Friday, January 29, 2010

Assorted Musings

Here are some assorted musings:

(1) Despite all the financial problems in Greece, Nouriel Roubini says the real threat to Eurozone is Spain. This emphasis on Spain seems reasonable given that it is the fourth largest economy in the region and is experiencing a severe recession along with an exploding budget deficit. It also appears there now will be a bailout for Greece making it less of a problem for the Eurozone. As I have noted before, these problems all point to the Eurzone not being an optimal currency area and, thus, not well suited to a one-size-fits all monetary policy. Along these lines, it was interesting to read this piece from The Economist:
It is often said that the IMF cannot intervene within the euro zone because it would be too humiliating, politically, for the EU to admit it could not look after one of its core members. That is clearly a view shared by senior officials. However, one source offered a further reason why the IMF is not welcome that I had not heard before. The fund's experts typically offer countries in trouble a mixture of fiscal and monetary advice, he explained: ie, they tell countries to cut public spending and raise taxes, but also to alter interest rates and take steps to stabilise their currency. If the IMF told Greece to cut public sector salaries, say, that would not shock the rest of the EU, he said. But what if the IMF demands that Greece tighten or loosen its monetary policy? Greece shares its monetary policy with the other 15 members of the euro zone: would the ECB be expected to change its monetary policies? And what would Germany have to say about that?
Although the contract on the Eurozone's future says we should not expect too much excitement in 2010, it will be interesting to see whether this currency union will shed some of its periphery over the next few years.

(2) Tyler Cowen seems to be buying into the Great Recalculation story promoted by Arnold Kling. He points to this map as evidence of the Great Recalculation and alludes to the idea in this New York Times discussion over Bernanke's reappointment. Scott Sumner responds by pointing us to this map which indicates the Great Nominal Spending Crash is a better story. I would also encourage Tyler to look at the last figure on this post which shows a broad decline in employment, a development more consistent with Sumner's view.

(3) Speaking of a the Great Nominal Spending Crash, it is worth noting that despite the great GDP numbers released today both domestic demand and aggregate demand are still experiencing low year-over-year growth rates. From these figures on the links above it is apparent that nominal spending is still far too low relative to trend.

(4) Bill Woolsey, in a reply to Scott Sumner post, does a great job summarizing the key questions facing the Fed. He provides answers with which I completely agree--it is almost as if he read my mind. (If only he would also read the part of my mind that sees the Fed's monetary policy in the early-to-mid 2000s as way too accommodating...)

(5) Scott Sumner alerts us to the possibility that the Fed may soon start targeting the demand for bank reserves rather than the federal funds rate. It would do that by adjusting the interest paid on excess reserves as the instrument of monetary policy. If I understand this potential development correctly, the Fed would effectively be targeting a quantity (monetary base) rather than a price (federal funds rate). Is this right or is there more to it?

(6) The always interesting Niall Fegurson discusses Obama's new proposals for regulating banks and finds them lacking. Martin Wolf agrees with him.


  1. If I understand this potential development correctly, the Fed would effectively be targeting a quantity (monetary base) rather than a price (federal funds rate). Is this right or is there more to it?

    I think of it differently. The Fed is still targeting a price (an interest rate), but is doing so with the intention to affect the demand for a quantity (base money) as opposed to simultaneously changing the supply of a quantity (as they do now).

    I guess this comes down to what you mean by target. I think it might be more useful to describe both policies as targeting some dual-mandate amalgam of inflation and activity indicators. In the current case, they use a quantity (the MB) to manipulate a price (FFR) to help hit this target. In the IOR case, they use a price (IOR) to manipulate demand for a quantity to help hit this target.

    Of course, yet another way to say it is that it allows the Fed to target both a quantity and a price; i.e. because it controls the opportunity cost of reserves without having to use the quantity of reserves to do so, so it can set the quantity of reserves separately.

  2. David, here is an article, with comments from Marvin Goodfriend, on the putative change in Fed instrument:

  3. Thanks dlr for the insights and ECB for the link. Although moving to paying interest on excess reserves may improve the efficacy of monetary policy, I suspect it will make the stance of monetary policy less clear for the public.