A very Important Day

[phil_20686]

So I woke up this morning, to discover that the Fed has made the most important policy statement in my lifetime.

 

They have agreed to open-ended easing until such time as either the unemployment rate approaches full employment, or the inflation expectations (significantly) breach the the two percent ceiling.

 

For reasons previously discussed, the inflation rate will not rise until the economy approaches full employment, as inflation happens when the production of money (really money*velocity = ngdp) outstrips the production of goods, but when there are idle resources monetary stimulus puts them to work and we get more goods in line with the money spent, so no inflation.

 

I also want to rebuke those Keynesians who believe that monetary policy works through concrete channels. Clearly there are still some of them on the FOMC board, because the FOMC said:

 

These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.

 

What actually happened:

http://www.themoneyillusion.com/wp-content/uploads/2012/09/Screen-Shot-2012-09-13-at-1.33.12-PM1-e1347557739504.png

 

 

Interest rates rose because expectations of future economic activity rose, and who wants to buy bonds at these prices if the economy is going to be roaring in ten years time.

 

Successful monetary policy will increase interest rates, because it will increase future expected GDP.

 

Monetary policy policy works through controlling the price of money (=the size of NGDP). Since the price is wrong, and this is preventing economic activity through sticky wages, moves to correct it are positive for the economy. In response, the stock markets have gone crazy. In particulars, mining companies, and broad etf commodities are up, and still rising strongly in European trading, because expectations of future economic activity are up. Us treasury yields are up. Even Uk treasure yields are up. Rebalancing into risk assets and out of defensive assets is continuing apace. Miners are up, banks are up, utilities are down.

 

Mark it in your history books. Today the fed saw the light, and so the US will now exit recession, banking condititions will improve, and within one to two years, barring European catastrophe, the US will be in the clear.

 

Now, if only the ECB would follow suit.......

[PassedOut]

So I woke up this morning, to discover that the Fed has made the most important policy statement in my lifetime.

 

They have agreed to open-ended easing until such time as either the unemployment rate approaches full employment, or the inflation expectations (significantly) breach the the two percent ceiling.

 

For reasons previously discussed, the inflation rate will not rise until the economy approaches full employment, as inflation happens when the production of money (really money*velocity = ngdp) outstrips the production of goods, but when there are idle resources monetary stimulus puts them to work and we get more goods in line with the money spent, so no inflation.

They have been reading your posts. Are there no bridge players on the ECB?

[phil_20686]

They have been reading your posts. Are there no bridge players on the ECB?

 

Not that I know of?

 

I think its largely been scott sumner who was responsible for this. He has a blog on which he has been banging on about it for years. Not to mention doing the conference circuit. You see all the media banging on about Micheal Woodfords paper at Jackson hole, and calling it the "woodford critique", but scott has been on top of it for like five years. Everyone on the blogosphere has been calling it the "sumner critique" for years lol.

 

But micheal woodford is probably the most influential academic economist around. I guess that gives you naming rights :P

[jonottawa]

I stopped pretending to understand economics when we started projecting trillion dollar deficits as far as the eye can see while mortgage rates were hitting historic lows. I'm surprised anyone is still pretending, tbh.

[MickyB]

This means I'll win my bet on Obama, right?

[phil_20686]

This means I'll win my bet on Obama, right?

 

Yes.

 

Intrade seems to have moved nearly five % in the last three days. People obviously think the big stock market rally is cementing his position.

[PassedOut]

Intrade seems to have moved nearly five % in the last three days. People obviously think the big stock market rally is cementing his position.

The republican VP candidate weighs in: Ryan calls Federal Reserve actions 'insidious'

 

"One of the most insidious things a government can do to its people is to debase its currency," Ryan said at an outdoor rally in Oldsmar, Florida. "We want honest money; that means we want honest government. It's one and the same. Now the secret to prosperity is not more money printing."

 

Ryan said QE3 might help banks on Wall Street but will do little to help middle-class families.

 

"We don't need sugar high economics; we don't need synthetic money creation," he said. "We need economic growth. We want wealth creation. We don't want to print money. We want opportunity and growth. And when they do this to our money, it undermines the credibility of our money."

Skis. Works out. Ran a marathon. Does not play bridge.

[luke warm]

i see the logic in what you say (in the other thread on it), but what still troubles me is the relationship between printing money and job creation... so far, granted it's only been a few days, all i've seen this do is help out wall street and the banks... what happens if unemployment does not drop? does that mean anything viz this policy?

[phil_20686]

i see the logic in what you say (in the other thread on it), but what still troubles me is the relationship between printing money and job creation... so far, granted it's only been a few days, all i've seen this do is help out wall street and the banks... what happens if unemployment does not drop? does that mean anything viz this policy?

 

The desired result, is that unemployment should drop, NGDP will rise, and inflation will stay low/rise moderately (say up from 1.4% towards the 2%target, maybe slightly over).

 

If unemployment drops and inflation rises (exceeds 3%), then the policy is too aggressive, and although it is "working", it should be scaled back, as the economy is not responding quickly enough, to warrant the scale. Obviously it is possible to print money "too quickly", and in that case you don't get any benefit from the "extra money" compared with a lower monthly buying rate, just extra inflation.

 

Conversely, if unemployment does not drop, and inflation stays low, then the policy is not aggressive enough, and should be expanded. I actually think this is quite likely, and they might need to step it up a bit further, but its really hard to guess at actual numbers. Better just to see what happens, and step it up in six months if it is not enough.

 

The true failure scenario is if unemployment does not drop, and inflation rises, then we were all wrong and this is a supply side issue. Of course, demand side issues can morph into structural issues. People who are unemployed for multiple years lose skills etc, so it might not be possible to go "all the way back" in terms of correcting demand, and lowering unemployment. We might easily find that the structural unemployment rate is a percent or so higher than it was.

 

As laid out in the other thread, I expect that we will see first a drop in unemployment, and then a rise in NGDP, and finally a rise in inflation as the economy approaches full employment (which may not be at the same unemployment rate as before).

 

Also, when I say "inflation" I mean core inflation, not the `noisy' headline inflation, which bounces all over the place.

[y66]

Skis. Works out. Ran a marathon. Does not play bridge.

Has no clue.

[PassedOut]

Mark it in your history books. Today the fed saw the light, and so the US will now exit recession, banking condititions will improve, and within one to two years, barring European catastrophe, the US will be in the clear.

 

Now, if only the ECB would follow suit.......

I thought of you when I read this piece by Larry Summers today: Learning from Britain’s fiscal model

 

An effective policy approach to Britain’s economic problems must start with the recognition that the principle factor holding back the British economy over both the short and medium terms is the lack of demand. It is certainly true that Britain faces important structural issues ranging from difficulties in promoting innovation to deficiencies in the system of worker training. But it is apparent from the relatively low level of vacancies, the reluctance of workers to leave jobs, the pervasiveness across industries and occupations of increased unemployment, and the testimony of firms regarding the formation of their investment plans that it is lack of demand that is holding the economy back from producing as much as it could.

 

Keynes, writing during the Depression, compared Britain’s economic problems to a “magneto” problem, referring to the fact that a car might have many infirmities but if its electrical system did not work the car would not go and if it was fixed the car would go even with other problems. So it is today. Moreover, to an extent that is greatly underappreciated in the policy debate, short-run increases in demand and output would have medium- to long-term benefits as the economy reaps the benefits of what economists call hysteresis effects.

Keep on blogging!

[JLOGIC]

This means I'll win my bet on Obama, right?

 

Ship it

[luke warm]

As laid out in the other thread, I expect that we will see first a drop in unemployment, and then a rise in NGDP, and finally a rise in inflation as the economy approaches full employment (which may not be at the same unemployment rate as before).

i expect to see: no (or very little) drop in unemployment and no rise in inflation... i believe they were going to pump something like $85B in every month or so, but i'm not sure about that

 

why not just print $16T and give it all (or most of it) to china :)

[phil_20686]

i expect to see: no (or very little) drop in unemployment and no rise in inflation... i believe they were going to pump something like $85B in every month or so, but i'm not sure about that

 

$85bn a month, half into mortgage backed securities, and half into us treasuries.

 

If this happens, then the policy is, in a sense "free". Since they are monetising the debt at no cost. In this case they should buy up all the US debt, and then just "retire it". Since the US treasury takes the Fed's profit, this will happen anyway. The only US debt that `matters' from a fiscal point of view is that not owned by the fed. (Well, not really true, its also the difference between the value the bond was issued at and the value that the bond was bought at by the fed - I am not being very clear, but basically profits made by the fed on accounts of its assets belongs to the tax payer).

 

If the policy does nothing, it is simply too small to matter, and needs to be expanded. 85/15,000= half a % point of US GDP per month, which is not very much. The problem is that economies are very important, and deciding what is the right policy is much easier than deciding quite how big it is. Maybe it should be 40bn, maybe it should be 200bn. We only find out by experiment. :)

 

I suspect bernanke has low-balled his estimate. If he does too much there is a chance that inflation would rise before unemployment started to fall, which would politically be a disaster for the fed, and would mean that even if it was working he might be forced to stop by the hard money lunatics on the fomc. If nothing happens, he can easily argue, look its not big enough. Further, if you are worried about inflation, and QE is not causing inflation, you look like an idiot, so its good for his position, he can expand it ever more confident that inflation is under control, as it continues to not rise. :)

 

Bernanke seems like a smart guy in a room full of idiots, so if I were him, I would take what I thought was the right number, and divide it by two. Assuming he knows better than I what the right number is, I am guessing it is low.

 

To put it in perspective, it is around one quarter of the monthly rate of buying during QE1, which did move inflation up by around 1%, if you believe the fed forecasts.

[luke warm]

$85bn a month, half into mortgage backed securities, and half into us treasuries.

 

If this happens, then the policy is, in a sense "free". Since they are monetising the debt at no cost. In this case they should buy up all the US debt, and then just "retire it". Since the US treasury takes the Fed's profit, this will happen anyway.

ok, so what would happen if they printed however much money is owed to china and just gave it to them? outside of china getting incredibly pissed, that is

[dwar0123]

ok, so what would happen if they printed however much money is owed to china and just gave it to them? outside of china getting incredibly pissed, that is

 

I don't think you can force liquidate bonds ahead of schedule. But if you just stopped issuing bonds to cover the cost of maturing bonds and just paid them off with printed money. I'd imagine inflation would skyrocket and China would be incredibly pissed.

 

Though this would take something like 30 years to unwind and I am not sure how it is relevant, this level of money creation is not on the same order of magnitude with respect to the QE and no one argues that at this level of money creation inflation wouldn't be very bad.

[y66]

Do the financially savvy guys who post here think it's a good time to take out a 30 year mortgage?

[hrothgar]

Do the financially savvy guys who post here think it's a good time to take out a 30 year mortgage?

 

I just refinanced a 30 year fixed

Screw gold. No better inflation hedge than a honking big 30 year fixed

[cherdano]

Do the financially savvy guys who post here think it's a good time to take out a 30 year mortgage?

Financially savvy guys will point out that it will depend on your personal finances, and on what you want to do with the money. If you are considering buying a house instead of renting, in a place where you expect to live 5+ more years, then the answer is probably yes.

[luke warm]

Screw gold.

you probably only say that cuz you didn't buy 1000 oz @ $400/per

[y66]

Thanks for replies on the 30 year mortgage question. We're considering refinancing a house that we plan to stay in indefinitely. 30 year fixed rates look pretty good right now, esp. if inflation starts taking off 3 or 4 years from now.