Wednesday, September 21, 2016

The Bank of Japan: Monetary Mastery or Quantitative Quagmire?

The New Abenomics Program
The Bank of Japan (BoJ) just launched a new phase in its monetary easing program popularly known as Abenomics. It is doing so in the hopes of shoring up economic growth. This monetary program until today had involved a targeted expansion of the monetary base at ¥80 trillion a year matched by ¥80 trillion in government bond acquisitions. There were also targeted purchases of ETFs and REITs on a smaller scale.1

The new phase unveiled today consist of three key developments. First, the BoJ will target the 10-year government bond interest rate at zero percent. Second, it will aim to overshoot its 2% inflation target so that it is truly symmetric. Third, it will drop its quantity target for the monetary base and simply make its expansion conditional on the inflation overshoot. Everything else in Abenomics remains roughly the same. 

So has the Bank of Japan finally mastered its monetary conditions in a way that will spur economic growth? Or is this just another step into the quantitative quagmire of Abenomics? The short answer: do not get your hopes up. There are two reasons why this probably will not make much difference. 

First, the BoJ is pegging the 10-year yield on government bonds at a level it would be at anyways. Because of slow global economic growth and continued uncertainty, yields on safe assets around the world have been falling since 2008. This race to the bottom for safe asset yields can be seen in the figure below:

Over the past eight years, this downward march of yields has occurred before, during, and after various QE programs. So while it is true that the BoJ has been the marginal buyer of Japanese government bonds over the last year, its actions are only doing what the global bond market was already doing and would have continued to do in the absence of BoJ actions. Put differently, the market-clearing or 'natural' interest rate that is based on fundamentals has been falling for some time and is already very low. The BoJ's new long-term interest rate target simply is a recognition of this fact. So there really is nothing new here.

Second, there is a serious credibility issue when it comes to the expansion of the Japan's monetary base. As seen in the figure below, the monetary base has seen a three-fold increase in its size since the beginning of Abenomics. If this expansion were truly permanent, then the price level would also increase threefold over the long-run. There is no way that can happen. The population is aging and depends increasingly on fixed income. Inflation for them is a non-starter. There is no political economy support for such a radical change in the price level.

Here is why this matters: some  portion of the monetary base injection (above that needed for normal money demand growth) needs to be viewed as permanent in order for spending and inflation to rise. If monetary injections are expected to be temporary they would do little to spur spending. If they are viewed as permanent, however, they would raise the expected future price level and thus temporarily push up expected inflation. The higher expected inflation, in turn, would spur robust spending in the present. But this requires some portion of the monetary base growth to be seen as permanent.

The problem, though, is that the expansion of the monetary base has been so large there is no way this growth can be seen a permanent for fear of excessive inflation taking off. The BoJ wants 2% inflation with some overshoot. If the threefold increase of the monetary base were made permanent, the BoJ would get 300% inflation with overshoot! Put differently, the massive expansion of the BoJ's balance sheet undermines its very goal of raising nominal spending and inflation.

So making the growth of monetary base conditional on inflation hitting its target is not credible. The monetary base is simply too large for the BoJ to get any traction this way.

So Does Abenomics Matter?
With all that said, Abenomics has been able to spur some aggregate demand growth and some inflation. Just nowhere near where the government wants it to be.  Below is a figure that shows the level of nominal spending (as measured by nominal GDP) for Japan.  Nominal spending has grown under Abenomics, far more than under the origional QE program of 2001-2006:

I used to think this moderate success was because the monetary base expansion under Abenomics was permanent. But now that the monetary base has gotten so large, I am doubtful for the reasons laid out above. So Abenomics has been moderately successful, but it is not entirely clear to me why this is happening.

It is worth noting one of the goals of Prime Minister Shinzo Abe's government is to raise nominal GDP to ¥600 trillion by 2020. Yes, Japan has a NGDP level target. The Prime Minister first called for this goal in September 2015 and spoke to it again in December 2015.  Since then, it has been in the government's economic and fiscal projections For example, here is the July 2016 executive summary of the projections. The nominal GDP goal stated near the top of the document.  

When the goal was first introduced, it was an ambitious 20% growth  goal for Japan's nominal GDP. It is now closer to 17% given the growth of nominal GDP since then, but this still remains a very ambitious goal as seen in the figure below. This figure shows different paths towards the ¥600 trillion by 2020. 

All of these paths seem ambitious given the recent growth rate of nominal GDP in Japan. It is not clear how to get there without having a major overshoot of inflation.  Maybe the BoJ could reiterate the governments nominal GDP level target and try to communicate that some small portion of the monetary base will be permanent and that it will be injected via purchases of perpetual government bonds. Admittedly, this would be a tough message to communicate. But it is not clear what alternatives there are for Japan. 

So to answer the question in the title to this post, I suspect Japan may be heading further into a quantitative quagmire rather than mastering its monetary conditions. 

P.S. Yes, the markets seem happy about this development so far. But they also seemed happy about the ECB's added stimulus in March 2016. That euphoria did not last and neither will this reaction to the BoJ. 

1ETFs were and continue be purchased at annual rate of ¥9 trillion while REITs are purchased at a targeted rate of ¥60 billion.

Monday, September 19, 2016

Macro Musings Podcast: Ryan Avent

My latest Macro Musings podcast is with Ryan Avent. Ryan is a columnist at The Economist magazine. He has previously been the news editor, economics correspondent, and online economics editor for The Economist. He is the author of The Gated City. His work has appeared at the Journal of Economic Geography, the New York Times, the Washington Post, the New Republic, Bloomberg, Reuters, and many other places.

Ryan has a new book that just came out titled “The Wealth of Humans: Work Power, and Status in the 21st Century” He joined me to talk about his new book, his work, and some of the pressing macroeconomic issues of the day.

We begin our conversation by covering what it is like to be a journalist at The Economist. We then move on to his new book, which makes the case that the economy is undergoing a transformative change because of the digital revolution. Ryan notes that while this change is ultimately a plus for the longrun, over the short-to-medium run it present challenges for the way we live and work. Work gives us meaning and income, but Ryan argues it is not clear what work will be like going forward as increased smart technologies displace labor. Will we, on the margin, move into new jobs or into more leisure?  We discuss possible solutions to smooth the transition to this new long-run state.

Ryan just returned from the UK so we also spend some time discussing Brexit and the economic and social forces behind it. We also discuss the Eurozone crisis and why it has persisted for so long. 

Finally, we cover the challenges with inflation targeting, the safe asset problem, and the futility of central banks trying to raise rates when global bond markets are pushing yields down. Once again, 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 shows are coming. 

Related Links

Monday, September 12, 2016

Macro Musings Podcast: Michael Bordo

My latest Macro Musings podcast is with Michael Bordo. Michael is a Professor of Economics at Rutgers University and a distinguished visiting fellow at the Hoover Institution at Stanford University. He has been a visiting scholar at numerous central banks and is a research associate of the National Bureau of Economic Research. Michael has published widely in the field of monetary economics and monetary history. Michael  joined me to talk about both recent and historical cases in monetary economics. 

We began by reviewing the Great Recession and what contributed to it. Among other things, we address whether growing inequality contributed to the recession. We also considered the evidence for the claim that recessions caused by financial crises necessarily lead to slow recoveries. The discussion then turned to Canada and why it did not have a banking crisis during the Great Recession and why its contraction was far milder than the one in the United States.

Michael has also studied the history of fiscal unions. Specifically, he has looked at the history of fiscal union in Argentina, Brazil, Canada, Germany, and the United States and what that means for the future of the Eurozone. The prognosis is not good. 

We closed out the show by talking about the historical record of deflation, rules-based monetary policy, and the use of inflation as a solution to excessive public debt. It was great 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 shows are coming. 

Related Links
Michael Bordo's Homepage

Monday, September 5, 2016

Macro Musings Podcast: Peter Ireland

My latest Macro Musings podcast is with Peter Ireland. Peter is a professor of economics at Boston college, a research associate at the National Bureau of Economic Research, and a member of the shadow open market committee. Peter has also been a visiting scholar at numerous Federal Reserve banks. Peter has published widely in monetary economics and has been on the editorial board of a number of top journals. Peter joins me to talk about monetary policy.

We begin our conversation by talking about his journey into macroeconomics. Peter did his graduate work at the University of Chicago where he studied under Bob Lucas, John Cochrane, and Michael Woodford. He shares how the spirit of Milton Friedman was very much alive during his time there and what that meant for learning macroeconomics. 

We then discuss the operational side of central banking by reviewing the meaning and role of the instruments, intermediate targets, and ultimate goals of monetary policy. Among other things, we discuss why central banks use short-term interest rates as the instrument of monetary policy rather than the monetary base and draw upon the classic Poole (1970) paper for insight. 

We next discuss the Taylor Rule as a tool to connect the instrument of monetary policy to its goals and then consider whether money supply aggregates could be a substitute for the Taylor Rule. We go on to discuss whether money has additional information not found in interest rates that could inform policy making. The answer seems to be yes if the Divisia monetary aggregates are used rather than the simple sum measures of the money supply. Peter notes that if one uses Divisia measures the empirical results showing a breakdown in the money supply - nominal income relationship are overturned. There is more and the conversation was fascinating 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 shows are coming!

Related Links
Peter Ireland's homepage
Peter Ireland's twitter account

Monday, August 29, 2016

Macro Musings Podcast: Hugh Rockoff

My latest Macro Musings podcast is with Hugh Rockoff. Hugh is a professor of economics at Rutgers University and has done extensive work on U.S. economic history. He is the coauthor of the popular textbook “History of the American Economy” and has served on the editorial boards of the Journal of Economic History and Explorations in Economic History.  

Hugh joined me for a fascinating conversation on U.S. monetary history. First, we discuss the idea of an optimal currency area (OCA) and consider how long it took the United States to become one. Hugh makes the case that it took about 150 years for the United States to become an OCA. As he notes, this does not bode well for the Eurozone. 

Second, we talked about the first two central banks of the United States, the 'free-banking' period, the monetary developments during the Civil War, and the flawed National banking system that emerged after the war.

Third, we covered one of the more underappreciated developments in U.S. monetary history: the existence of two floating currencies over the period 1861-1879. There was the well known 'Greenback' in Eastern United States, but there was also the 'Yellowback' in the Western United States. This development is not only interesting, but relevant for current conversations about the Eurozone splitting into two separate currencies. 

Finally, we concluded by talking about how some of the New Deal programs of the 1930s helped turn the United States into an optimal currency area. This was a great 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 shows are coming!

Related Links
Hugh Rockoff's homepage
Hugh Rockoff's paper How Long Did It Take the U.S. to Become an Optimal Currency Area?
Hugh Rockoff's paper Yellowbaks out West and Greenbacks Back East

Monday, August 22, 2016

Macro Musings Podcast: Doug Irwin

My latest Macro Musings podcast is with Doug Irwin. Doug is a professor of economics at Dartmouth College, a research associate with the National Bureau of Economic Research, and former staff member of the President’s Council of Economic Advisors. Doug also served as an economist at the Federal Reserve’s Board of Governors.

Doug is one of the leading experts on trade economics and has published widely on the topic, in both journals and books. His books include Free Trade Under Fire, Against the Tide, an Intellectual History of Free Trade, and Peddling Protectionism: Smooth-Hawley and the Great Depression. Doug is currently working on The Battle Over U.S. Trade Policy a Historical Look at U.S. Trade Policy Since the Founding of the Country and has also researched the role the interwar gold standard played during the Great Depression. 

Doug joined me for a fascinating conversation on trade. We began the show by reviewing the main arguments for free trade and why it seems to have taken a black eye this election cycle. Among other things, we consider whether the sluggish recovery since the crisis has been a reason for why free trade has become so much more contentious, not only here but in other advanced economies. 

We then discuss some of the recent research on trade as well as some of the recent and not-so-good popular work on the topic. Along the way we consider whether free trade is a good idea for small, developing economies. 

To help put the trade debate in perspective, we then review the development of trade policy in U.S. history. Finally, we talk about the role the interwar gold standard played in creating the Great Depression. It was a great conversation throughout. This is timely topic. 

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 shows are coming!

Related Links
Doug Irwin's personal web page
Dout Irwin's twitter account

P.S. Here is a link to the upcoming monetary policy conference.

Wednesday, August 17, 2016

The Unwinding of QE Has Begun

Don't look now, but the Fed is quietly unwinding QE. As seen in the figure below, the Fed's share of marketable treasuries has been shrinking:

To be clear, this is a passive unwinding of QE. The Fed's treasury holdings have not changed, but the stock of marketable treasuries has grown. Nonetheless, this is still an unwinding according to the portfolio channel of monetary policy. This channel says the Fed's taking of safe treasury assets from the public would force investors to rebalance their portfolios toward riskier assets. This rebalancing, in turn, would reduce risk premiums, lower interest rates, push up asset prices, and help shore up the recovery.

Now the portfolio channel should be working in reverse. The public is getting a larger share of treasuries relative to the Fed thanks to the ongoing budget deficits. Moreover, this passive unwinding by the Fed is being reinforced by other central banks according to CNN Money:
In the first six months of this year, foreign central banks sold a net $192 billion of U.S. Treasury bonds, more than double the pace in the same period last year, when they sold $83 billion. 
China, Japan, France, Brazil and Colombia led the pack of countries dumping U.S. debt. It's the largest selloff of U.S. debt since at least 1978, according to Treasury Department data. 
"Net selling of U.S. notes and bonds year to date thru June is historic," says Peter Boockvar, chief market analyst at the Lindsey Group, an investing firm in Virginia.
So have all these central bank actions caused U.S. treasury yields to take off? Have the Bill Grosses of the world finally vindicated themselves? The answer is no. Treasury yields continue to remain at historic lows despite the unloading of treasuries by central banks. How can that be? Here is CNN again with the answer:
Despite all the selling by these countries, private demand for the bonds has sky rocketed. Demand is so high that the U.S. can afford to pay historically low interest rates. The 10-year U.S. Treasury hit a record low of 1.34% earlier this year, before bouncing back to about 1.58%, currently.
In other words, central banks have not been very important in shaping the path of long-term treasury yields. You, me, and our financial intermediaries, on the other hand, have been a key reason for the decline of U.S. treasury yields to historic lows. While not the only factor, our seemingly insatiable desire for safe assets has been a pivotal factor behind the low interest rates. And, as can be seen in the figure below, the decline in safe asset yields is a global phenomenon:

This is the safe asset shortage problem. As seen in the figure, the trend in safe asset yields turned down in 2008. This common change in trend should reinforce the point above that this is not a consequence of central bank's actions. Instead, as outlined here, the safe asset shortage problem is the consequence of a reduction in the supply of safe assets, an increase in demand for them, and an ongoing spate of bad economic news that keeps this economic sore from naturally healing. 

The failure of treasury yields to rise with the unwinding of QE is just another data point that confirms this understanding. Here's hoping the Bill Grosses of the world take note.