oldfart
Older than dirt
Trading insults is lots of fun, but I think we ought to get beyond the ideological shit on rare occasions and actually discuss something important.
The reason given for the recent volatility in financial markets this month is that the participants are wondering when the Fed will stop buying and start selling securities. There was actually a pretty good article in "National Review" about six months ago which actually says the same thing as Krugman does. So what are they talking about?
Economists across the political spectrum use one model or another that accepts one basic Keynesian point: that monetary stimulus like the Fed has been conducting will have to be reversed at some point or it will cause excess inflation. I think everybody agrees on that. The question is, how do we know when we are at that point and what does the Fed do then?
The answer given by the New Keynesians is that while we are in an extremely weak economy there is zero risk of inflation and a huge cost if we deleverage too early. On the other side, people like Martin Feldstein have been warning of high inflation for over five years and don't think that expansionary monetary policy is helping much right now. Recently the argument has emerged that this monetary policy is creating a "bubble" which risks another bust.
Now there is a quick, easy, and good way to measure what the markets think future inflation will be. The genius of using this is that monetary policy chiefly effects the real economy through expectations, especially in financial markets, so to a large extent it doesn't matter if the expectations are true or not. If lots of people think that the Fed is going to reduce its buying, regardless of the reasons for that belief or its accuracy, the bond market will sell off bonds, bond prices will fall, and published interest rates will rise. Next week at the Treasury auction new issues will fetch lower prices and the yield rates on newly issued bonds will be higher. QED.
Now this is not a Left-Right thing; it is mechanically how "open market operations", the day-to-day monetary policy of the Fed, functions. It would be exactly the same if Rand Paul were chairman of the Fed. But here's the new wrinkle: that weekly auction not only sells things like the ten year Treasury note, it also sells a Treasury Inflation Protected Security (TIPS) which adjusts its face value for the inflation rate. Of course this costs a bit more. The spread between the regular Treasury note and TIPS is the market's prediction of future inflation. You can check out the auction results yourself at TreasuryDirect - Home
Now this spread is a great little tool for macro models. It is market determined and does not depend on a sample. The market has trillions of dollars at stake, so we know they are serious. There is no sampling error and no controversy about how survey questions are worded and such polling stuff. And it does measure inflation expectations. The spread has begun creeping up lately, from about 1.7% to about 2.0% over the last few months.
So if we are worried about inflation like Feldman, all we have to do is pick a trigger level for the spread and scream like banshees when it is reached. The current official goal is 2% and the CBO model predicts inflation of 2.0--2.5% through the end of 2014 and modestly higher after that. We might reasonably expect that a 70's style monetary tightening Volker style would not be indicated until at least a 3.5--4% level, but that's what the debate is about.
Whatever trigger point is chosen, there remains the question of what do do when it is reached. This is probably a good question for later as I have gone on longer than I anticipated already. Suffice it to say that traditional monetary theory of any flavor recommends pretty much the same action and that even the "National Review" doesn't think it will be hard to implement.
Peace and crabs from Joe's.
The reason given for the recent volatility in financial markets this month is that the participants are wondering when the Fed will stop buying and start selling securities. There was actually a pretty good article in "National Review" about six months ago which actually says the same thing as Krugman does. So what are they talking about?
Economists across the political spectrum use one model or another that accepts one basic Keynesian point: that monetary stimulus like the Fed has been conducting will have to be reversed at some point or it will cause excess inflation. I think everybody agrees on that. The question is, how do we know when we are at that point and what does the Fed do then?
The answer given by the New Keynesians is that while we are in an extremely weak economy there is zero risk of inflation and a huge cost if we deleverage too early. On the other side, people like Martin Feldstein have been warning of high inflation for over five years and don't think that expansionary monetary policy is helping much right now. Recently the argument has emerged that this monetary policy is creating a "bubble" which risks another bust.
Now there is a quick, easy, and good way to measure what the markets think future inflation will be. The genius of using this is that monetary policy chiefly effects the real economy through expectations, especially in financial markets, so to a large extent it doesn't matter if the expectations are true or not. If lots of people think that the Fed is going to reduce its buying, regardless of the reasons for that belief or its accuracy, the bond market will sell off bonds, bond prices will fall, and published interest rates will rise. Next week at the Treasury auction new issues will fetch lower prices and the yield rates on newly issued bonds will be higher. QED.
Now this is not a Left-Right thing; it is mechanically how "open market operations", the day-to-day monetary policy of the Fed, functions. It would be exactly the same if Rand Paul were chairman of the Fed. But here's the new wrinkle: that weekly auction not only sells things like the ten year Treasury note, it also sells a Treasury Inflation Protected Security (TIPS) which adjusts its face value for the inflation rate. Of course this costs a bit more. The spread between the regular Treasury note and TIPS is the market's prediction of future inflation. You can check out the auction results yourself at TreasuryDirect - Home
Now this spread is a great little tool for macro models. It is market determined and does not depend on a sample. The market has trillions of dollars at stake, so we know they are serious. There is no sampling error and no controversy about how survey questions are worded and such polling stuff. And it does measure inflation expectations. The spread has begun creeping up lately, from about 1.7% to about 2.0% over the last few months.
So if we are worried about inflation like Feldman, all we have to do is pick a trigger level for the spread and scream like banshees when it is reached. The current official goal is 2% and the CBO model predicts inflation of 2.0--2.5% through the end of 2014 and modestly higher after that. We might reasonably expect that a 70's style monetary tightening Volker style would not be indicated until at least a 3.5--4% level, but that's what the debate is about.
Whatever trigger point is chosen, there remains the question of what do do when it is reached. This is probably a good question for later as I have gone on longer than I anticipated already. Suffice it to say that traditional monetary theory of any flavor recommends pretty much the same action and that even the "National Review" doesn't think it will be hard to implement.
Peace and crabs from Joe's.
