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SufficientRe: BoE paper (self.badeconomics)

IntegraldsLiving on a Lucas island が 投稿

thing

This is less an R1 and more a desire to clear the air, to show how the pieces fit together, and to show that yes, you can think in terms of bog-standard AD-AS and be alright. All the fine details melt away when you realize that, at the end of the day, the Fed adjusts the stance of monetary policy to meet its dual mandate.

General

I'm going to begin with two statements. Both are true.

  • Over any given six-week interval, the Fed instructs its New York desk to perform open-market operations to keep the Fed funds rate near its intended target. The market quantity of reserves is endogenous in that the Fed adjusts reserve supply to keep the FFR near target.

  • Over any given two-year interval and beyond, the Fed adjusts the (expected path of the) Fed funds rate to keep inflation and unemployment near their mandated targets. The FFR is endogenous in that the Fed instructs its NY desk to conduct OMOs until the FFR is consistent with the Fed hitting its inflation and unemployment targets.

Is money endogenous?

That's a silly question. Damn near everything is endogenous.

If the Fed targets the monetary base, then the base is exogenous by construction and everything else is endogenous, including the broad money stock and the interest rate.

If the Fed targets the interest rate, then the interest rate is exogenous by construction and everything else is endogenous, including the base and the broad money stock.

If the Fed targets inflation, then inflation (or, the inflation forecast) is exogenous by construction and everything else is endogenous, including the base, the broad money stock, and interest rates.

The most accurate possible statement is, "at present, away from the ZLB, the Fed instructs its New York desk to engage in open-market operations to implement a target Federal funds rate over a six-week period. In turn, the Fed adjusts the target Federal funds rate to keep its inflation forecast near 2% at a two-year horizon and keep unemployment low." The Fed adjusts the supply of reserves to hit an interest rate target, and adjusts the interest rate target to hit its dual mandate.

The interest rate is exogenous on a given six-week interval but is endogenous over longer periods. Inflation (forecasts) are exogenous over a 2+ year interval if the Fed is doing its job. (Footnote: realized inflation will still fluctuate due to shocks that the Fed cannot offset, just as the FFR fluctuates on a daily basis due to small daily shocks on the FF market.) See also Svensson's lovely paper on the topic.

Banks and bank lending and whatnot

  • In the US, banks have reserve requirements. In normal times, those reserve requirements are binding.

  • Any individual bank, in partial equilibrium, can make up for a reserve shortfall by borrowing on the overnight Fed funds market. An individual bank is not reserve constrained because it acts as a price taker on the FF market.

  • In any given six-week interval, the banking system as a whole is not reserve-constrained because the Fed instructs its New York desk to engage in OMOs, adding or draining reserves from the aggregate banking sector as needed to keep the FFR near its intended target value. This is, perhaps, surprising. However, there's no need to panic.

  • Over time, if all banks simultaneously find themselves borrowing from the Fed funds market and lending to the public, the Fed will find itself inexorably increasing the quantity of reserves. Increased lending will translate to increased economic activity and prices will begin to rise. In turn, the Fed will notice that inflation is rising above target and will instruct its New York desk to undertake contractionary OMOs, draining reserves until the FFR rises, broader interest rates rise, and nominal spending growth cools. (Footnote: Monetarists, this is standard hot potato stuff, just with banks added in the middle. You should be comfortable here.)

  • This is standard "adjust the stance of monetary policy to keep AD stable" stuff from Econ 101. The Fed instructs its New York desk to engage in open-market operations to implement a target Federal funds rate. In turn, the Fed adjusts the target Federal funds rate to keep its inflation forecast near 2% at a two-year horizon and keep unemployment low.

Other general comments

  • The LM/MP curve is horizontal in (Y,r) space during any given six-week period. The money supply curve is horizontal in (M,r) space during any given six-week interval. The quantity of money is endogenous in multiple senses; to be specific, the quantity of reserves is endogenous to the FFR target.

  • The LM/MP curve is vertical in the long run. The Fed adjusts the interest rate until inflation (or the exchange rate, or NGDP) is on target. The Fed picks whatever interest rate is necessary to hit those targets. You cannot skip this step or ignore it. It is this step that allows us to think in RBC terms in the medium/long run.

  • The Fed only indirectly controls the FFR (via its control of reserve supply, plus its instruction to vary reserve supply to hit the FFR target). It has even less direct control over broader lending rates. Nevertheless, broader lending rates are linked to the FFR and the Fed can influence those rates via its influence on the FFR. The proofs are via no-arbitrage and profit maximization. The practice is in looking at the comovement amongst interest rates.

  • Over a two-year+ period it is perfectly fine to think in purely real terms, because when the Fed is successful in hitting its inflation target we are living as if we were in RBCland. (The point of central banking is to replicate the RBC equilibrium.) Ellen McGratten (and David Hume) is right that you can ignore monetary complications over the long run.

There is nothing in the prior paragraphs that would be out of place in Mishkin's monetary book.

What is objectionable in the BoE paper?

A few things strike me as troublesome.

  • Under "two misconceptions," there's a sentence about "Saving does not by itself increase the deposits or ‘funds available’ for banks to lend." This is true in any given six-week interval but is not true over the medium or long term. Banks can create money from nothing, but they cannot create goods from nothing, and if society wishes to invest more, it must consume less and save more. This is typically mediated through the interest rate. A general increase in the desire to save will bid down interest rates and move us along the investment demand curve.

  • The two paragraphs on QE are rather muddled and confused. "It is possible that QE might indirectly affect the incentives facing banks to make new loans, for example by reducing their funding costs, or by increasing the quantity of credit by boosting activity." Yes, that's exactly how it works. Further, the mere issuance of new reserves seems to matter in the way that conventional theory would suggest. If a working paper is taboo, then perhaps a BPEA paper would work.

Final thoughts

  • The IS curve (and the loanable funds model) is about real resources and the C/I split in real terms. The LM (or MP) curve is about the financial market and the money/bonds split in nominal terms. The point of IS-LM (or IS-MP) is to reconcile these two models.

  • The Fed instructs its New York desk to engage in open-market operations to implement a target Federal funds rate over a six-week period. In turn, the Fed adjusts the target Federal funds rate to keep its inflation forecast near 2% at a two-year horizon and keep unemployment low.

  • Read this.

  • Also read this.

  • For the role of the "loanable funds" theory, see also here and here.

Now if you'll excuse me I need a drink.

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[–]commentsrushi evry1 im noah!!! holds up fez 54 ポイント55 ポイント  (16子コメント)

Hey there

I see you're

assuming S = I

It would be a shame

if that were

Technically incorrect

[–]roboczarI see a linear VAR and I want to paint it black 10 ポイント11 ポイント  (0子コメント)

o no u di'nt

[–]Superrman1 5 ポイント6 ポイント  (9子コメント)

I'm a first year econ student/freshman/undergrad/whatever you wanna call it, I'm not amerifat. Anyway... I've learned that S = I so far in my econ 101 courses. Is there an ELI5 explanation for why S = I is "technically incorrect"?

[–]commentsrushi evry1 im noah!!! holds up fez 11 ポイント12 ポイント  (6子コメント)

That's a good question. From a macroeconomic perspective Trump is the return of the alpha male. Whenever you see societies that are collapsing you'll see a return of alpha males. That's why people like Mike Cernovich are coming to dominate the Twitterverse and why people like Ben Shapiro and the other cucks are starting to fall apart.

But seriously, S =/= I for a pedantic reason that I don't remember. But it makes for a good meme.

[–]IntegraldsLiving on a Lucas island[S] 5 ポイント6 ポイント  (0子コメント)

I=S

[–]LNhart 2 ポイント3 ポイント  (0子コメント)

It'th the Baboon mindframe: Marry a lawyer wife, don't work yourthelf, then get a divorthe and thue her and get filthy rich. Then thcam your dumb fanth for money, write a shitty book about being a ALPHA and make a shitty movie and then become even richer! The baboon mindframe

[–]roboczarI see a linear VAR and I want to paint it black 1 ポイント2 ポイント  (3子コメント)

Liquidity preference and the paradox of thrift. Not all savings makes it to investment due to LP.

[–]commentsrushi evry1 im noah!!! holds up fez 3 ポイント4 ポイント  (2子コメント)

What? Neither of those things mean S =/= I in a simple IS-LM model, IIRC. Liquidity preference just means the intercept term in the money demand function in nonzero.

[–]IntegraldsLiving on a Lucas island[S] 8 ポイント9 ポイント  (0子コメント)

I think he's confusing supply and quantity supplied. Common mistake.

I have a post on this forthcoming.

[–]roboczarI see a linear VAR and I want to paint it black 1 ポイント2 ポイント  (0子コメント)

To put it another way, firms don't immediately invest savings into capital goods. In fact, there is no guarantee that savings need be invested in new capital goods at all, if the preference for liquidity is higher than the preference for savings, i.e. the paradox of thrift.

[–]IntegraldsLiving on a Lucas island[S] 6 ポイント7 ポイント  (0子コメント)

commentsrus is memeing you. S=I.

[–]slugwindFiat currency is the gold standard of monetary policy. 4 ポイント5 ポイント  (4子コメント)

Why does that matters? Surely SAVINGS and savings is the same thing as INVESTMENT and investment, and if two things are labeled by the same word, they must be causally connected over all timescales, right? So I can totally take a long-run model and beat conclusions out of it, by plugging in data collected over 3 months, by assuming that the rate at which firms invest is equal to yearly aggregate spending in the whole economy, no ?

[–]IntegraldsLiving on a Lucas island[S] 9 ポイント10 ポイント  (3子コメント)

I have no idea what you're on about.

[–]slugwindFiat currency is the gold standard of monetary policy. 2 ポイント3 ポイント  (1子コメント)

Investment and saving as aggregates in a whole economy are quite different beasts than the investment and saving of an individual actor inside it, yet at alarming frequency you run into the notion that policies which increase them must be "good", because all else being equal ( which is typically not the case anyway ), something that happened in sub-sector of the economy, over a limited period of time, in response to somebody's pet policy, is somehow proof that an absolutely terrible misrepresentation of keynesianism is accurate.

I'm not going to mention any specific policy proposals though, but just clarify that: No! You cannot assume that sufficient spending will always cure a recession (not aimed at Integralds ).

[–]geerussellarmchair chartalist 4 ポイント5 ポイント  (0子コメント)

Investment and saving as aggregates in a whole economy are quite different beasts than the investment and saving of an individual actor inside it

It's possible to get very specific about what they are for the economy as a whole by referring to the capital account entry from the national acconts.

Expenditure equals income. Confusion and debate around this most simple and tautological of concepts arise from the accurate but entirely counter-intuitive label of gross savings for income along with the colloquial small-i usage of investment to describe personal saving.

Ask anyone how much they saved last year, approximately no one will respond with their gross income, but that's what gross savings is... so we get endless back and forth of people talking past one another over terminology.

[–][deleted] 1 ポイント2 ポイント  (0子コメント)

This strikes me as a highly unamerican phrase, are we rubbing off?

[–]besttrousers 22 ポイント23 ポイント  (3子コメント)

It's happening!

[–]gorbachev 14 ポイント15 ポイント  (1子コメント)

I needed this.

[–]IntegraldsLiving on a Lucas island[S] 9 ポイント10 ポイント  (0子コメント)

.

[–]say_wot_againMachine learning is a fad 13 ポイント14 ポイント  (0子コメント)

Thank you based Integralds.

[–]grevemoeskr"good RI but insuficient" - SWA 5 ポイント6 ポイント  (3子コメント)

Quick question that probably shows my lacking applied macro knowledge: Does the Fed target the money supply or the interest rate? Or, in other words, is the IS-LM view of how central banks works backwards? And is there central banks that actually targets the money supply, outside the ECBs weird money growth mandate?

[–]IntegraldsLiving on a Lucas island[S] 4 ポイント5 ポイント  (2子コメント)

Some terminology:

The Fed targets inflation.

The Fed uses the Federal funds rate as its intermediate instrument. It moves the Fed funds rate until inflation is (expected to be) equal to target (at some horizon).

The Fed uses the monetary base as its instrument. It moves the monetary base (via OMOs) until the Federal funds rate is at the desired level.

The Fed meets every six weeks. In those discussions, it determines the level of the Fed funds rate that is appropriate for hitting its inflation target. It then instructs its New York desk to conduct OMOs until the Fed funds rate is at the appropriate level.

So, base => OMOs -> FFR -> inflation.

[–]gus_ 2 ポイント3 ポイント  (0子コメント)

So, base => OMOs -> FFR

I think you're nearly 10 years behind the times on this point. QE turned a ton of securities into reserves, flooding the system with excess reserves, which would cause the FFR to fall to 0%. But they coincidentally started paying interest on reserves to maintain the FFR in a more direct way.

At this point, it makes no difference when the monetary base fluctuates: the rate is pinned to the floor (which they can raise/lower directly).

[–]Petros557there is no such thing as a market failure 0 ポイント1 ポイント  (0子コメント)

so the fed puts money into the fed bank account(increasing the base) of the nyfed which then loans it out at the rate(ffr) instructed so the desired level of inflation is reached.

[–]roboczarI see a linear VAR and I want to paint it black 8 ポイント9 ポイント  (16子コメント)

There is nothing in the prior paragraphs that would be out of place in Mishkin's monetary book.

There is nothing in the prior paragraphs that would be out of place in a post-Keynesian endogenous money primer. The paper is strictly descriptive. The rift appears when determining what the facts on the ground imply based on the available data.

Observational equivalence and the identification problem rears its ugly head once more.

[–]IntegraldsLiving on a Lucas island[S] 23 ポイント24 ポイント  (15子コメント)

I've always said that accounting cannot help us discriminate among well-formulated models.

Every model will be consistent with Y=C+I+G+NX and MV=PY.

What matters is the behavioral model that surrounds the accounting. On that front, I'm sorry to say, the mainstream has everyone else beat -- if only because it has so bitterly and deeply debated those behavioral assumptions for the last eighty years.

[–]roboczarI see a linear VAR and I want to paint it black 7 ポイント8 ポイント  (0子コメント)

Undoubtedly. The post-Keynesian criticism is that the deep and bitter debate was done in a hermetically sealed environment where specific assumptions about the fundamental nature of the models used in that debate were taken for granted when it's not entirely clear that they should have been.

But that's well beyond the scope of this paper.

[–]ZT17 3 ポイント4 ポイント  (13子コメント)

You seem very educated, so do you mind if I ask what school/branch of economics you associate with the most?

[–]jambarama 13 ポイント14 ポイント  (10子コメント)

This question doesn't make much sense. See this post for details. The tl;dr is the "schools" of economics are mostly leftover ideas of old economists that modern economists didn't pick up.

[–]ZT17 4 ポイント5 ポイント  (9子コメント)

I see. Could you recommend a good Macro textbook or an author in general who has good books?

[–]iamelbenI am the Walras 6 ポイント7 ポイント  (4子コメント)

Alternatively, here are some links:

This is Mankiw's seminal intermediate macro text. It contains calculus (but that is sufficiently cordoned off in footnotes and appendices.)

This is Mishkin's undergraduate monetary text (an older version, but still good)--the text cited by /u/Integralds in above comments.

This is Ljungqvist and Sargent's graduate macro theory text (requires advanced calculus and differential equations).

All good additions to your digital bookshelf.

[–]PonderayFollows an AR(1) process 4 ポイント5 ポイント  (1子コメント)

Ljungqvist and Sargent's

You're a cruel person for recommending this.

[–]iamelbenI am the Walras 7 ポイント8 ポイント  (0子コメント)

My pain is your pain :-)

[–]a_s_h_e_nall hail 1 ポイント2 ポイント  (1子コメント)

oooh I had Mishkin rented, super happy to have the dl. thanks man!

[–]iamelbenI am the Walras 2 ポイント3 ポイント  (0子コメント)

I got you, boo. We still need to have that drink. I'm going to be in the area for the holidays. PM me when/if you're free.

[–]wumbotarianhemispheric common market 4 ポイント5 ポイント  (0子コメント)

If you're looking for an undergraduate level book, Jones Macroeconomics teaches you the New Keynesian model.

[–]jambarama 4 ポイント5 ポイント  (0子コメント)

To be clear, in not OP. He is a practicing economist, I'm not even in the field. That said, he's got a suggested reading list on the/r/economics wiki that is worth looking at.

[–]Randy_Newman1502Administration saves the nation 5 ポイント6 ポイント  (1子コメント)

For textbooks, any recommendation would depend on your mathematics background. If you are just starting out (say, high school level calculus background), then this is the book I would suggest.

If you are familiar with more advanced calculus techniques and are decent at mathematics, then I would suggest you try this book.

This is a decent free macro textbook available online. I have only read a couple of chapters of this and its pretty decent for being free.

[–]wumbotarianhemispheric common market 5 ポイント6 ポイント  (1子コメント)

so do you mind if I ask what school/branch of economics you associate with the most?

I think he associates himself with "macroeconomics" since he has a PhD in economics and focuses on macro.

[–]IntegraldsLiving on a Lucas island[S] 8 ポイント9 ポイント  (0子コメント)

Yeah it's a difficult question to answer succinctly. I have a basket of models that I find plausible for different purposes. I know how to put them all together, at least conceptually, but if I were to put them together the result would just be "macroeconomics."

[–]DracoX872<= DEMON GOD OF FREEDOM 13 ポイント14 ポイント  (0子コメント)

Q U A L I T Y

[–]HeFlipYaThere isn't a literal connection, dude. 5 ポイント6 ポイント  (0子コメント)

Hoping someone can explain this to me:

Any individual bank, in partial equilibrium, can make up for a reserve shortfall by borrowing on the overnight Fed funds market. An individual bank is not reserve constrained because it acts as a price taker on the FF market.

I think I'm missing something as I don't understand why price taking is relevant to not being reserve constrained. In this scenario I'm imagining an individual bank having a particularly productive day of creating loan deposits, resulting in their reserves requirement not being met. They borrow on the overnight fed funds market, from other banks, deposit those borrowed funds with the fed, thereby meeting their reserve requirement ratio. Is that an accurate description, and if so, why the emphasis on being a price taker?

[–]smurphy1 6 ポイント7 ポイント  (6子コメント)

In the US, banks have reserve requirements. In normal times, those reserve requirements are binding.

Banks must always meet their reserve requirement eventually so I'm not sure why you added the qualifier "in normal times". Unless you meant something else.

[–]say_wot_againMachine learning is a fad 9 ポイント10 ポイント  (1子コメント)

He meant influencing decision making at the margin. In normal times, banks are close to their reserve requirements, and ceasing to satisfy them requires borrowing reserves at the FFR. In the post-QE world this doesn't happen.

[–]smurphy1 5 ポイント6 ポイント  (0子コメント)

In normal times, banks are close to their reserve requirements, and ceasing to satisfy them requires borrowing reserves at the FFR. In the post-QE world this doesn't happen.

In the pre QE world the mechanism used by the Fed to set the FFR required there be little to no excess reserves otherwise the FFR would be bid down and away from the target. With IOR this is no longer necessary however there must still be enough to meet the reserve requirement at a minimum. When I look at the linked FRED graph I see a period where banks lent and the Fed provided more reserves if there was not enough and drained reserves if there was too much. After the fact this has the appearance of banks lending right up to some limit imposed by reserves but it's not what actually happened. I'm not sure I fully understand what you guys are seeing when you look the same link.

[–]roboczarI see a linear VAR and I want to paint it black 5 ポイント6 ポイント  (0子コメント)

Unless it's the BoE where there is no reserve requirement at all. It's all about capital adequacy ratios, these days.

[–]Petrocrat 2 ポイント3 ポイント  (2子コメント)

And to use the word binding is sleight of hand. How binding, really, is something that can be satisfied retroactively?

[–]smurphy1 2 ポイント3 ポイント  (1子コメント)

With the picture he linked I think he meant that "in normal times" banks lend up to a multiple of their reserves resulting in zero excess reserves. But since that is wrong I'm giving him the benefit of the doubt that he meant something else and I'm simply misunderstanding his statement.

[–]Petrocrat 1 ポイント2 ポイント  (0子コメント)

Agreed, I don't see the relevance between the statement and the graph.

[–]geerussellarmchair chartalist 7 ポイント8 ポイント  (43子コメント)

There are a number of problematic statements in this RI but I'm just going to highlight a couple to start:

If the Fed targets the monetary base

As the Volcker debacle of ffr volatility made abundantly clear, that's simply not an option. Job one of the central bank is not the dual mandate, it is to furnish an elastic supply in support of this activity. If they fail to do so, it's a trainwreck for the payments system as bank deposit liabilities would no longer trade at par with each other or with central bank liabilities and we're all the way back to square of of the pre-central bank era.

Generally, what is objectionable in this RI is the quixotic attempt to explain money by... ignoring money in favor of a good-only view which just leads to badinstitutionalism, as illustrated here:

Under "two misconceptions," there's a sentence about "Saving does not by itself increase the deposits or ‘funds available’ for banks to lend." This is true in any given six-week interval but is not true over the medium or long term. Banks can create money from nothing, but they cannot create goods from nothing, and if society wishes to invest more, it must consume less and save more. This is typically mediated through the interest rate. A general increase in the desire to save will bid down interest rates and move us along the investment demand curve.

The statement is true over any time period because it's a statement about how financial assets are created. Of course banks can't create goods from nothing--and the paper doesn't claim they can. The connection between the monetary operations outlined in the paper and Investment is how Investment spending is financed.

Back to bog standard ad/as, it's a simple monopoly. The central bank sets price, meeting quantity demanded at the policy rate. A general increase/decrease in the desire to save money doesn't move the rate.

[–]varhafa 8 ポイント9 ポイント  (9子コメント)

A general increase/decrease in the desire to save money doesn't move the rate

In a simple monopoly a change in demand will move the equilibrium price.

[–]geerussellarmchair chartalist 3 ポイント4 ポイント  (8子コメント)

A general increase/decrease in the desire to save money doesn't move the rate

In a simple monopoly a change in demand will move the equilibrium price.

As long as you have the monopolist satisfying the quantity demanded at their chosen price, the price is stable. Of course they could try not to but in the case of a central bank this just means inducing price volatility. Given obligations to maintain the payments system, that volatility is for naught as quantity demanded still has to be satisfied.

[–]varhafa 7 ポイント8 ポイント  (7子コメント)

Then it's not a simple monopoly, the central bank isn't maximizing profit. And, even so, it's only stable in the short term, in the medium and long run the central bank isn't targeting interest rates and will change prices after a relevant change in money demand.

[–]geerussellarmchair chartalist 3 ポイント4 ポイント  (6子コメント)

I'm not sure how it is you see profit maximizing as entering the picture. Being the monopoly issuer of central bank reserves the central bank is a price-setter not a price-taker for those reserves. As such it sets the FFR and, given its obligations to the payments system, lets quantity float.

Nothing about that is specific to short/medium/long term.

[–]varhafa 7 ポイント8 ポイント  (5子コメント)

It doesn't enter, that's why the simple monopoly isn't a relevant model. And the interest rate target is specific to the short run, in any period longer than a single committee meeting the central bank isn't just letting quantity float.

[–]geerussellarmchair chartalist 5 ポイント6 ポイント  (2子コメント)

in any period longer than a single committee meeting the central bank isn't just letting quantity float

Quantity demanded is determined outside the scope of central bank control. If quantity demanded isn't satisfied, the system can't meet its reserve requirements (less important) and its daily settlement needs (essential to the function of the financial system).

So, quantity floats or the system crashes. This was true yesterday, still the case today, will still hold tomorrow. It's not a short/long term thing.

[–]varhafa 5 ポイント6 ポイント  (1子コメント)

Are we talking about the same thing? Changing interest rates doesn't prevent demand from being satisfied. By not floating I was talking about not letting the interest rate constant in response to a demand change, which is the original point we were discussing. A specific base interest rate target is a short run thing, it isn't the central bank's medium or long term target.

[–]geerussellarmchair chartalist 1 ポイント2 ポイント  (0子コメント)

Regardless of long or short run or whether they choose to hold it constant or move it at their discretion, the point is they're always setting a policy rate.

[–]IntegraldsLiving on a Lucas island[S] 8 ポイント9 ポイント  (1子コメント)

Correct. In any period longer than a single committee meeting the central bank is adjusting the base to hit an interest rate target, which in turn it is adjusting to hit an inflation target.

[–]geerussellarmchair chartalist 0 ポイント1 ポイント  (0子コメント)

Correct. In any period longer than a single committee meeting the central bank is adjusting the base to hit an interest rate target, which in turn it is adjusting to hit an inflation target.

I've seen you explain the IOR floor in detail before so I know you're well aware of how that rate maintenance regime works. Given that, you have to also know the above quote doesn't accurately describe the current FFR rate maintenance regime.

The implication of the central bank being able to determine the monetary base is even more inapplicable for the pre-IOR regime because any excess would push the rate below target and any shortfall would push the rate above target. Leaving them with only one option, then as now, supply the quantity demanded at the policy rate.

All of which is 100% consistent with describing it as a simple monopoly where the monopolist sets price, letting quantity float.

[–]model_econ 7 ポイント8 ポイント  (3子コメント)

I am pretty sure you are wrong on the issue of the duel mandate.

Looking at the Federal Reserve Act, specifically 12U.S.C §255a (I think that is how I quote that), we can see the specific role assigned to the board of governors and the FOMC.

I will just quote the entire relevant section: "The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates." which is effectively the duel mandate.

I think that FED page is just a simplification, but I could be wrong.

[–]geerussellarmchair chartalist 4 ポイント5 ポイント  (2子コメント)

I am pretty sure you are wrong on the issue of the duel mandate.

Then we shall settle this like gentlemen. Pistols at dawn. :)

I think that FED page is just a simplification, but I could be wrong.

I believe you're correct in your understanding of what the dual mandate is and what you quoted, however it was essentially an afterthought tacked on in the 70s. Kind of comes back to what I like to describe as the plumbers vs wizards view of the Fed. There's a day-to-day operations level where they are hands-on "plumbers" keeping the financial system flowing. Furnishing an elastic supply of reserves, engaging in rate and liquidity operations, regulation and supervision and other such activities. All of which is grounded in very direct, tangible levers.

Then there's the "wizards" view where the Fed is steering any/all aspects of the macro economy with technocratic benevolence. With long and variable lags and lots of hand-waving about transmission mechanisms--or even whether the question of "how" even matters.

I'm saying the questions about bank operations and what the BoE paper is describe falls mostly in the realm of financial plumbing and institutional arrangements without really taking a position on the wizarding world of the dual mandate one way or the other.

[–]model_econ 4 ポイント5 ポイント  (1子コメント)

I am not going to apologise for misspelling since that sets a dangerous precedent.

It is the case that the dual mandate was enacted in the 70s but I wouldn't call it an afterthought given how it was the first establishment of an objective for monetary policy.

While I am not directly approaching the topic of this post's intention directly I would probably suggest that the separating of "wizards" and "plumbers" is a bit of folly since the acts of the plumbers is frequently mandated by those wizards. So you can't put up Chinese walls between them and hope that effectiveness isn't transmitted. Again, I am mostly debating the semantics of your posts and not their content.

[–]geerussellarmchair chartalist 4 ポイント5 ポイント  (0子コメント)

It hardly matters what the objectives are if they aren't backed up by a coherent understanding of the underlying operations without which there is a real risk cargo cult policy in pursuit of those objectives. That relationship you describe goes both ways as the gap between what the wizards want and what they can actually do is bridged and constrained by the plumbers.

[–]IntegraldsLiving on a Lucas island[S] 8 ポイント9 ポイント  (28子コメント)

If the Fed targets the monetary base

As the Volcker debacle of ffr volatility made abundantly clear, that's simply not an option...

Slow down.

The statement I made is called a conditional. It is a statement of the form, "If A, then B." If the Fed sets a target for the monetary base and sticks to it, then the base is exogenous and everything else is endogenous. If the Fed sets a target for the FFR, then the FFR is exogenous and everything else is endogenous.

Your response is confusing because I never made any claim that the Fed actually sets an exogenous path for the base, nor did I say anything about whether setting an exogenous path for the monetary base was desirable.

I'll address the second half of your post later, but the answer is closely related to this post which was already linked in the OP. The discussion in that post is not exactly addressing your point, but it's easy to see that the form of the explanation will be similar.

If you wish, you can make Ms horizontal in the figures.

[–]geerussellarmchair chartalist 2 ポイント3 ポイント  (27子コメント)

I understand it was a conditional, one in a series of three: target the monetary base; target the ffr; target inflation.

What I was trying to pin down is of those three what do they, what can they actually control. So I started by ruling out the monetary base for practical reasons because crashing the system is not an option. That leaves FFR and inflation.

They clearly have the tools and capability to set the FFR. They can peg it at a specific rate, establish a corridor, or allow it to move freely but in every case it is an expression of central bank policy discretion as opposed to externally imposed on the Fed.

In the third case of targeting inflation, that's just a special case of setting the FFR. Adopting a reaction function turns the FFR into a weathervane, it doesn't create mastery over the wind.

So the entire "Is money endogenous?" section of the RI collapses into: Quantity is endogenous and the FFR is a function of Fed policy. No qualifiers about ZLB or short/long term necessary. Also, given the institutional arrangements, there is no hot potato effect as the supply is elastic to demand and any excess is either drained (under the pre-IOR rate-maintenance regime) or remains inert (under IOR).

[–]IntegraldsLiving on a Lucas island[S] 10 ポイント11 ポイント  (26子コメント)

They clearly have the tools and capability to set the FFR. They can peg it at a specific rate, establish a corridor, or allow it to move freely but in every case it is an expression of central bank policy discretion as opposed to externally imposed on the Fed.

What is perhaps interesting is that this paragraph is false by your own criterion of "not practical because it crashes the system. Specifying an inflation-aggressive reaction function is essential to determinacy.

The main papers are Sargent and Wallace, McCallum 1981, and Woodford. S&W show that interest rate pegs are unstable; McCallum shows that an interest rate reaction function is stable; Woodford examines the case of a standard NK model.

In the third case of targeting inflation, that's just a special case of setting the FFR. Adopting a reaction function turns the FFR into a weathervane, it doesn't create mastery over the wind.

There are two cases: monetary policy doesn't affect the price level, or it does.

If it does not, you have to specify a reaction function to get determinacy anyway.

If it does, then the Fed can both set and hit an inflation target.

Amusingly for /u/say_wot_again, I'm going to let Paul Romer explain why money does, indeed, affect output and prices.

[–]geerussellarmchair chartalist 4 ポイント5 ポイント  (11子コメント)

S&W show that interest rate pegs are unstable; McCallum shows that an interest rate reaction function is stable; Woodford examines the case of a standard NK model.

I'll have to defer on that for the moment because to respond I'd need to parse out the assumptions those claims rest on. For example, do they require loanable funds to be true as a financial constraint? Is it a real goods argument writing money out of the story completely? etc.

There are two cases: monetary policy doesn't affect the price level, or it does.

Rather than the broad rubric of "monetary policy" we should probably specify the lever being pulled. There's a case where interest rates have effects but they're context dependent and may be a weak, non-determinate vector. After all, a change in rates means different things to net creditors vs net debtors while both the status and magnitude of those circumstances are subject to change.

Also, before we wander too far afield I'll note that this is somewhat of a tangent from and not a challenge to the clarifications provided in the BoE paper on how financing works.

[–]gavroche1832 4 ポイント5 ポイント  (10子コメント)

There's a case where interest rates have effects but they're context dependent and may be a weak, non-determinate vector. After all, a change in rates means different things to net creditors vs net debtors while both the status and magnitude of those circumstances are subject to change.

I think this may be the key issue on which you and Integralds are talking past each other. Your earlier posts gave the general impression that your position was that changing the FFR cannot possibly affect inflation going forward. But as I understand it, you are now saying that the effect is ambiguous/uncertain.

Integralds seems to be claiming a causal mechanism by which FFR can affect inflation involving money supply. You are denying that this is a plausible explanation, but is viable in theory if certain assumptions hold (e.g. if firms' investment decisions are extremely sensitive to interest rates and dominate all other effects). Your main objection is that these assumptions are brushed under the rug.

Did I get it right?

[–]geerussellarmchair chartalist 3 ポイント4 ポイント  (9子コメント)

you are now saying that the effect is ambiguous/uncertain

Yes.

Integralds seems to be claiming a causal mechanism by which FFR can affect inflation involving money supply. You are denying that this is a plausible explanation, but is viable in theory if certain assumptions hold (e.g. if firms' investment decisions are extremely sensitive to interest rates and dominate all other effects). Your main objection is that these assumptions are brushed under the rug. Did I get it right?

Yes!

I'll also reiterate here the strange internal inconsistency there. A extreme strong belief in the indirect effects of monetary policy on inflation and employment to the extent it's basically a dial the central bank can turn to set those variables. Coupled with a curiously skeptical position about the substance of monetary policy in saying the central bank can't really set rates, only sorta kinda maybe nudge them but at the same time it can set the "money supply" wherever it please. Here the insistence on ignoring money becomes a serious analytical handicap leading to badinstitutionalism comments like this.

So we have a view of monetary dominance where the central bank just points to a spot and the economy goes there, resting on a foundation of don't know/don't care when it comes to the concrete steps it can take to produce the desired results.

[–]Petrocrat 1 ポイント2 ポイント  (8子コメント)

So we have a view of monetary dominance where the central bank just points to a spot and the economy goes there, resting on a foundation of don't know/don't care when it comes to the concrete steps it can take to produce the desired results.

This is such a frustrating attitude to deal with. You actually get that "don't know/don't care" attitude about the mechanism from the mainstream such as:

They set a target for the short term interest rate they think will produce money growth that is consistent with the value of the currency falling against a basket of goods (the CPI) such that the prices of the goods in said basket will increase by 2% annually.

But really the mechanism doesn't matter. As many mainstream economists pointed out it could be a black box for all we care. here

How can mainstream economists not care about understanding the mechanism? Isn't working out that undertanding the very point of their field, if it is, indeed, a science?

[–]say_wot_againMachine learning is a fad 0 ポイント1 ポイント  (7子コメント)

Yes they care what the black box is. But the point is that the A -> B pipeline is extremely well documented empirically. We have ample empirical evidence that monetary policy has an outsized effect on inflation and (in the short run) output. If you dispute the mainstream explanation for how that pipeline works, feel free to do so, but your competing theory must be able to reproduce that pipeline. If you get that wrong, it doesn't matter how elegant the English of your proposed mechanism is.

[–]Petrocrat 1 ポイント2 ポイント  (0子コメント)

Yes they care what the black box is.

So what's inside the black box, then? If money is the medium of transmission, then how does it transmit that money all the way to deposits and the CPI goods that deposits purchase?

If the medium of transmission is not money, then what is the medium and how does that work? If the whole of the theory is expectations/forward guidance, then I've heard enough about that to dismiss it.

[–]geerussellarmchair chartalist 0 ポイント1 ポイント  (5子コメント)

We have ample empirical evidence that monetary policy has an outsized effect on inflation and (in the short run) output.

I see a lot of faith-based assertion without a lot of substance behind it on that.

[–]Petrocrat 2 ポイント3 ポイント  (13子コメント)

There are two cases: monetary policy doesn't affect the price level, or it does.

There is more than one price level, though, so I don't think it's as simple as only these two cases. There are numerous sectors (as defined by their shared collective ledgers), each sector has its own relative price level pertaining to the assets traded on those ledgers. Failing to properly analyze the economy according to its sectors or bins of activity is a severe fatal shortcoming of modern macro.

When you use the term "price level" as you did, I think you are referring to the price level of general consumer goods. You are also speaking about it as if that price level is the only one and is representative of all transactions.

But, monetary policy doesn't actually directly intervene in the checking deposit accounts of consumers. It intervenes in the reserve accounts of banks, so it can affect the price level of assets that banks are exchanging among themselves (i.e. T-securities, reserves), but not the price level of consumer goods which it is not buying.

Commercial banks do intervene in the checking deposits accounts of consumers, so their actions can affect the consumer price level. Since monetary policy affects banks' ledgers it's plausible that monetary policy, by some tortuous mechanism can have a dilute effect on the consumer price level, but it is a very loose linkage (edit: the linkage would be very loose since whatever monetary policy action taken that is directed towards consumers would be attenuated by passing through the commercial banks before it reaches consumers) .

[–]alexanderhamilton3 5 ポイント6 ポイント  (12子コメント)

Wait. Are you seriously saying central banks can't target the CPI?

[–]Petrocrat 4 ポイント5 ポイント  (10子コメント)

Not directly, no (with the recent exception of the housing component of CPI since 2008). The commercial banks are interposed between the central bank and the consumer market. So any central bank action that is intended to affect the consumer price level is interceded by the commercial banks, who may or may not cooperate in transmitting that action across.

While the above logical consequence is not mainstream cannon, it is based on the mainstream economic concept of the price mechanism. Simply put, the price level is formed by actions of buyers and sellers of the goods in question. Since central banks do not buy or sell goods factored into the CPI (again with the exception of housing since 2008), they cannot directly influence it. They can influence financial paper (since they are a buyer of that) and in so doing influence bank behavior. But whether that influence is transmitted to the CPI is not guaranteed in the least, and depends more on what the commercial banks choose to do under the monetary policy set forth.

[–]alexanderhamilton3 2 ポイント3 ポイント  (9子コメント)

While the above logical consequence is not mainstream cannon

Because twenty years of experience have shown us that they clearly can target CPI inflation.

[–]Petrocrat 3 ポイント4 ポイント  (8子コメント)

I beg to differ. If anything the empirical evidence is the stronger case to be made against your thesis. It points to the central bank being unable to reliably or causally influence CPI. Japan is the prime example having seen low inflation despite central bank efforts since the early 1990s. The US and Europe are now also examples with around a decade of their respective central banks missing their inflation target to the downside, despite vocal effort to increase inflation.

edit: added supporting links

[–]Commodore_ObviousAlways Be Shilling 1 ポイント2 ポイント  (0子コメント)

The inflation target isn't a goal in itself that central banks strive to nail perfectly, it is just their way of signaling an intention to maintain low but positive inflation, and to prevent deflation. Inflation that is below target but still positive doesn't create much of a deflation expectation as long as people believe the central bank will act if/when their data suggest deflation risk.

[–]alexanderhamilton3 2 ポイント3 ポイント  (6子コメント)

I beg to differ

Thankfully it's not really a matter of opinion. A couple of years of below (or above) target inflation in the face of the worst recession in seventy years doesn't erase two decades of success. See UK, Australia or well pretty much any other developed country in the period after they set a numerical inflation target. The claim that this happened by accident is quite frankly laughable. Anyone making this claim is engaged in slothful induction in defence of dogma. Your examples are cherrypicking for the following reason:

Japan is the prime example having seen low inflation despite central bank efforts since the early 1990

When their target was price stability. They only recently announced a numerical inflation target

The US and Europe are now also examples

Even in your own graph the US performance amounts to a remarkable success. The ECB does not target 2% inflation. The mandate is to maintain price stability. Which they interpret at inflation under 2%. They also raised rates in 2011. Because they were trying to avoid overshooting their target.

[–]geerussellarmchair chartalist 1 ポイント2 ポイント  (0子コメント)

There's a big difference between targeting something and determining it. Moving nominal rates in reaction to CPI isn't the same thing as having policy control over CPI.

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