Sunday, January 22, 2017

Sane and Silly Economics from Sumner, Yellen and the BIS

This article was first published by me at Talkmarkets:

Scott Sumner, well known market monetarist, discusses Janet Yellen's procyclical bias on a recent post at The Money Illusion blog. He believes that Yellen's experimental idea to let inflation run hot in an expansion, would be a mistake. 3% inflation, Sumner says, while unemployment is low, would ultimately destabilize the economy. You could argue about how low unemployment is. But lets say Prof is right for the purposes of this article.

Before I talk about Sumner's comments that make sense, I would like to speak to a comment he makes that I disagree with, that may prove to even be as silly as some Fed and BIS talk.

Sumner said: 
Yellen’s statement was not an indication of Fed policy, but merely the musings of one person.  It’s very unlikely to be put into action.  And yet bond prices plunged. Now imagine if all 12 members of the FOMC got on a stage and said they were raising the inflation target from 2% to 3%.  The impact on the bond market would have been at least 10 times greater than what occurred yesterday.[Emphasis mine]
I disagree with the last sentence of that quote. I am skeptical, because of the conundrum, that the Fed has the power to bust open long yields upward. I think increases would be short lived, and a massive buying opportunity for bond investors. It seems to me that Scott Sumner and most market monetarists, and most economists, do not take seriously the conundrum caused by massive bond demand as collateral. I still believe that there is a solution for this long bond problem that is shared at the end of this article. Monetary policy is simply aimed at the wrong entities.

And I am thinking that the Fed would not even up the target to 3% in a downturn. Until someone shows us otherwise, the Fed behaves as if it is in a straight jacket of derivative insanity. It is useless to talk to Professor Sumner about this issue of bond demand because he is mum. You have to wonder why. And Yellen is just talk, if, as Sumner says, the rest of the governors would never impose the 3 % target. The bond market seems to be rigged by Fed talk, and by bank manipulation, to push yields on the long bond up incrementally, but only to create buying opportunities.

As to the sane and sound thinking, Sumner shares this about procyclicality:
It would be destabilizing to let inflation go to 3% while unemployment is low.  It would bring the recovery to a premature end, triggering another recession as soon as the economy was hit by another oil shock.  Instead, the Fed should shoot for 3% inflation during the next recession—not during this expansion.  But they currently lack a policy regime capable of achieving that (countercyclical) outcome.  Yellen’s policy remains resolutely procyclical.  NGDPLT anyone?
NGDPLT would require measurements of GDP that are not easy to come by, so I like economists who try to solve the problem with helicopter money in down times, as I wrote about them in past articles.
There is proof from other economists that the Fed and central banks are procyclical, offering easy money during expansion and tight money during contraction. That just makes things worse.

Sumner says, in the comment section of his article, that easy and tight are not always the issue. He says that procyclical money is the problem. Currency that appreciates during good times is procyclical and currency that appreciates during bad times is countercyclical, according to the World Bank.

Countercyclical policy is generally better, because it smooths out booms and busts, but human nature is not inclined to go with it. The World Bank also says that appreciation in good or bad times may not  always be caused so much by easy or tight money at home, but may be caused by net foreign asset positions that have nothing to do with domestic tight or easy money. That reality could complicate issues at home, to be sure.

However, since the US economy is suffering, tight money on mainstreet remains a big problem.  Banks are holding onto money and  are paid for their massive excess reserves and fear lending to main street. That is a big problem that can give rise to populist anger. We all know what that exercise in political hostility has done to the nation, as strife and frustration seems to be increasing. People are talking about assassinating leaders, and as frightening as that talk is, they haven't yet turned their wrath towards bankers, although that day could come.

So, raising rates would be really good because some fear a downturn that would bring us into an unfortunate negative rate regime if we start from low rates in an expansion. But I understand those who say that at this point in the recovery, raising rates could temporarily cause a large setback.

So, there is a solution:

As Kyle Bass says, there is simply no other solution than helicopter money. The Fed won't have to touch interest rates. The conundrum can be left alone. Inflation could be controlled because helicopter money would not be aimed at Wall Street, which is awash in money, but rather to main street, which is depressed as to money supply.

Facing any major slowdown, the Fed needs to appreciate the positions of Kyle Bass and Eric Lonergan and Adair Turner, and not be so insulated from new ideas from the outside. After all, the Fed already possesses monetary tools to improve things at home but is frozen in its will to use them.

Just remember, when someone wants fiscal policy solutions as Fischer does, they are calling for more  spending and bond creation, and realize that the new gold collateral must be minted by deficit spending. That is highly irresponsible when monetary policy is not dead, just comatose, because of silly people like Janet Yellen and Stanley Fischer and the Bank of International Settlements.

One would think that Fischer, saying it is difficult to tamper with interest rates in these economic times, would jump for joy for real helicopter money which would not increase government debt. But people like Richard Koo no doubt scare the Fed with sky is falling pronouncements about helicopter money. But clearly helicopter money would not necessarily promote massive lending once people pay off their debt. Lending can be controlled, still, by credit score requirements, by payment of interest on excess reserves, by government advocating what millennials now do, practice frugality. Government can teach people that banks are foolishly procyclical and will pull the rug out from under you if you get into too much debt.

Koo says helicopter money is the end of monetary policy and would create too many bonds in circulation, as the Fed would have to sell bonds to get rid of excess reserves that banks could lend out. Well, there is a shortage of bonds now. Debt free (to the government) helicopter money, would at least be better than more fiscal debt!

And the BIS says this, and it can't be right:
 If the reserves are non-interest bearing - as they must be for helicopter money-the increase will inevitably also drive the short-term (overnight) rate to zero. This is because when the system as a whole has an excess of reserves, no one wants to be left holding it but someone must.
Why would this have to be? The Fed would not be lending out excess reserves as helicopter money. They would create helicopter money and bypass the banks to issue it, not increasing reserves at all! There is no rule saying continuing interest payments on reserves would be contrary to helicopter money. That is crazy, silly talk by the BIS. The BIS is saying that Milton Friedman is wrong and it is saying that all reserves must be paid down for helicopter money to work. That is ridiculous. Keep having central banks pay interest on excess reserves to the banks if that is your worry, BIS. Keep Wall Street from price gouging on rents and it would work just fine, in a controlled environment, as Lonergan seeks. If this attempt is not made the wealth divide will only increase and destabilize the economy, the very thing central bankers don't want.

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