Monday, October 31, 2016

Macro Musings Podcast: Rudi Bachmann

My latest podcast is with Rudiger Bachmann. Rudi is an associate professor of economics at the University of Notre Dame and a research affiliate at the Center for Economic Policy Research. Rudi has published widely on macroeconomic issues in top journals and is an active member of the German Economic Association. He also blogs and write popular press articles for the German media. Rudi joined me on the show to discuss German macroeconomics as well as some of his own research. 

Our conversation begins by noting that German macroeconomics appears to be very different than Anglo-American macroeconomics. Rudi notes that is partly a misperception problem, but there is indeed something different. What is different is how macroeconomics is currently practiced in Germany: it reflects the ordoliberalism view that stresses a rules-based approach to policy. This approach to macroeconomics makes lawyers rather than economists top advisers to policy in Germany and it reflects the lasting legacy of Walter Eucken. This view not only affects Germany, but macroeconomic policy throughout the EU. 

One of the interesting issues that emerge from this discussion is that the German polity seems to worry more about repeating the mistakes of the Weimar hyperinflation in the early 1920s than the mistakes of the Great Depression in the late-1920s. The former is well known but the latter was arguably more consequential since it helped bring the Nazi to power in Germany. It is not clear why the hyperinflation experience trumps the Great Depression experience, but its experience helps shape the ordoliberalism approach to economic policy in Europe today. 

Rudi and I then shift our conversation to the future of Europe. Rudi remains hopeful that EU project will survive the Eurozone crisis and other challenges now facing it.

We conclude by discussing Rudi's work on uncertainty and the business cycle and the importance of inflation expectations for consumers. 

This was a fascinating conversation throughout. 

You can listen to the podcast on Soundcloud, iTunes, or your favorite podcast app. You can also listen via the embedded player above. And remember to subscribe since more shows are coming.

Related Links
Ruid Bachmann's homepage

Sunday, October 30, 2016

The Return of Monetary Mischief to Zimbabwe?

Bloomberg is reporting that Zimbabwe might be up to some monetary mischief again. The government has started printing currency and, as first noted by JP Koning, the way they are doing it seems dubious. So, as a reminder to the government of Zimbabwe, it might be wise to revisit how bad the monetary mischief got back in 2008. You do not want to repeat that experience.

Steve Hanke found the monthly inflation rate hit 79.6 billion percent in November 2008 (89.7 sextillion percent on a year-on-year basis). That is how bad it got. This bout of hyperinflation began in early 2007 and ended in late 2008. At that point the government shut down the printing presses and allowed its citizens to freely use foreign currency. The country quickly dollarized and the country once again had a stable medium of exchange.

One way to visualize this hyperinflation is to look at the progression of currency printed by the government. Below are some slides I put together that shows this development. It is interesting to observe that in early 2007 Zimbabwe had similarly sized dollar notes to those in the United States. That quickly changed as prices began exploding.

So take note Zimbabwe. Let's not repeat the painful experience of 2007-2008.

P.S. What would happen to places like Zimbabwe if Ken Rogoff's proposal to eliminate U.S. gained traction?

Friday, October 28, 2016

The Knowledge Problem In Monetary Policy

I have a new working paper with Josh Hendrickson titled Nominal GDP Targeting and the Taylor Rule on an Even Playing Field. Using a standard New Keynesian model, Josh and I show one of the advantages of a nominal GDP target is that it is more robust to the knowledge problem facing central bankers than is the standard approach that implicitly invokes some kind of Taylor rule.

Here is an excerpt from the paper on the knowledge problem:
One of the key challenges facing monetary policy authorities is the knowledge problem. As first noted by Hayek (1945), this problem arises because the information needed for optimal economic planning is distributed among many individual firms and households and therefore outside the knowledge of a central planning authority. This observation, when specifically applied to central banking, means that the information required to make activist countercyclical policies work is not available. Consequently, monetarists like Friedman (1953, 1968), Brunner (1985), and Meltzer (1987) argued early on against central bank discretion and instead called for simple rules that committed monetary authorities to stable money and nominal income growth. 
The knowledge problem was later shown by Orphanides (2000, 2002a, 2002b, 2004) to apply not only to central banks that conduct discretionary monetary policy but also to ones that follow a “constrained discretionary” approach to monetary policy. That is, even central banks that follow some kind of Taylor rule in a flexible inflation-targeting regime are susceptible to the knowledge problem...
The biggest information challenge comes from attempting to measure the output gap in real time. The output gap is the difference between the economy’s actual and potential level of output and is subject to two big measurement problems. First, real-time output data generally get revised and often on the same order of magnitude as the estimated output gap itself. Second, potential output estimates are based on trends that rely on ever-changing endpoints. Orphanides finds the latter problem to be the biggest contributor to real-time misperceptions of the output gap. This means that even if real-time data improved such that there were fewer revisions, there would still be a sizable problem measuring the real-time output gap.  
To illustrate these problems, figure 1 replicates Orphanides’s (2002b) construction of real-time output gap measures using vintage real output data and compares them to final output gap measures using the Hodrick-Prescott and Baxter-King filters… 
The top panel in figure 1 shows both the real-time and final output gap measures. To help discern how different these measures are, the second row plots the real-time output gap misperceptions, or the difference between the real-time and final output gaps. Both the HodrickPrescott and the Baxter-King filters reveal sizable measurement problems, particularly in the 1970s. The Hodrick-Prescott filter shows real-time output gap misperceptions reaching as much as 5 percentage points, while the Baxter-King filter shows up to 2 percentage points in the 1970s.  
Orphanides (2004) sees these large measurement errors as a key contributor to the unmooring of inflation in the 1970s. He shows that, if the real-time estimates of the output gap and inflation from the 1970s are plugged into a Taylor rule like equation... the result is pretty close to the actual monetary policy that occurred during this time. The Great Inflation, in other words, was not the result of the Federal Reserve failing to properly respond to the economic developments of the time. It was the result of the Federal Reserve failing to properly measure the output gap.  
Interestingly, figure 1 also indicates that the Great Moderation period of 1984–2007 was characterized by relatively smaller real-time output gap misperceptions. These findings raise questions about the claims of Taylor (1999), Clarida, GalĂ­, and Gertler (2000), and others who see the Federal Reserve’s Federal Open Market Committee after Chairman Paul Volker’s term as more disciplined in its response to inflation. They suggest, instead, that Walsh (2009, 216) may be correct in his assessment that the success of targeting inflation has more to do with the “good luck” coming from a “benign economic environment” than from improved monetary policy.
Below is Figure 1:
There is much more to the paper. Read it the rest here.

P.S. Here is an earlier post on the knowledge problem facing central bankers when they try to divine changes in the inflation rate. 

Monday, October 24, 2016

Macro Musings Podcast: Narayana Kocherlakota

My latest Macro Musings podcast is with Narayana Kocherlakota. Narayana is a professor of economics at the University of Rochester. He has published widely in economics, including in the areas of money and the payment system, business cycles, financial economics, public finance, and dynamic contracts. He also writes regularly for Bloomberg View

Formerly, Narayana was the president of the Minneapolis Federal Reserve bank, where he served between 2009 and 2015.  He joined me to talk about his time at the Fed and his current views on Fed policy.

This was a fascinating conversation throughout and a must-listen episode for all Fed watchers. The first part of our conversation covered what it was like being a regional Fed president. This included, among other things, how he stayed informed, how he managed the Minneapolis Fed, and how he prepared for FOMC meetings.

We then moved onto the the FOMC and the dynamics of the meeting itself. The preparation, the room, the seating, the order of business, and the rules of engagement are all important part of the FOMC decision-making process, but also are little known to outsiders. Narayana fills us in on the details as we discuss these and other issues--including whether FOMC members are more guarded in what they say because transcripts will be released--surrounding the FOMC meeting. 

Our conversation next turned to the actual conduct of monetary policy since the crisis. What role did the Fed policy play in the recovery? Could it have done more? If so, was a more aggressive monetary policy even possible? Also, to what extent did public pressure play on shaping Fed policy versus the internal thinking of FOMC members themselves.

Finally, we discuss ways to improve Fed policy and whether the supply side of the economy is endogenous, in  part, to demand pressures. This was a great conversation. 

You can listen to the podcast on Soundcloud, iTunes, or your favorite podcast app. You can also listen via the embedded player above. And remember to subscribe since more shows are coming.

Related Links:
Narayana Kocherlakota's home page
Narayana Kocherlakota's twitter account
Narayana Kocherlakota's Bloomberg articles

Friday, October 21, 2016

Has Macroeconomic Policy Been Different Since the Crisis?

Brad DeLong wonders whether macroeconomic policy has been different in the post-2009 recovery. If we assume the role of macroeconomic policy is to stabilize aggregate demand growth, then my answer is an unequivocal yes. Macroeconomic policy was very different during the recovery than in previous periods. 

It was different in two key ways. First, aggregate demand growth was kept below its pre-crisis trend growth rate. Since the recovery started in 2009Q3, NGDP growth has averaged 3.3 percent. This is well below the 5.4 percent of 1990-2007 period (blue line in the figure below) or a 5.7 percent for the entire Great Moderation period of 1985-2007. Any way you slice it, macroeconomic policy has dialed back the trend growth of nominal spending. This can be seen in the figure below.

Second, aggregate demand growth was not allowed to bounce back at a higher growth rate during the recovery like it has in past recessions. Put differently, macroeconomic policy in the past allowed aggregate demand to run a bit hot after a recession before settling it back down to its trend growth rate.  This kept the growth path or level of NGDP stable. You can see this if the figure above by noting how the growth rate (black line) would typically go above the trend (blue line) temporarily after a recession. 

Had macroeconomic policy allowed this NGDP growth to follow its typical bounce-back pattern after a recession, we would have seen something like the red line in the figure. This line is the dynamic forecast from a simple AR model based on the Great Moderation period. This naive forecast shows one would have expected NGDP growth to have reached as much as 8 percent during the recovery before settling back down. Instead we barely got over 3 percent growth.  

So yes, macroeconomic policy has been different since the crisis. This policy choice, in my view, is a key reason whey the recovery was so anemic. 

P.S. Speaking of NGDP growth, Ambrose Evans-Pritchard NGDP has a sobering piece in the Telegraph noting that nominal demand has been persistently falling since late 2014. This decline in nominal economic activity, in my view, is tied to the Fed's implicit tightening of monetary policy via the talking up of rate hikes since mid-2014. 

Monday, October 17, 2016

Macro Musings Podcast: Izabella Kaminska

My latest Macro Musings podcast is with Izabella Kaminska. Izabella is part of Financial Times Alphaville, where she has been since 2008. She has written extensively on monetary policy, fiscal policy, financial technology, and is key force behind the Financial Times Festival of Finance. As a longtime follower of her work, it was a real treat to have her on the show.

We started our conversation by talking about blockchain technology and its implications for the payment system. Izabella is not optimistic about blockchain's future and wonders whether it will fulfill the expectations and hopes many observers have set out for it. 

Next, we move on to the topic of universal banking. This is the idea that a central bank would open its balance sheet to anyone, including households and non-financial businesses. Doing so would solve the bank run problem and reduce the probability of a financial crisis. There are already movements in that direction with introduction of the Fed's overnight reverse repo program (RRP)  and derivative houses opening accounts with the Chicago Fed. In the limit, universal banking would mean individuals could have personal checking accounts at the Fed. While this might solve the bank run problem, it would also mean a much larger government role in financial intermedation. We discuss why this would probably end very badly.

Izabella then discusses her take on unconventional monetary policy, especially the use negative interest rates. She is very critical of negative interest rates and explains why. Our conversation then segues into what can be done by policymakers during a deep recession. 

We conclude by taking a look at the book Trekonomics, by Manu Saadia, and consider its implications for future of economic growth. We also spend some time comparing the economics of Star Trek to Star Wars.The conversation was fascinating throughout.

You can listen to the podcast on Soundcloud, iTunes, or your favorite podcast app. You can also listen via the embedded player above. And remember to subscribe since more shows are coming.

Monday, October 10, 2016

Macro Musings Podcast: Claudio Borio

My latest Macro Musings podcast is with Claudio Borio. Claudio is the director of the Monetary and Economic Department at the Bank for International Settlements (BIS) and has been at the BIS in various roles since 1987. Previously, he was an economist with the OECD. Claudio is the author of numerous publications in the fields of monetary policy, banking, finance and issues related to financial stability. He is a leading voice on macroprudential regulation as well on international monetary stability issues. Claudio joined me to talk about these and other issues.

We began our conversation by considering what it is like to work at the BIS, the banks for central banks. We then segue to a discussion on the period leading up to the Great  Recession, a time when the BIS was one of the few institutions warning about the credit and housing boom. How did they get it right when so many central banks got it wrong? One answer is the BIS perspective on macroeconomics goes beyond the standard took kit of interest rates, inflation, and output gaps. The BIS, for example, does not see price stability as a sufficient condition for financial stability, it looks at gross capital flows rather than net, and it closely follows excessive credit growth. This thinking was largely absent from central banks prior to 2008.

Our conversation next moved to the international monetary system, the outsized role the dollar and the Fed plays in it, the Triffin dilemma, and what can be done to make the global financial system more robust. 

Claudio gave an interesting talk late last year title Revisting the Three Pillars of Monetary Policy. The three pillars are the importance of the equilibrium interest rate, the long-run neutrality of monetary policy, and the need to avoid deflation in all circumstances.We discuss why a more nuanced understanding of these ideas is needed and how it may have produced better macroeconomic policy before the crisis. For example, Claudio notes that this understanding would have made it easier to avoid the 'debt trap' that much of the global economy seems to be stuck in at the present. It also would have made central banks less fearful of benign deflationary pressures--those created by positive supply shocks--and thus avoided unnecessarily easy monetary policy during the housing boom period.

We then consider Claudio's coauthored article that reviews the vast amount of research that has been done on estimating the effect of the various unconventional monetary policies tried since the Great Recession. Claudio's survey of the literature finds that these policies have influenced yields and asset prices, but their effect on the real economy is more uncertain.

Finally, we close by asking Claudio what advice he would give to a young, budding macroeconomist. It was a fascinating conversation throughout. 

You can listen to the podcast on Soundcloud, iTunes, or your favorite podcast app. You can also listen via the embedded player above. And remember to subscribe since more shows are coming. 

Related Links
Claudio Borio's web page at the BIS
Global Imbalances and the Financial Crisis: Link or No Link? (2011) Claudio Borio and Piti Disyatat
Unconventional Monetary Policies: A Reappraisal (2016) - Claudio Borio
The Cost of Deflation: A Historical Perspective - Claudio Borio, Magdalena Erdem, Andrew Filardo and Boris Hofmann.
Revisting the Three Pillars of Monetary Policy - Claudio Borio
The Great Liquidity Boom and the Monetary Superpower Hypothesis--David Beckworth and Chris Crowe

Monday, October 3, 2016

Macro Musings Podcat: Andy Levin

My latest Macro Musing podcast is with Andrew Levin. Andy is a professor of economics at Dartmouth College and previously served two decades as an economist at the Federal Reserve Board, including two years as a special adviser to Chairman Ben Bernanke and Vice Chair Janet Yellen. Andy, in short, has a deep understanding of the history and workings of the Board of Governors and the FOMC .

During his time as a special adviser he helped spearhead the advent of the FOMC press conference, the Summary of Economic Projections, and the now infamous dot plot graph. He also was involved with the FOMC's official adoption of its 2 percent inflation target. Andy discusses these developments with me and how he would like to see them further refined. 

We also discussed what happened in 2008. The economy was contracting and yet for much of the year the Fed was signalling it was worried about inflation and wanted to raise rates. Specifically, beginning around April 2008 the market expectation of where the federal funds rate would be 12 months ahead started rising. It rose all the way to about 3.5 percent by June 2008--the market was expecting the Fed to raise rates 150 basis points in mid-2008! Although it slowly came down, the fed fund futures rate 12-months ahead still remained higher than the actual federal funds rate through September. This can be seen in the figure below:

Andy notes that the FOMC transcripts reveal that even by the September 2008 meeting Fed officials were still not grasping the severity of the crisis. Why? We discuss whether they were simply too focused on inflation or whether insular thinking and group think prevented the Fed from appreciating the severity of the downturn during 2008.   

We then moved on to Andy's proposed reforms. These have received coverage in the media and support from the 'Fed Up' campaign. Andy's reforms are driven by four key problems he finds with the Fed: (1) Regional Fed banks face a conflict of interest given their private ownership, (2) the process for choosing Fed officials is opaque and broken, (3) their is a lack of diversity at the Fed, (4) the Fed is shielded from public oversight. Andy's solutions to these problems are to (1) end commercial ownership of the regional Fed banks, (2) make Fed officials limited to a single, non-renewable 7-year term, (3) make all Fed employees public employees with a better representation of the American public, and (4) align transparency at the Fed with the standards of other public institutions. 

We close the discussion by looking at Andy's research on the anchoring of inflation expectations, the need to do periodic evaluations of the Fed's objectives, and the question of why inflation has been persistently below target for the past five years. This was a thought-provoking conversation throughout. 

You can listen to the podcast on Soundcloud, iTunes, or your favorite podcast app. You can also listen via the embedded player above. And remember to subscribe since more shows are coming. 

Related Links
Andy Levin's homepage
Andy Levin's twitter account
Andy Levin's reform proposal