I feel like a lazy bum. Friday morning Ben Bernanke created $250,000,000,000 in new wealth before I’d even finished breakfast. That’s right, his speech led to about a 1/2% pop in equity prices. Given world markets seem to respond to Fed easing by about as much as US markets, that’s a half percent of roughly $50,000,000,000,000 (aka 50 trillion.)
And don’t say all the gains melted away by lunchtime. That’s not how equity markets work. Sure the disappointing consumer data depressed prices a few hours later, but they remain 1/2% above the level they would have been without that easing.
Bernanke didn’t actually say too much new, but he was pretty definitive. It seems we will get QE, and no change in the 2% inflation target. That might be viewed as disappointing. But the speech itself was fairly dovish (or pro-growth.) Indeed Bernanke staked out an almost Svenssonian position:
1. He clearly stated that inflation could be too low.
2. He strongly implied 2% is the right number.
3. He suggested that current forecasts are for well below 2% inflation.
4. He said that’s not good enough, policy needs to be more expansionary if inflation is expected to be too low at a time of 9.6% unemployment.
5. The Fed needed to do something about this situation.
I think Bernanke’s gamble is that 2% inflation will be enough, as long as they go all out for that figure. Using intro macro, Bernanke’s suggesting that the short run aggregate supply (SRAS) curve is now so flat that even getting up to 2% inflation would require much faster RGDP growth. He considered the initial recovery to be “reasonably strong.” I disagree, but if that’s his definition of fairly strong, then yes, 2% inflation would probably generate enough growth to satisfy Fed moderates like Bernanke.
The title of this post has a double meaning. I’m going to argue that monetary policy is really, really important at the zero bound. And in section 2 I’ll argue that monetary economics talk is also really, really important . (I know . . . how self-serving for a monetary economics blogger.)
Part 1. Why policy is important: Unless you want to be a complete ostrich, I don’t see how anyone could seriously deny that over the past 6 weeks the world equity markets have been repeatedly reacting to a long string of Fed statements and press releases. Yes, I know that the financial press cannot always be relied upon when they speculate as to what caused stocks to rise. But if anyone looks at this issue seriously, and with an open mind, I can’t see how they can fail to see the highly persuasive evidence that Fed announcements strongly affect equity markets. As just one example, the Dow occasionally soars or plummets by several hundred points immediately after a 2:15pm Fed target rate announcement.
To me, this suggests we shouldn’t even be arguing anymore about “pushing on a string.” Equity markets are up by 10% to 20% over the last 6 weeks (in both nominal and real terms), that’s a very important effect regardless of whether traders are operating with a faulty model or not. I can’t imagine how Chicago-type economists can go on about how swapping one zero-interest asset for another does nothing. Surely an extra $5 trillion in real wealth is something. They need to stop paying attention to their models, and look at what the markets are saying.
As for Mr. Krugman, his own model says swapping one zero interest asset for another is highly effective, if the action is expected to be permanent. (If temporary, it isn’t effective whether interest rates are at the zero bound or not.) Yet Krugman consistently pooh-poohs the prospects for conventional OMOs. I’m reminded of the stories that people like Richard Kahn had to keep reminding Keynes what he was trying to say in the General Theory.
In my view the whole pushing on a string debate is over. Case closed. If people want to close their eyes to how the markets are reacting to hints of Fed easing, that’s their prerogative. Of course some will argue that it is higher inflation expectations that are doing the job. But any permanent QE will create higher inflation expectations; that’s the whole point. And we’ve always known that temporary QE doesn’t do anything. So what’s the debate all about?
Part 2: Why monetary pundits matter: In my view $5 trillion is a reasonable estimate of the amount world stock markets have increased as a result of Fed talk about easing policy since the beginning of September. That’s 10% of my crude estimate of total world stock market equity. The exact number isn’t important, just the order of magnitude; $3 trillion or $7 would have the same qualitative implications. And the total gains to society have probably been far greater, as monetary stimulus also helps workers, not just capitalists. (Of course it’s a zero-sum game for bond markets.)
So who is responsible for all this wealth creation? Surely some credit must go to the Fed, after all, they are the institution that is ultimately responsible for determining monetary policy. But I think others also deserve some credit. Back in August, before all this occurred, Paul Krugman made the following observation:
So why am I even slightly encouraged? Because the critics did, at least, succeed in moving the focal point. Not long ago gradual Fed tightening was the default strategy; but as I said, at this point the Fed realized that continuing on that path would have unleashed both a firestorm of criticism and a severe negative reaction in the markets.
What we need to do now is keep up the pressure, so that at the next FOMC meeting the members are once again confronted by the reality that not changing course would be seen as dereliction of duty. And so on, from meeting to meeting, until the Fed actually does what it should.
I know: it’s a heck of a way to make policy. In a better world, the Fed would look at the state of the economy and do what was right, not the minimum necessary. But wishing for that kind of world is like wishing that Ben Bernanke were running the place.
Pretty prophetic eh? No wonder Brad DeLong is always saying Krugman’s right about everything. I agree, the Fed (like the Supreme Court) clearly does respond at least somewhat to outside pressure. So how much credit do we pundits deserve for this stock rally? Let’s take a conservative figure, assume it’s 10% due to outside pressure and 90% from the Fed seeing the light without any outside influence. So the pundits created a mere $500 billion in stock wealth since September 1st. Of course I’d like to take some credit for all this, especially since the Fed mentioned NGDP targeting in its most recent minutes. But in all honesty I think the markets reacted to level targeting of prices, not NGDP. I’ve also pushed level targeting, but Woodford and Eggertsson probably deserve most of the credit. So of the total of $500 billion in new wealth created by pundits pushing for easy money, let’s give Woodford and Eggertsson each 10%. Perhaps uber-pundit Paul Krugman deserves 5%, and for all us small fry pushing for monetary stimulus I’ll assign a trivial 1% share. And recall that’s only 1% of the 10% share assigned to all pundits–1/1000 of the total.
In other words, we at TheMoneyIllusion deserve credit for a mere $5 billion dollars in wealth creation. And I say “we” because it’s a collaborative project. For instance commenter Marcus Nunes sent me the old Bernanke papers from 1998 and 2003, in which he told Japan to do all the things that we are now telling the Fed to do. After I posted long excerpts, lots of other bloggers and media outlets started picking up on the story. Don’t think that Bernanke isn’t aware of what he told the Japanese to do, and don’t think he isn’t aware of all the media outlets quoting those comments. So I figure Nunes deserves about a billion. Notice how these tiny crumbs, $5 billion, $1 billion, roughly correspond to the wealth of Facebook’s two founders.
Am I serious? I’m not quite sure. It all sounds as ridiculous to me as it must to you. On the other hand, Krugman’s argument sounds pretty reasonable to me, so I can’t see any good reason why it might not be true. The bottom line is that no matter how thin you slice it, no matter how trivial the contribution to a sound monetary policy, good advice to the Fed is extremely valuable. Monetary economics is quite important, too important to be left to amateurs. Unfortunately, some of our most important monetary policymakers have relatively little training in the field.
BTW, economists at the Fed must be high-fiving themselves after I allocated $4.5 trillion in wealth creation to their brilliant policy ideas. But before they get too excited, and start dreaming about where they’ll spend their money, I feel it necessary to point out that Fed officials still have some unpaid debts associated with an earlier policy boo boo (click to enlarge):
Which proved very costly (click to enlarge):