David Beckworth recently interviewed Tom Graff:
Graff: The other thing I would just point out is that the first quarter GDP being negative was quite spurious. The final demand numbers, which basically takes out some of the trade impact, was quite positive. So the only reason why it was negative was because import numbers were so high and having a really strong import is a sign of a strong economy, not a weak economy. But this quarter’s a little different. This quarter, the biggest negative effect was from fixed investment, which includes home building, and equipment purchased by companies and stuff like that. And that going negative is pretty notable, right? That’s probably a first order effect of the Fed tightening financial conditions, and it’s interesting that’s happened so quickly. Because remember, this GDP’s only counting April, May, and June, and a lot of those fixed investments decisions are made over an extended period, so the fact that’s turned negative so quickly is definitely notable.
Beckworth: Yes, I have found that striking too. And as you mentioned, a little surprising because you think of monetary policy working with long and variable lags, as Milton Friedman said, but as my colleague Scott Sumner likes to say, monetary policy can also work with long and variable leads when it comes to financial conditions and in turn, these investments as you mentioned. So the Fed has tightened financial conditions and they are already having an impact on housing and construction. So I guess the takeaway is monetary policy works and has worked really quickly.
I’ve always been critical of the long and variable lags view of monetary policy. In my view, the impact of policy on spending and output is relatively quick, although some sticky wages and prices do respond with a lag.
A more conventional economist might respond as follows: Yes, the economy slowed at about the same time as the Fed raised rates, but late last year the Fed signaled that it would soon pivot to policy tightening, and longer-term interest rates rose in anticipation of this future tightening. So the recent economic sluggishness is the lagged effect of a tightening of financial conditions that resulted from Fed policy signals late last year.
I think that view is partly correct and partly incorrect. It is correct that signals of future tightening do represent the tightening of monetary policy. Indeed that’s what David and I mean by “long and variable leads”. The effects can occur in response to these signals, before the actual implementation of “concrete steps” such as raising short-term interest rate targets or quantitative tightening.
On the other hand, in this case I don’t believe the initial signals actually had the effect of tightening policy. While it’s true that long-term rates drifted somewhat higher in late 2021 and early 2022, the natural interest rate was rising even faster, due to rapidly accelerating inflation/NGDP growth. Thus policy was effectively looser, despite somewhat higher longer-term rates. The Fed was behind the curve.
The question of policy lags seems very mysterious and hard to pin down. Ideally, we’d have a well functioning and highly liquid NGDP futures market. In that case, changes in NGDP futures prices would represent monetary policy shocks, and you could easily derive the length of policy lags by looking at the time delay between a change in NGDP futures prices and the change in current NGDP.
PS. The Hypermind NGDP market is a first step toward this goal:
READER COMMENTS
Thomas Lee Hutcheson
Oct 21 2022 at 8:23pm
The TIPS reacted as expected to changed in the Federal Funds rates. In March 2020 the 5 year expectation began to exceed the 10 expectation. In retrospect that might have been a signal that the Fed needed to start tightening
Jose Pablo
Oct 22 2022 at 9:17am
“While it’s true that long-term rates drifted somewhat higher in late 2021 and early 2022, the natural interest rate was rising even faster, due to rapidly accelerating inflation/NGDP growth”
As a matter of fact (leaving “costs of carry” aside) it would make sense to buy a “basket of goods” today with money borrowed at the actual rate. With inflation significantly higher than the interest rate you will make money with this strategy.
This not happening should be because agents anticipate this “basket of goods” being less valuable in the future; so, they anticipate lower yearly inflation in one year time (or some changes in relative prices in the “actual basket of goods” you are buying: in buildings or equipment).
[Of course, this just try to illustrate an idea, not to be a detailed business plan you can act on. Kind of in line with Cochrane’s idea that, at some point, real interest rates should become positive to stop inflation … not there yet]
Spencer
Oct 22 2022 at 9:24am
The distributed lag effect of money flows, long and short-term, have been mathematical constants for > 100 years. There are other variables. The lag may be lengthened or shortened by Alfred Marshall’s cash balances approach/demand for money.
The remuneration of IBDDs introduced another lag – one on asset prices. It’s a variant of the Contillon effect.
I.e., asset valuation prices are driven from the appraisal of loan collateral, in this case Reserve Bank credit, which depends upon Gresham’s law: “a statement of the least cost “principle of substitution” as applied to money: that a commodity (or service) will be devoted to those uses which are the most profitable (most widely viewed as promising), that a statement of the principle of substitution: “the bad money drives out good”.
The FED’s monetary transmission mechanism was legal reserves up until March 26, 2020. “The difference between transaction accounts and savings deposits is no longer relevant for reserve requirement purposes; presently, they both have zero reserves required.”
Friedman pontificated that: “I would make reserve requirements the same for time and demand deposits”. Dec. 16, 1959.
Link: Charles Hugh SmithCharles Hugh Smith Blog | Bank Reserves And Loans: The Fed Is Pushing On A String | Talkmarkets
Selgin confuses legal reserves (pre 1959 requirements) with liquidity reserves and ignores Anderson’s reconstruction mistake.
The Monetary Base and Total Reserves: Fed Confusions and Misreporting – Alt-M
Spencer
Oct 22 2022 at 9:43am
Contrary to Volcker, who:
“believes in principle the Fed should pay interest on reserves held against deposits on rounds of equity”
As George Selgin pointed out:
“The 2006 Financial Services Regulatory Relief Act gives the Fed permission to pay interest on reserves. The IOR rate was always higher than “the general level of short-term interest rates” which is imposed in the Law. “A Legal Barrier to Higher Interest Rates,” The Wall Street Journal, Sept. 28, p. A13.
Conflicting: “Yes, I hold that commercial banks are credit intermediaries and not just credit creators” — George Selgin
Economists don’t know a debit from a credit:
Interest On Reserves, Part I – Alt-M
Interest On Reserves, Part II – Alt-M
I.e., no discussion of disintermediation imposed on solely the nonbanks.
Economists don’t know:
the difference between the supply of money & the supply of loan funds,
the difference between means-of-payment money & liquid assets,
the difference between financial intermediaries & money creating institutions,
doesn’t know that interest rates are the price of loan-funds, not the price of money,
that the price of money is represented by the various price (indices) level
Spencer
Oct 22 2022 at 9:37am
Contrary to Volcker, who:
“believes in principle the Fed should pay interest on reserves held against deposits on rounds of equity”; the payment of interest on IBDDs induces nonbank disintermediation, an outflow of funds.
As George Selgin pointed out:
“The 2006 Financial Services Regulatory Relief Act gives the Fed permission to pay interest on reserves. The IOR rate was always higher than “the general level of short-term interest rates” which is imposed in the Law. “A Legal Barrier to Higher Interest Rates,” The Wall Street Journal, Sept. 28, p. A13.
Economists don’t know a debit from a credit:
Interest On Reserves, Part I – Alt-M
Interest On Reserves, Part II – Alt-M
But there is no discussion of disintermediation imposed on solely the nonbanks.
Economists don’t know:
the difference between the supply of money & the supply of loan funds,
the difference between means-of-payment money & liquid assets,
the difference between financial intermediaries & money creating institutions,
doesn’t know that interest rates are the price of loan-funds, not the price of money,
that the price of money is represented by the various price (indices) level,
Spencer
Oct 22 2022 at 9:42am
Contrary to Volcker, who:
“believes in principle the Fed should pay interest on reserves held against deposits on rounds of equity”
As George Selgin pointed out:
“The 2006 Financial Services Regulatory Relief Act gives the Fed permission to pay interest on reserves. The IOR rate was always higher than “the general level of short-term interest rates” which is imposed in the Law. “A Legal Barrier to Higher Interest Rates,” The Wall Street Journal, Sept. 28, p. A13.
Conflicting: “Yes, I hold that commercial banks are credit intermediaries and not just credit creators” — George Selgin
Economists don’t know a debit from a credit:
Interest On Reserves, Part I – Alt-M
Interest On Reserves, Part II – Alt-M
I.e., no discussion of disintermediation imposed on solely the nonbanks.
Economists don’t know:
the difference between the supply of money & the supply of loan funds,
the difference between means-of-payment money & liquid assets,
the difference between financial intermediaries & money creating institutions,
doesn’t know that interest rates are the price of loan-funds, not the price of money,
that the price of money is represented by the various price (indices) level
Spencer
Oct 22 2022 at 10:00am
Monetarism has never been tried. Volkers two recessions were caused by him ignoring the distributed lag effect of money flows:
Link:
Pain: the name of the game – by Marcus Nunes – Money Fetish (substack.com)
Divisia M4 showed a monetary contraction at the same time.
“In fact, if the money supply had been measured correctly by a Divisia metric, Chairman Volcker would have realized that the Fed was slamming on the brakes from 1978 until early 1982.”
Monetarism involves controlling total reserves, not non-borrowed reserves as Paul Volcker found out. Volcker targeted non-borrowed reserves (@$18.174b 4/1/1980) when total reserves were (@$44.88b).
Volcker’s operating procedure (which hasn’t changed since Paul Meek’s (FRB-NY assistant V.P. of OMOs and Treasury issues), described in his 3rd edition of “Open Market Operations” published in 1974.
One dollar of borrowed reserves provides the same legal-economic base for the expansion of money as one dollar of non-borrowed reserves. Legal or required reserves represents the monetary base. Legal reserves were the monetary transmission mechanism, not interest rates.
The fact that advances had to be repaid in 15 days was immaterial. A new advance could be obtained, or the borrowing bank replaced by other borrowing banks. That’s before the discount rate was made a penalty rate (Bagehot’s dictum). And the fed funds “bracket racket” was simply widened, not eliminated.
Spencer
Oct 23 2022 at 10:09am
Sorry about the duplicates. The posts didn’t appear right away.
The new times series isn’t good at pointing out the inflections. But short-term money flows are up, so stocks are up. It won’t last past the 4th qtr. And long-term money flows are down until Dec. So, inflation should fall. Those lags are ex-ante.
Spencer
Oct 23 2022 at 11:15am
If you look at short-term money lags, you’ll see an uptick corresponding to Atlanta’s GDPnow 2.9% forecast for the 3rd qtr.
5/1/2022 ,,,,, 0.109
6/1/2022 ,,,,, 0.111
7/1/2022 ,,,,, 0.087 bottomed
8/1/2022 ,,,,, 0.123
9/1/2022 ,,,,, 0.100
10/1/2022 ,,,,, 0.124
11/1/2022 ,,,,, 0.151
12/1/2022 ,,,,, 0.143
Spencer
Oct 23 2022 at 11:17am
If you look at long-term money flows, you’ll see a decline in inflation during the same period:
5/1/2022
,,,,,
1.320
6/1/2022
,,,,,
1.230
7/1/2022
,,,,,
1.193
8/1/2022
,,,,,
1.277
9/1/2022
,,,,,
1.197
10/1/2022
,,,,,
1.202
11/1/2022
,,,,,
0.960
12/1/2022
,,,,,
0.638
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