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Scott Sumner has written dozens of blog posts trying to explain to why the fiscal multiplier is zero if the central bank targets the NGDP level, the price level or inflation. Said in another way Scott – as do I – strongly believe that the impact of fiscal policy strongly dependent the monetary policy reaction to fiscal tightening or fiscal easing (Even today Scott has a discussion of the fiscal multiplier). In fact I don’t even think it is meaningful to talk about fiscal policy as something that can “stimulate” demand. Hence, in a pure barter economy we cannot imagine fiscal policy having any impact on demand as demand always will equal supply in a barter economy. The famous Say’s Law holds in a barter economy and as such there would be full crowding out of fiscal policy. Hence, fiscal policy will only have an impact on demand if monetary policy “plays along”.
Guest post: Central Banks Should Quit “Kicking Them While They Are Down!"
Following the US media's reporting on the Republican primaries it seems like the candidate who will be nominated for the GOP candidacy for US presidency and who will eventually might win the presidential elections will be decided by their views about a retro-toy called Etch A Sket. Might I suggest that US political pundits instead start following the actions of an Italian called Mario - Mario Draghi!
Since the ECB introduced it's 3-year LTRO on December 8 the signs that we are emerging from the crisis have grown stronger. This has been visible with stock prices rebounding strongly, long US bond yields have started to inch up and commodity prices have increased. This is all signs of easier monetary conditions globally.
Recently (since December) we have seen US bond yields start to inch up and at the same time oil prices (and other commodity prices) have also inched up. This seem to be a great worry to some commentators - "Higher oil prices and higher bond yields will kill the fragile recovery" seem to be the credo of the day. This, however, reveals that many commentators - including some economists - have a hard time with basic demand-and-supply analysis. Said, in another way they seem to have a problem distinguishing between moving the supply curve and moving the demand curve along the supply curve.
Recently I have been thinking whether it would be possible to understand all financial market price action through the lens of the equation of exchange - MV=PY. In post I take a look at the bond market.
Traditional monetarists used to consider money-velocity as rather stable and predictable. In the simple textbook version of monetarism V in MV=PY is often assumed to be constant. This of course is a caricature. Traditional monetarists like Milton Friedman, Karl Brunner or Allan Meltzer never claimed that velocity was constant, but rather that the money demand function is relatively stable and predictable.
Today S&P500 closed above 1400 for the first time since June 2008. Hence, the US stock market is now well above the levels when Lehman Brothers collapsed in October 2008. So in terms of the US stock market at least the crisis is over. Obviously that can hardly be said for the labour market situation in the US and most European stock markets are still well below the levels of 2008.
Josh Barro has an interesting comment on the economic policies of US presidential candidate. However, more interesting really is his comments on past and present US monetary policy:
Just as with fiscal policy, an improving economy will change our monetary policy needs. Contrary to popular opinion, the Federal Reserve has not been irresponsibly “printing money” in recent years. The weak economy has led people to hoard cash instead of spending it — which has more than overcompensated for the Fed’s supposedly aggressive policies.
Today, given the recovering economy, the Fed is now just about loose enough. This hopefully means that the economic recovery will accelerate, no longer held back by bad monetary policy.
But the Fed must resist the urge to tighten prematurely, which could set us back into another slump. A moderate period of moderate inflation is nothing to be afraid of; in fact, it will help underwater homeowners to get out of hock and improve the housing markets.
Josh is of course right. US monetary policy has not been loose, but rather too tight. The recession is a result of a sharp increase in dollar demand. Josh is also right that monetary policy now seem to have become more accommodative. This is visible from the improvement in US macroeconomic data, but obviously also something we can observe directly from the financial markets - rising stock prices, higher bond yields and higher commodity prices. So yes, there certainly seem to be both a recovery and some stabilisation in expectations. Said, in another way it seems like the Fed is regaining some credibility.
That said, the discussion about monetary policy should really not be about whether it is a bit too tight or a bit too loose at the moment. Rather we need to continue to discuss what the Fed should target. There need to be a continued discussion about the Fed's operational framework and about it's target. Market Monetarists obviously would prefer that the Fed introduced a NGDP level target. I wonder if Josh Barro would support that?
HT Blake Johnson