Cutting-Edge Macro of 1829 Watch: I Really Don't Think That Stephen Williamson Quite Gets It... - Grasping Reality with Both Hands
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Grasping Reality with Both Hands The Semi-Daily Journal of Economist J. Bradford DeLong: Fair, Balanced, RealityBased, and Even-Handed Department of Economics, U.C. Berkeley #3880, Berkeley, CA 94720-3880; 925 708 0467; delong@econ.berkeley.edu.
Economics 210a Weblog Archives DeLong Hot on Google DeLong Hot on Google Blogsearch July 11, 2010
Cutting-Edge Macro of 1829 Watch: I Really Don't Think That Stephen Williamson Quite Gets It... He writes: New Monetarist Economics: New Keynesians and New Monetarists: What's the difference between a New Keynesian and a New Monetarist? This sounds like I'm leading off to tell a joke (a duck walks into a bar...), but I'm not. A New Keynesian thinks that the real interest rate is too high, while a New Monetarist thinks the real interest rate is too low. In New Keynesian theory, the basic idea is that the key inefficiency that monetary policy should be correcting arises from the sticky price friction.... [A] particular problem, which I think is the key to how New Keynesians think about the current state of the world, is that the nominal interest rate cannot fall below zero (the "zero lower bound")... the real interest rate is then too high relative to what it would be in an efficient flexible price world. This is essentially the story that Bob Hall told on Wednesday, and it's consistent with all or most of the New Keynesian work I have seen at the SED meetings here in Montreal. From a New Monetarist point of view, a key element of the financial crisis relates to the scarcity of liquid assets... outside money... Treasury securities.... When the Fed conducts an open market purchase of Treasuries, it swaps the first type of liquidity for the second. My view is that one reason this matters is that it increases the scarcity of the the second type of liquidity. The financial crisis also increased the scarcity of the second type of liquidity. For example, some mortgage backed securities, which had been widely traded in financial markets, and had served as collateral in various credit arrangements, dropped in value and were no longer traded. An increased scarcity of the second class of liquid assets is reflected in a lower real interest rate - these assets carry a larger liquidity premium. The correct
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central bank response to such a phenomenon, in additional to stepping in temporarily take up some of the intermediation functions that seemed to have shut down in the private sector, is to sell Treasuries, not to purchase them (which would increase the first type of liquidity, not the second).... The key point is that an important phenomenon in a financial crisis is a shortage of "type 2" liquid assets, reflected in a low real interest rate, rather than a real interest rate that is too high, as in New Keynesian theory. I recall... Larry Summers, I think it was... when Lehman blew up saying that our key macroeconomic problem was now that risk- and default spreads were going through the roof and so risky private businesses that wanted to borrow to invest could not do os on terms that made investment profitable. Why had spreads gone through the roof? Because all the AAA financial-engineering paper had blown up and was no longer AAA, and as a result there was a desperate global shortage of high-quality assets: places where you could park your money and be sure it would stay there and not evaporate. (Williamson calls these "'type 2' liquid assets," but it is not liquidity so much as quality that is of the essence.) Open market operations--even quantitative easing--has lost its bite because simply trading one high-quality Treasury bill for one high-quality reserve deposit didn't do anything to move assets supplied to the private market in the needed direction. What is needed, in such a situation, is: 1. open-market policy: keep the Federal Funds rate at zero for a long time to come-until unemployment falls. 2. banking policy: use government-sponsored recapitalizations and guarantees to turn what were then regarded as risky and dodgy private assets into higher-quality ones to expand the private supply of what Williamson calls "'type 2' liquid assets; 3. unconventional monetary policy I: have the Federal Reserve and the Treasury expand the supply of "'type 2' liquid assets" by taking risk onto its own balance sheet through borrowing from the banking system and buying up low-quality assets in return; 4. unconventional monetary policy II: raise the inflation target to put a (small) inflation tax on holdings of "'type 2' liquid assets and so diminish demand for them; 5. expansionary fiscal policy: have the federal government print up a huge honking tranche of extra Treasury bonds and so expand the supply of "'type 2' liquid assets--and then spend the money putting people back to work. Williamson wants to say that (1) is Old Monetarist, and is good; (2) and (3) are New Monetarist, and are good; and (4) and (5) are New Keynesian, and are bad. I think that's wrong: all five are good, for reasons that would have been obvious to Walter Bagehot, John Stuart Mill, the 1829 older-and-wiser version of Jean-Baptiste Say: aggregate spending is too low--aggregate demand is low and so there is excess supply of goods and services--because there is excess demand in financial markets. But the excess demand is not a conventional Fisher-Friedman monetarist excess demand for means of payment, for the circulating medium: it is a Bagehot-MinskyKindleberger excess demand for safe high-quality places to park your money. Anything that boosts the supply of (or reduces the demand for: Bob Hall appears to work on the demand side here) high-quality assets that the private sector can hold relieves the financial excess demand that underpins the goods-and-services excess supply. http://delong.typepad.com/sdj/2010/07/cutting-edge-macro-of-1829-watch-i-really-dont-think-that-stephen-williamson-quite-gets-it.html
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To say that (2) and (3) are good because they deal with a problem of an interest rate that is too low while (4) and (5) are bad because they deal with a problem of aninterest rate that is too high is, I think, to misconstrue the situation. The interest rates are different things, on different assets, paid by different people. The risky interest rate corporations must pay is too high and the safe interest rate the government must pay is too low. (1), (2), (3), (4), and (5) (at least until government borrowing rises so high that it begins to crack government debt's status as a safe high-quality asset) are all good things. The key is to shrink the market price of quality. This is the line of argument that underpins Paul Krugman's repeated declarations that rising long-term Treasury bond rates--falling prices--would in our current state be a sign of increasing health--a sign of a shrinking market price of quality and thus of improved credit market functioning--and not a sign of danger. Brad DeLong on July 11, 2010 at 08:08 AM in Economics, Economics: Federal Reserve, Economics: Finance, Economics: Fiscal Policy, Economics: Macro, Obama Administration | Permalink Favorite
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Comments dilbert dogbert said... We, the little people, sure looked for a safe place to park extra funds from the sale of a house. It was better to let the mice of inflation nibble away at its value than the pigs of wall street invest it till it was all gone. In the 10 years we have had money in stocks the value has gone nowhere. The ride up was fun but the stomach flipping plunges not so much. Now that the value of the only real investment the middle class has, housing, has been stolen the smart money, via the cat food commission is looking for its next big strike Social Security. After Social Security I expect they will go after the other public and private pensions. Remember the old story - First they came for the communists.... You can finish. Darn! Isn't this a great country or what? Reply July 11, 2010 at 10:48 AM TR said... This is the clearest prescription of where policy should be that I have encountered as a casual follower of this debate- thanks for that. Taking the five points, we indeed seem http://delong.typepad.com/sdj/2010/07/cutting-edge-macro-of-1829-watch-i-really-dont-think-that-stephen-williamson-quite-gets-it.html
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to unfortunate and ill-served by our public officials in that inflation hawks at the regional fed banks have been clamoring to roll back 1, even as house and senate deficit hawks block 5. Perhaps more surprising, its my understanding that Treasury and the Fed are winding down activity on 2&3. If this is true, we appear to be headed in the wrong direction on all 5 points, even though the statements from Summer's group at the Whitehouse seem sympathetic to the concerns expressed by Krugman in his NYT column and those expressed in this blog by our host. What gives? Where would you place current policy in relation to these five points? Or what grade would you give our collective efforts in these five areas? Reply July 11, 2010 at 11:16 AM Graydon said... Somewhere in one of O'Brian's Aubrey and Maturin novels the narrator's own voice -and remember that O'Brian was not, for most of his life, anything other than poor -rises through Maturin's rather strongly, in the critique of the capital-worship of the English upper class; how they had to worship it, because they could not produce it. I think a huge part of the confusion of policy is due to many of the policy-makers thinking of wealth, capital, as a thing which exists, it the way rocks or trees exist, as a part of the independent natural world. They've completely lost the connection that labour produces capital. So in their concern for capital they don't recognize that they should include a concern for the labour that produces the capital in the first place. It's an easy enough mistake to make if you've always been rich, or even never been poor and have forgotten not being rich; money is a thing, it's always been there, and the natural order of the world is to increase it. Only, of course, it hasn't; someone had to do the work to create it. Losing track of that, even beyond the usual "I deserve the entirety of the surplus production of the lower orders" upper-class rapacity, looks to me like most of the explanation of both the crisis and the policy response to the crisis. Reply July 11, 2010 at 11:49 AM Anon said... Finance follows the real economy. The real economy "deflates", it reduces the stages of production when under stress, and so the real economy becomes less accurate. When considered as a Shannon channel, the real economy acts as if it wants to reduce the precision of consumer goods, serving fewer markets with greater volumes at less frequency. In other words, the economy becomes a five bit calculator when it previously was a six bit calculator. Finance has to follow that if finance makes any sense. There are now fewer stages of production for finance to count inventory, so finance deflates and reduces its own stages of production. Nothing can be done until the real economy finds a growth engine to drive back to six bit precision. The best thing finance can do is map to the real economy, unless it is finance itself that is undergoing technology change, which might be the case. There is a surplus of technology available to count up inventory in real time, I am not sure that bankers know this; they may be out foxed. Reply July 11, 2010 at 12:46 PM Joe Smith said... Government could also move to improve transparency in the market place so that investors can have confidence in the quality of the assets they are buying. Remember
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that Warren Buffett was able to extract something like 25% to 35% per annum from General Electric!!!! at the height of the liquidity crisis. (Way to go Warren.) Faster regulatory moves to eliminate the systemic risks created by derivatives (by regulating or outlawing them) might have done a lot more to free up capital any monetary policy could. Reply July 11, 2010 at 12:50 PM Roland Buck said... The idea that there is a shortage of treasuries at a time in which the Federal Government is selling a lot of them to finance the deficit is totally preposterous. The Fed is monetizing very little of the current deficit. That is, open market purchases of the Fed of treasuries, reducing their supply is much smaller in magnitude than the sales of treasuries by the Treasury, increasing their supply. Therefore the effect of changes in the supply of treasuries on the total supply of the Type 2 liquid assests has been to greatly increase this supply. To the extent that there is a lack of supply of private-sector liquid assets, having the Fed sell government bonds will not address this. Reply July 11, 2010 at 01:12 PM bakho said... Creating AAA assets, 1940s. GI Bill Style: From June 22, 1944, until passage of the Korean GI Bill, VA backed 2,360,603 home loans. In 1947 the peak year for World War II veterans, VA approved 640,298 loans, including 562,985 for homes, 24,690 for farms and 52,623 for businesses. US Govt sells AAA bonds. Sets up super low interest loan fund for new business start ups for unemployed that can produce a coherent business plan. Limit loan period to 5 years. Reply July 11, 2010 at 01:20 PM bakho said in reply to bakho... Second paragraph was how to repeat this in 2010. Reply July 11, 2010 at 01:21 PM mhnj said... Perhaps you could also work out what would happen in the scenario that "government borrowing rises so high that it begins to crack government debt's status as a safe highquality asset". If long-term bond yields rose not because of a private-sector preference shift from riskless to risky assets, but because US Treasury bonds became perceived as risky...What would happen to the unemployment rate if that scenario happened? What's the probability? Does it make sense for the government to pursue such a policy on a risk-adjusted basis? Reply July 12, 2010 at 02:20 PM Brooks Gracie III said... How about this? It seems crazy, but I have never seen anything that disproves the concept. Start with dated money (in the form of bills), that loses a certain portion of its value over time (maybe 10% every 4 months). To avoid this fate, people would simply buy Treasuries or money market deposits. So enact an increased tax on money market or T-Bills/Notes. The point is, to get people to invest their savings in something productive. Raise the capital gains rate on stocks when the investment is pure speculation--i.e. buying an existing stock from another investor, or dead real estate which provides no new money http://delong.typepad.com/sdj/2010/07/cutting-edge-macro-of-1829-watch-i-really-dont-think-that-stephen-williamson-quite-gets-it.html
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flowing into the economy. Eliminate any taxes on gains from a purchase of stocks where the funds go directly to the company, for expansion and additional hiring. This prescription would very likely boost our economy. Right now, the Fed cannot boost M3 because banks aren't lending, but just buying T-bills/notes, while borrowing at a lower rate. This does less than nothing to spur the real economy. Reply July 12, 2010 at 08:17 PM Comments on this post are closed.
Economists Debate The Philosophy Behind British Budget Cuts
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Me:
NPR (blog) - Oct 21, 2010 The New York Times reports on this as a battle between supporters and antagonists of John Maynard Keynes, and the whole idea of Keynesian economics. ... Related Articles » « Previous Next »
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