Matt Nolan

QE discussion fun

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Last week I was away from the internet and work – as I was trying to finish off my paper for the NZAE conference this year.  So I missed this post by Cochrane (including a bunch of great comments) and a reply by Sumner.  Yah.

I’d note something that doesn’t come from these posts – some other people are simultaneously saying QE does nothing to increase NGDP, and that it creates asset bubbles.  This argument is far from clear to me, if QE is doing nothing because it is merely a swap of assets with the same yield with no macro impact then why do asset prices change?  Isn’t the increase in asset prices partially due to a lift in expected NGDP growth.  “Bubble” isn’t an answer to everything – we sort of need to understand where it is coming from.

I am sort of hoping some people may stumble here to tell me what I’m missing 🙂

Update:  AAMC on twitter reminded me about this post, which I’d seen as well.  The Cochrane post and comments are, to my mind, a discussion on the same sort of issues – and the Sumner post is a reminder that we have to think about the monetary policy rule and the expectations channel, and base money is special because it is a medium of account (I’m a bit nervous here, as I suspect T-bills are also seen as a medium of account in a large number of contexts, which takes us back to the Cochrane post).

All in all, the debate about QE as a mechanism is important.  Thank goodness we are not in this situation in NZ.

jamesz

Housing fuelled consumption boom?

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In the EJ:

There is strong evidence that house prices and consumption are synchronised. There is, however, disagreement over the causes of this link. This study examines if there is a wealth effect of house prices on consumption. Using a household-level panel data set with information about house ownership, income, wealth and demographics for a large sample of the Danish population in the period 1987–96, we model the dependence of the growth rate of total household expenditure with unanticipated innovations to house prices. Controlling for factors related to competing explanations, we find little evidence of a housing wealth effect.

Matt Nolan

The excel error in Rogoff-Reinhart

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I see the Rogoff-Reinhart figures regarding the correlation between GDP growth and the size of the debt stock are currently under attack – due largely to an unfortunate excel error discovered reported by Mike Konczal.  Here are the list of posts about it at the moment:

All very nice.  Depending on the message people were trying to sell they either said the result was meaningless, or central, so I don’t think this makes any actual difference.  Honestly, without clear causal drivers there just were not good evidence based claims for actual policy adjustments – a lot of people were actually just saying we need to do X based on their preconceptions.  And they found this correlation either something that supports that (somehow) or something they need to rule out.

Over the last few years I have seen authors, at different times, use R-R as central to their argument on one thing, and then dismiss it for arguments regarding other issues (I’m not going to name names).  For example, you can’t use this result to say we need more savings policy because the stock of debt is to high, then complain that the study is flawed when you want more government borrowing … just focus on the actual core elements of your frikken argument instead!

My problem with the result isn’t the excel errors, or anything R-R appear to have said – it is the way it has been used as an inconsistent marketing tool by people for selling their own unrelated ideological policies.  I’m just hoping that this shuts that up.

As a side note, here are my feelings on twitter:

People who think the R&R result caused austerity overestimate the impact evidence has on government policy.

Matt Nolan

Ex-ante concerns about moral hazard

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Fascinating post by Stephen Williams, who is a great monetary economist.  In it, he goes through speeches at the Federal Reserve from September 2007 – a few months into the burgeoning credit crisis.  In it he shows that there was a debate between the views of “inherent instability” and “induced fragility” for what was going on – this sort of trade-off was captured in the Sargent paper (at least in part) that we’ve mentioned before.

Now when I’ve described the crisis to people I’ve stuck to the inherent instability line, the trilogy of articles (*,*,*) I did on Rates Blog was supposed to give that impression to people – with the third article pointing out that moral hazard exists as a more long-term point.  According to this, the Fed and then the ECB didn’t do enough to stop a bank run due to “too much” weight on moral hazard – and this drove a deep crisis.

However, the induced fragility hypothesis is also compelling (note they could both have happened – but where you put the weight determines what policy lessons you learn).  According to this, it wasn’t until the policy actions of late 2007 and then the bail out of Bear Sterns then the moral hazard became compelling.  However, once financial institutions saw they would be bailed out, they immediately took on lots of risk – making the system a lot more fragile when the Fed finally decided not to bail out Lehman Brothers.

There is evidence for this, Lehman Brothers took on a lot of debt – highly risky debt – following the collapse of Bear Sterns.  I remember reading the paper that had this, a paper that actually said it was the bailout of Bear Sterns that made the crisis worse, but I have forgotten where it is … I’ll link when I find it.

If the spectre of moral hazard fed into the fragility of the finanical system that quickly, the justification for bailouts becomes a lot weaker – if we accept significant inherent instability in the financial sector, then regulation with a lender of last resort becomes more acceptable.  Evidence helping to determine what weights to put on these explanations will be very useful for designing regulation (or the lack of) in the post-GFC world.

Induced fragility as a medium term concept is a central part of how most economists see this crisis.  However, it is an open question about whether the bailout of Bear Sterns (and the earlier TAF) created “induced fragility” that made the collapse much worse.  More research on this issue will be pretty interesting, and will help to inform what sort of trade-off we are facing with policy.

Matt Nolan

Financial regulation: Efficiency vs stability trade-off

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Over at Rates Blog the trilogy of articles I’ve put up about the GFC has been completed with this one.  The first two artices are here and here, and the blog post I did on them are here and here.  Infometrics will be popping up some more articles on Tuesday’s, but they won’t be on the GFC anymore 😉

So in the first two I mentioned uncertainty about the lender of last resort function as a catalyst for the crisis, and a reason why it persisted.  However, this isn’t a costless function – it is true that introducing financial regulation to induce “stability” will impact on the efficiency of the financial markets.

We like to pretend this is not the case.  We like to pretend that the government has the knowledge and ability to figure out what the “externality” is and what “credit ratios” are appropriate – and so faced with a crisis we tend to focus solely on stability.

However, this is not the case.  In fact, the crisis occurred in part due to our determination to make the banking sector around the world more competitive – leading to the development of the shadow banking sector to avoid regulation.  In such a case, we can only get “appropriate” regulation when we in turn accept lower competitiveness in the banking sector.  And given the “supernormal profits” banks get in this case, they are ripe for second best style regulation through the central bank.

In truth, we either throw out the central bank and have competition over the medium of account through banks directly (allowing them to work together in the face of bank runs), or we have a central bank who directly regulates the whole businesses – it was our attempt to get the best of both worlds that helped us wander into the situation we found ourselves in.

Now none of this is news for central banks – they have been trying to length maturities for bank liabilities and clarify and improve regulation in the banking sector for some time.  The crisis was a reminder of the unintended consequences of regulation – firms (in this case banks) can innovate to avoid regulation as well, and that can be costly.  This must be taken into account, and the full cost involved should be accepted, when it comes to setting up policy – rather than throwing around piecemeal rushed ideas and concepts.

Matt Nolan

More on describing the crisis

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Rates blog posted another article by me, this time talking about why the GFC persisted.  So in the first one I laid down Fed actions as the catalyst, and in the second one I’ve primarily laid the blame on institutional confusion in Europe.  I’m not sure anyone will find this article, by itself, particularly enlightening.  These first two are both simply descriptive (although with a background structure guiding what I talk about), and their only purpose is to illustrate that the “crisis” itself was kicked off by a sudden change in the expected actions of policy makers, and uncertainty about that action.  This isn’t to say that even with perfect policy we wouldn’t have had a recession – but it is to say that the depth and length of the slowdown that has occurred is related to such policy inconsistency.

So if we live in a world where we have decided that a lender of last resort is required in the case of such a crisis, what does that mean for the rest of the time.  After all such a commitment leads to moral hazard.  I’ll be covering that next week in the conclusion article.

The reason I’ve tied these three articles together as I have is because I wanted to create a clear narrative, and then work out what that suggests from policy – that requires answering a bunch of stylised facts (the timing in the crisis, the length of the crisis) with a central story.  The world is not that simple, and so every movement and every “bad thing” that occurred cannot be explained by such a clear narrative.  But it does allow us to help identify an issue and then understand what this means.