Friday, March 17, 2017

Macro Musings Podcast: Jason Furman


My latest Macro Musings podcast is with Jason Furman. Jason is currently a Senior Fellow at the Peterson Institute for International Economics. Previously, Jason spent eight years serving on President Obama’s Council of Economic Advisers, including the chair position from 2013-2017. Jason also worked on the Council of Economic Advisers under President Clinton.

Jason joined me to talk about his time at the CEA. Among other things, we talk about fiscal policy, the fiscal multiplier, monetary policy offset, and the platinum coin. This was a super fun talk throughout. 

You can listen to the podcast on Soundcloud, iTunes, or your favorite podcast app. You can also listen via the embedded player above. And remember to subscribe since more episodes are coming.

Related Links
Jason Furman's Twitter Account
Jason Furman's Webpage

Monetary Policy Analysis is Hard: Inflation Edition

I have a new article at The Hill that responds to some of the buzz created  by the Cecchetti et al. (2017) paper that was delivered at the U.S. Monetary Policy Forum:
What causes inflation? Most people believe inflation is caused by central banks adjusting monetary conditions... But is this right? A recent study by some top economists has raised questions about this conventional wisdom.  
The study found that the standard indicators... [like] economic slack, inflation expectations, and money growth were, in fact, unrelated to inflation. These findings caused quite a stir and even led the Wall Street Journal to declare that “everything markets think they know about inflation might be wrong”. 
This understanding misses, in my view, the deeper and more important point of the Cecchetti et al. paper. As the authors note in a separate blog post, the lack of a relationship between the standard indicators and inflation is actually an indication that the Fed has done a good job in managing inflation:
While the USMPF report is titled Deflating Inflation Expectations, we do not conclude that expectations are unimportant. In fact, quite the opposite: the failure of measured inflation expectations to help forecast changes in inflation is probably a side effect of monetary policy’s success in stabilizing them. 
This point, though, is a subtle one that is often missed by observers and that is why I wrote my piece for The Hill. Drawing upon Nick Rowe's work, I used the following example to illustrate the idea:
Imagine that the Fed is a driver, the economy is a car, the gas pedal is monetary policy and the car's speed is the inflation rate. The Fed’s objective here is to keep the car moving steadily along at 65 miles per hour.  
When the car starts climbing hills, the Fed pushes further down on the gas pedal. When the car starts descending from the hills, the Fed lays off the gas pedal. Over many hills and miles, the Fed is able to maintain 65 MPH by making these adjustments to the gas pedal.  
 A child sitting in the backseat of the car who was oblivious to the hills but saw the many changes to the gas pedal would probably conclude the gas pedal has no bearing on the speed of the car. After all, no matter what happened to the gas pedal the car’s speed never changed.  
 As outside observers, we know better. We know the driver was adjusting the gas pedal just enough to offset the ups and downs of the hills so that a constant speed was maintained. In terms of our Fed analogy, monetary policy was adjusted just enough to offset the ups and downs of the economy so that a stable inflation rate was maintained.
So many people have failed to grasp this point, especially over the past eight years. The Fed got the inflation it wanted over this period by pushing the gas pedal--QE and low rates--just enough to offset the drag of the Great Recession on the price level. Although the Fed wanted a quick recovery, it wanted even more to maintain stable and low inflation. This is evident in their core inflation projections in the FOMC's Summary of Economic Projections (which always saw 2% as ceiling) and in the FOMC's revealed preferences.

This meant the FOMC was not willing to allow an inflation overshoot which, in addition to making their inflation target symmetric, would have allowed more rapid catch-up growth in aggregate demand. As I have said elsewhere, this was the Fed's Dirty Little Secret: its policies were never going to create a robust recovery given the Fed's asymmetric approach to inflation targeting.

But I digress, the point of this post is to remind us that analyzing monetary policy is hard. One cannot simply draw conclusions by looking at interest rates, output gaps, money growth and comparing them to inflation Depending on how the Fed is conducting monetary policy, these indicators should be uncorrelated with inflation if the Fed is doing its job.

Given the importance of this idea, I have excerpted an earlier post on this topic below the fold.

Friday, March 10, 2017

Macro Musings Podcast: Larry White

My latest Macro Musings podcast is with Larry White. Larry is a professor of economics at George Mason University where he specializes in monetary economics and monetary history.

Larry joined me to talk about India's demonetization's efforts and Austrian macroeconomics. This was fun and fascinating conversation throughout.You can listen to the podcast on Soundcloud, iTunes, or your favorite podcast app. You can also listen via the embedded player above. And remember to subscribe since more episodes are coming.

Related Links
Larry White's Homepage

Friday, March 3, 2017

Macro Musings Podcast: Tim Duy


My latest Macro Musing podcast is with Tim Duy. Tim is a professor of economics at the University of Oregon, a columnist for Bloomberg, and a former economist at the U.S. Department of Treasury. 

Tim is also a widely read Fed-watcher and he joined me to talk about Fed watching and the future of U.S. monetary policy. If you want to get into Fed watching this podcast is just for you. Tim shares his approach and what defines a successful Fed watcher. 

We also discussed some of Tim's recent comments about the normalization of Fed monetary policy. The FOMC plans to return to normal monetary policy by first raising it interest rate target and then by reducing the size of its balance sheet. Tim thinks this is a bad idea, as he has written in several Bloomberg articles. He would like to see a simultaneous raising of interest rates and shrinking of the Fed balance sheet as the Fed returns to normalcy. We discuss why he favors this approach.

This was a fascinating conversation throughout. You can listen to the podcast on Soundcloud, iTunes, or your favorite podcast app. You can also listen via the embedded player above. And remember to subscribe since more episodes are coming.

Related Links
Tim Duy Homepage

Friday, February 24, 2017

Macro Musings Podcast: Hester Peirce


My latest Macro Musings podcast is with Hester Peirce. Hestor is a Senior Research Fellow and director of the Financial Markets Working Group at the Mercatus Center. She previously served on Senator Richard Shelby’s staff on the Senate Committee on Banking, Housing, and Urban Affairs. In that position, she worked on financial regulatory reform following the financial crisis of 2008 as well as oversight of the regulatory implementation of the Dodd-Frank Act. Hester also served at the Securities and Exchange Commission as a staff attorney and as counsel to Commissioner Paul S. Atkins.  Hester was also nominated by President Obama to be an SEC Commisioner.

Hester joined me to discuss a new book she co-edited with Ben Klutsey titled “Reframing Financial Regulation: Enhancing Stability and Protecting Consumers” This book covers a lot of topics on how to better regulate the financial system. 

We spent most of our time talking about how to improve the stability of the financial system. The laws and regulations emanating from Dodd-Frank (DF) were supposed to make the financial system safer, but a number of recent papers--Nissim and Calormiris (2014)Sarin and Summers (2016)Chousaks and Gorton (2017)--find the banking system weaker now and not meaningfully safer than pre-2008. Others, like Minneapolis Fed President Neel Kashkari, are worried about financial institution that remain too big to fail (TBTF) since they still fund with too much debt. Moreover, it is not clear if the reforms made in DF, like living wills and the Financial Stability Oversight Council, will actually make much difference should the TBTF institutions get in trouble again. President Kashkari, consequently, has proposed a number of reforms to end TBTF.

Hester and I discussed these concerns as well as the possibility that DF has actually increased the fragility of the financial system. One area, in particular, that is creating new potential problems for financial stability is the new DF central clearinghouse utility for derivatives. These central clearinghouses or CCPs were created as a way to improve transparency about derivatives so that regulators and other observer would know what is happening in this part of the financial system. Ironically, however, they appear to be making the financial system more fragile. This is because the CCPs concentrate all the risk from formerly bilateral relationships into one financial firm, making it another TBTF institution. Put differently, DF has inadvertently created more Lehmans or AIGs. 

Now some of the clearinghouse existed before DF, but they have grown and absorbed more risk since DF. In fact, the Financial Stability Oversight Board has designated some of the CCPs as TBTF institutions that need to be monitored. Other reports have come out saying "clearing house push has created unforeseen systemic risk" or "U.S. Treasury warns clearinghouses could spread risk". So it is not clear whether DF on balance has increased the safety of the financial system.

Hester and I do discuss other issues that are covered in the book, but I wanted to highlight here what I see as one of the bigger issues still facing us eight years after the crisis.

If you are interested in the book, you can download it or individual chapters from here. This is a great resource to have as the new President and Congress consider revamping financial regulation.

This was a fascinating conversation throughout. You can listen to the podcast on Soundcloud, iTunes, or your favorite podcast app. You can also listen via the embedded player above. And remember to subscribe since more episodes are coming.

Related Links
Macro Musings podcast with Anat Admati (similar these covered).

Friday, February 17, 2017

Macro Musings Podcast: Sebastian Mallaby



My latest Macro Musings podcast is with Sebastian Mallaby. Sebastian is a senior fellow at the Council on Foreign Relations and a contributing columnist to the Washington Post. Previously, he worked with the Financial Times and the Economist magazine and is the author of several books. He joined me to talk about his latest book “The Man Who Knew: The Life and Times of Alan Greenspan”.

This was a fascinating conversation throughout. You can listen to the podcast on Soundcloud, iTunes, or your favorite podcast app. You can also listen via the embedded player above. And remember to subscribe since more episodes are coming.

Monday, February 13, 2017

The Monetary Superpower: As Strong As Ever

In a forthcoming paper, Chris Crowe and I argue the Fed is a monetary superpower:
[A] defining feature of the US financial system is that its central bank, the Federal Reserve, has inordinate influence over global monetary conditions. Because of this influence, it shapes the growth path of global aggregate demand more than any other central bank does. This global reach of the Federal Reserve arises for three reasons. 
First, many emerging and some advanced economies either explicitly or implicitly peg their currency to the US dollar given its reserve currency status. Doing so, as first noted by Mundell (1963), implies these countries have delegated their monetary policy to the Federal Reserve as they have moved towards open capital markets over the past few decades. 
These “dollar bloc” countries, in other words, have effectively set their monetary policies on autopilot, exposed to the machinations of US monetary policy. Consequently, when the Federal Reserve adjusts its target interest rate or engages in quantitative easing, the periphery economies pegging to the dollar mostly follow suit with similar adjustments to their own monetary conditions.  
[...] 
The second reason for the global reach of US monetary policy is that a large and growing share of global credit is denominated in dollars. That means the Federal Reserve’s influence over the dollar’s value gives it influence over the external debt burdens of many countries.  
[...] 
The third reason for the extended reach of US monetary policy is that other  advanced- economy central banks are likely to be mindful of, and respond to, Federal Reserve policy given the large size of the dollar bloc...  These  findings imply that even  inflation- targeting central banks in advanced economies with developed financial markets are not immune from the influence of Federal Reserve policy. This has led Rey (2013, 2015) to argue that the standard macroeconomic trilemma view is incomplete. 
There is more in our article, but I wanted to share this excerpt because a new working paper from Ethan Ilzetzki, Carmen Reinhart, and Kenneth Rogoff sheds light on our claim that Fed is a monetary superpower. 

Specifically, this new paper shows that contrary to conventional wisdom exchange rate regimes across the world have not become significantly more flexible since the end of the Bretton Woods System. This surprising finding is backed up by a large cross-country data set that spans the period 1946-2015. Moreover, they show that the limited exchange rate flexibility has coincided with an expanding reach of the dollar. From their abstract:
Our central finding is that the US dollar scores (by a wide margin) as the world’s dominant anchor currency and, by some metrics, its use is far wider today than 70 years ago. 
Here is the key chart from their paper as it relates the monetary superpower argument. It shows the share of world GDP that has the dollar as its anchor currency:


What this graph implies is that about 70 percent of world GDP has its monetary policy effectively set by the FOMC! Given the size of the dollar bloc and its spillover effects, it is likely the Fed's total influence on global monetary conditions is even larger. 

This is staggering. It means that twelve Fed officials that meet in Washington D.C. largely determine global monetary conditions. The Fed is truly a monetary superpower. 

Related Links