increase the supply of apples. Now suppose that the federal government announced that they were going to subsidize apple consumption. This would increase the demand for apples. If the Fed tried to hit the same price target for apples, this would now require an even greater increase in the supply of apples than it would without the subsidy. This is exactly what is happening with interest on reserves.

The Fed has increased the supply of reserves, but they have also increased the demand for reserves. Thus, if they want to lower the price of money (increase the price level/nominal income), they have to increase supply more than they would have to do in the absence of interest on reserves. The build-up of reserves is therefore not evidence that monetary policy is ineffective, but rather evidence that monetary policy requires larger quantitative changes in the face of interest on reserves.