No, The Fed Is Keeping Rates Low

As is now well known, Ben Bernanke has just launched a blog (welcome!) at the Brookings Institution. His first analysis post was "Why are interest rates so low?". He offers an explanation using textbook economic theory. As one might guess, I disagree with him about the framework used. However, my argument here is that even if I grant that his framework is (roughly) correct, he is still not able to draw the conclusions that he does.

Fed Lift-Off: Making Mountains Out Of Molehills

With the U.S. policy rate locked at zero and no Quantitative Easing in sight, reporters and commentators on the monetary policy beat have to dig really deep into the barrel in order to find content. Some of the latest kerfuffles around "lift off" (the first rate hike that pulls policy rates firmly away from zero) illustrate this. In summary, if the-Fed wants to hike rates, they will be able to do so. Moreover, I doubt that any rate hike trajectory will meaningfully depart from the previous policy of an average of 25 basis points a meeting.

Theme: Government Financial Operations

Modern Monetary Theory (MMT) emphasises the importance of monetary operations within modern economies. They explain the difference between Greece and Japan, a distinction that some find hard to make. This article provides a limited overview, and a set of links to some of my related articles on this topic.

Minsky On Bank Position-Making Instruments

Although the financial system appears extremely complex, the underlying principles tend to be stable over time. One of the fundamental needs of a banking system is for position-making instruments, which are financial instruments that can be bought and sold to manage liquidity. The economist Hyman Minsky often highlighted the importance of these instruments. This article summarises his discussion of this topic, which is useful for understanding some of the operations underlying government finance, in particular the repo market.

Primer: Can We Consolidate The Central Government And Central Bank?

One of the strengths of Modern Monetary Theory (MMT) is that it provides a clean analytical framework for the analysis of "modern" economies (economies with a free-floating currency and which controls its central bank). One of the ways in which it does this is to consolidate the central bank with the fiscal side of the central government. Such a consolidation has extremely important effects for understanding government default risk, and is controversial as a result.

UPDATE: This text was incorporated into the eReport Understanding Government Finance (link).

Book Review: Smaller Faster Denser Lighter Cheaper

The book Smaller Faster Lighter Denser Cheaper: How Innovation Keeps Proving The Catastrophists Wrong by Robert Bryce is a celebration of technical progress, in particular progress fueled by capitalism. As someone in the Peak Oil camp, I was curious to take a look at some of the more optimistic views of the future. Although I do not disagree with Bryce's assessment of the past, the weaknesses within his analysis did not really cause me to reassess my gloomier long-term outlook.

Demographics: The Non-Crisis Of The Dependency Ratio

It is fashionable to wring one’s hands about the impending demographic crisis that is about to hit the developed countries, at least amongst those who want to be seen as serious. There is no doubt that social programmes will need to change over time, but that should not be a shock: one of the definitions of something being dead is that it does not react to changes in its environment. In this article, I look at the demographic situation for the United States, and offer a high level explanation why it is not particularly worrisome. In order to be brief, I am looking only at the capacity to produce real goods and services here, and not the financial measures that are the usual justification for panic.

Brief Fed Comments

The Fed dropped "patient" from the statement, and the 10-year U.S. Treasury rallied 13 basis points to 1.92%. I am unsure what bond bears did in their previous lives, but they seem to be dealing with a lot of bad karma right now.

Update On Profits And Inflation

In the post-war period, there has been a strong secular relationship between inflation rates and the share of national income. In summary, corporate profits were at their lowest share when inflation was the strongest. As I noted in Low Inflation, High Profits, this relationship call into question the political neutrality of central banks' low inflation mandates. However, this is a topic of discussion that does not come up too often.

Canada Reaching The Wile E. Coyote Moment

It looks like the Canadian economy has run over the cliff; all that remains is the fateful moment when it is time to look down. The February Labour Force Survey was at best mediocre, but the ugliness lies in the details. Over the past year, 130 thousand jobs were created (a 0.7% annual growth rate), but 43% of those jobs (56 thousand) were in the Construction sector. The travails of Canada's oil and gas sector are highly publicised, but the collapse in construction employment is what will cause Canada to replicate the United States' downward spiral in the last recession.

Note To Reporters: You Cannot Analyse A Sovereign Like A Corporation

Reporters and (apparently) readers have a hard time differentiating between the different fields within finance, and so they happily treat comments made by people like internet analysts (!) as representing "what the markets think" about government fiscal ratios. Since bad fiscal analysis is more exciting than good analysis, that is what appears in the media.

Please note that the difference between corporate financial analysis and the analysis of governments is found in the book Understanding Government Finance (link).

Fed Rate Hike Cycles And Bond Yields

In the post-1990 era, most Treasury bond bear markets are associated with Fed rate hike cycles. (There have been some counter-trend selloffs, such as the “Taper Tantrum” of 2013.) The 1994 episode was a notorious bear market that persisted throughout the hike cycle, whereas later bear markets tended to be more front-loaded, with losses concentrated before the Fed even starts to hike rates. This is what one would expect in an environment where the Fed is transparent about its policy actions.

Nick Rowe's Question Is Silly Because It Ignores Stock-Flow Norms

In the article A silly question for anti-austerians, Professor Nick Rowe asks "anti-austerians" (which I am) whether they believe a debt-to-GDP ratio of 1000% and/or a fiscal deficit of 50% would require corrective steps (that is, austerity). If not, there are presumably less "silly" levels for these ratios where austerity is still warranted. In my view, his question misses the point: you can't get there from here, as a result of stock-flow norms. In my view, if a welfare state is following sensible policy, it cannot hit "unsustainable" government debt-to-GDP ratios as the private sector would begin dis-saving before hitting those levels.

Primer: Understanding Covered Interest Rate Parity

Covered interest rate parity is the relationship that determines the fair value of forward currency levels. It is easily understood from the perspective of an international bond investor or issuer, and these entities ensure that it holds in practice.