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Professional blogger and full time investor in real estate, stocks and bonds. Focus is on cross over investing, multi asset and long-short. Started a small private hedge fund.
  • Market Monetarism  0 comments
    Aug 1, 2014 9:48 PM

    Every now and then, a new economic school of thought gets born. Such was the case in 2011 when Danish economist Christensen coined the phrase "market monetarism". In brief it is not a theory but rather an argument for central banks to adopt a nominal GDP target ('NGDP'). Thus far a NGDP target has been rejected by central banks although both Bernanke and Carney have spoken of its potential benefits. One benefit often mentioned is that a nominal GDP target allows the economy to achieve quicker stability as the premise of higher income is more powerful than a forecast of lower unemployment and stable inflation. 

    When an economy is in a monetary disequilibrium-a combination of high unemployment and low inflation--only consequences of tight or loose monetary policy can be observed in markets. Because markets are forward looking, large QE programs are priced like conventional policy. In other words, asset prices adjust like they would have done in response to a policy rate change. According to this view, markets are an indicator of future (forecast) GDP that can be above or below the NDGP target.

    The GDP forecast has become a hot debate this year. With Q1 GDP now at -2.1% year over year and Q2 trailing at 4%, there is an anemic about 2% real GDP created. Adding 2.1% inflation, nominal GDP is just shy north of 4%, the lowest since 2009. The bond market has corresponded appropriately by rallying 75 basis points --0.75%--since January. A weak GDP and signs of structural headwinds lowering the economy's potential, has advocates within the Fed to change to the mandate towards GDP targeting.

    As Yellen suggested last year, the real equilibrium Fed Funds rate is likely to stay well below average because of low growth and low inflation. In her speech last year June, she showed that an optimal control approach in setting the Fed Funds rate may be appropriate. This is a method where a specific "loss-function" conditional on a baseline Fed's GDP forecast is simulated to determine the Fed's neutral policy rate. In other words, optimal control being perhaps the next variant of the Fed's forward guidance, suggests an approach that has 'market monetarism' characteristics. If Yellen is appointed, a market monetarist approach within the Fed is a future possibility.

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