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Wednesday, July 23, 2014

My Initial Reaction To Optimal Fiscal Policy Theory

I am giving my first impressions of the literature on "Optimal Fiscal Policy", which is yet another sub-field of Dynamic Stochastic General Equilibrium (DSGE) models. Like any other area of academic enquiry, there is a huge wave of articles that are variations on a few themes. It appears that this field represents steps towards a more realistic model framework for DSGE models, but it is unclear whether they represent a practical advance over Functional Finance insights into fiscal policy.

Sunday, July 20, 2014

The Bond Bear Market Of 2014 Has Been Delayed

Chart: 10-Year JGB Yield
Strategists went into 2014 with a consensus bearish view on bonds (as was also the case in 2010-2013...). The market action so far has not been kind to that view, with yields plunging in the developed markets. It may be that I have fallen into a too mellow summertime mood, but my guess is that this is largely a squeeze of the bond bears during quiet markets (although there are obvious geopolitical concerns).

Wednesday, July 16, 2014

Yes, Interest Rates Are Artificial

Noah Smith discusses at the Bloomberg View the strange idea that floats around on the internet - that the current low interest rate regime is "artificial". The idea being that "the market", if left to its own devices, would set interest rates higher. He discusses why that view makes little sense. However, I would amplify his arguments to state that it is almost impossible for "markets" to set interest rates, other than by completely restructuring the economy in a fashion where the government and existing pools of finance capital largely disappear.

Tuesday, July 15, 2014

Canada - Sluggishness Reigns

Chart: Canadian Unemployment Rate
I am just catching up some data, and I wanted to highlight the rather tepid Canadian employment data for June. There is no sign that the economy is building up towards "escape velocity"; rather, the job market is decelerating. Given the magnitude of the Canadian housing bubble, that is not what policy makers want to hear.

Wednesday, July 9, 2014

Are Fed Rate Hikes Coming Sooner?

There has been a run of stronger data in the United States, and there have been some calls for an acceleration of monetary policy tightening. It seems like the timing will be set by the personalities of the policy makers, and my guess is that the middle of 2015 remains a reasonable base line forecast. Higher inflation in Canada has whip-sawed the Bank of Canada, but I doubt that this is too meaningful.

Sunday, July 6, 2014

Comments On John Cochrane's Critique Of New Keynesian Models

I am once again looking at one of John Cochrane's papers. He has written a new working paper, "The New Keynesian Liquidity Trap", in which he explains the rather strange properties of the New Keynesian models when they hit the Zero Lower Bound for interest rates. He also wrote an op-ed for the Wall Street Journal in which he questions the case for fiscal activism which is based on those models. I think this is a good example of the dysfunctional nature of mainstream economics - I agree with his analysis of the 'New Keynesian' models, but I think his policy views make very little sense.

Wednesday, July 2, 2014

If r < g, DSGE Model Assumptions Break Down

The relationship between interest rates and the growth rate of the economy is critical for government fiscal dynamics. In the literature for Dynamic Stochastic General Equilibrium (DSGE) models, the discussion of the governmental budget constraint appears to have an embedded assumption that the real interest rate on government debt is greater than the economic growth rate (“r>g”). However, there is no reason that this has to be true, and the mathematics of the budget constraint fails if the condition does not hold. This poses a problem for the constraint, as a true mathematical constraint is something that is always true. Once this constraint is dropped, a good portion of the recent academic literature discussing fiscal policy becomes irrelevant. (Despite my opportunistic use of “r” and “g” in the title of this article – in order to capitalise on the popularity of a recent book – it has nothing to do with inequality.)