September 07, 2011
Following the Swiss lead
Today Econbrowser is pleased to feature a guest post from Johns Hopkins University Professor Jonathan Wright, in which he proposes an option for economic stimulus by the Federal Reserve.
Following the Swiss Lead
by Jonathan Wright
On Tuesday, the Swiss National Bank (SNB) adopted a bold policy of pledging to sell Swiss Francs in an unlimited amount to ensure that the exchange rate viz-a-viz the euro is at least 1.2 Swiss Francs per euro. The exchange rate promptly jumped over 8 percent to a bit more than 1.2 Swiss Francs per euro. The SNB can clearly weaken its currency in this way, so long as its commitment is unwavering. The SNB did so, judging that this is the best available way of meeting its underlying macroeconomic objectives. Indeed, the SNB may not actually have to intervene heavily. It’s a nice case study in the power of credible commitment and rational expectations.
The Fed could decide to do something similar at the next FOMC meeting, except with Treasury securities rather than the exchange rate. Concretely, the Fed could commit to buying any Treasury security with a maturity date in or before 2016 at a yield of (say) 25 basis points. The commitment would remain until the securities matured. This would reinforce and extend the existing commitment to keeping short rates low and would be a failsafe version of quantitative easing. It would be different from QE1 and QE2 in pegging a price, not a quantity. This strategy would be very likely to lower rates on other assets that are close substitutes. Fiscal policy would be a better tool, but of course that is not in the Fed’s domain. At this point, directly targeting longer-term interest rates is the most promising course for boosting demand available to the Fed (except perhaps for raising the short-run inflation target).
Posted by James Hamilton at September 7, 2011 05:08 PMdigg this | reddit
Any chance you could be talked into replacing one of the Fed Regional Bank heads at Dallas or Philly or Minneapolis?
Posted by: 2slugbaits at September 7, 2011 05:34 PM
oncretely, the Fed could commit to buying any Treasury security with a maturity date in or before 2016 at a yield of (say) 25 basis points.
Wouldn't this price fixing effort cause many unintended consequences? What happens when the inflation kills the currency and American society begins to resemble Wiemar Germany?
Posted by: Vangel at September 7, 2011 06:19 PM
Or we could just legalize the money drop.
Posted by: Lord at September 7, 2011 08:13 PM
@Vangel, have you looked at the real yield curve recently?
Posted by: Patrick at September 7, 2011 08:23 PM
Vangel makes a good point. Other good questions: What happens when the aliens invade? Will they accept dollars in tribute, or will they insist on gold?
Posted by: Walt at September 7, 2011 11:57 PM
"Following the Swiss lead" would be to peg the USD at RMB 3.
Then watch the lights come back on at factories from coast to coast.
Not much chance of that happening, I know, but a man can dream.
Posted by: john haskell at September 8, 2011 01:21 AM
I was all for trying QE2. As I believe Krugman says, now is the time to try everything. But it seems pretty clear to me that QE2 had no impact on the real economy. Clearly the stock market and commodities boomed in the short term (and have since fallen), but GDP has been weak since the launce in November 2010.
The result is disappointing, but I don't think its surprising. I don't believe the current constraint on investment is the cost of credit. It seems pretty clear the current constraint is lack of demand. Its seems to me that demand is unlikely to be sparked by a lowering of longer term rates. More likely what's needed is an increase in jobs through fiscal spending and an improvement in consumer balance sheets through debt forgiveness.
In any case, I'm also confused by what seems like an overt attempt by the Fed to impact the prices of risky assets. If you believe that risky assets such as stocks and bonds are a claim on a future stream of cash flows, then raising prices in the short term does nothing except reduce future returns and likely increase colatility. If the attempt is to create a wealth affect, my understanding is that research on the subjecvt indicates a negligible correlation and in any case, such an affect neglects the real problem which is over-extended consumer balance sheets.
Thanks for the post.
Posted by: Hurricane at September 8, 2011 05:26 AM
*sigh* looks like the fed is leaning toward operation twist, says calculatedrisk.
low rates are not the problem, and lowering them further will not do much. With the 5 yr at .87% and 10 year sub-2%, lowering them further will not help.
Fundamentally, the transmission mechanism between low rates and demand is broken. For example, even at historically low rates, consumer mortage refinancing is extremely low and dropping. Corporations are flush with cash, and not expanding. Lots of capital projects would look great (positive NPV) - not with lower interest rates - but with higher demand.Meanwhile, small business and consumers to not have access to credit. (some are turing to hedge fund vehicles for financing).
low rates cannot help when lending standards are too tight, and when final demand is weak.
The fed should:
* commit to either an UE target or GDP growth target and pledge unlimited QE until that target is met. NGDP target works best.
* lower interest on reserves to zero, at least, and remove the perverse incentive to hold reserves when treasuries are yielding less. banks are hoarding reserves. ideally, they make the interest on excess reserves negative (banks cannot really hoard "cash" - they have to buy assets like treasuries or store vault cash; vault cash has storages costs and there is limited space). ideally, pushing all risk free assets at the front end of the curve (including deposits negative).
but lower rates, operation twist... nonstarters.
Posted by: dwb at September 8, 2011 05:50 AM
Johnathan Wright is wrong about the SNB not having to intervene heavily.
At 1.2, Euro-Swiss has no upside. The SWF becomes a perfect safe haven currency. To keep the SWF there, the SNB will have to buy up a mountain of Euro's exiting the EU banking system.
For Wright to be right, the SNB would have to deliver a "two way trade" at its target. That means it must threaten to keep upping its target for EUR-SWF. This has inflationary consequences. It is not quite as easy as he makes it out to be.
Posted by: David Pearson at September 8, 2011 06:56 AM
The Fed is out of ammunition. Trying to fire more shots to pump up demand is foolish. Capital is on strike. The only thing more foolish would be another stimulus spending binge. Put Michael Jordan in a straitjacket and demand he dunk basketballs and see what happens. I count zero. We can create lots of new government jobs pretending to study why he cannot dunk basketballs. Pretending we have more demand than we really do is not going to help anything. Demand does not start with spending. Demand is not some concrete want by the public for certain products or services which can then be commanded to be produced creating jobs. Attempts to influence demand always have been and always will be very short run temporary propositions because demand is only part of the equation. It is not a holy grail as Krugman would seem to believe. Earthquakes and alien invasions only set back our current standard of living requiring wasted rebuilding to achieve a prior state. It is only if we declare the post invasion state the new benchmark is the economic activity generated of any benefit whatsoever. I simply cannot understand how otherwise intelligent people think flushing money down the toilet will help.
Posted by: Hitchhiker at September 8, 2011 07:13 AM
The question, really, is what the Fed should do in an impossible situation. Some actions may have little or no effect but what's the alternative?
Increasing inflation target "by any means necessary" is likely seen as a big risk. These are unusual times though; perhaps it is time for the Fed to take the reins like a boss.
Posted by: jesse at September 8, 2011 07:48 AM
We all know what the problem is: OVER-LEVERAGE. Banks are hoarding cash because many do not have enough reserves to conform with Basel3 guidelines, or because their clients do not have enough assets to secure loans assuming another recession. Potential bank clients are overwhelmingly service and retail businesses whose market has been shrinking...
I vividly remember Ross Perot exhorting America about the "Sucking Sound" of industrial job off-shoring. Industrialists at the time thought that exposing America to international competition would serve as the discipline to lower wages and distribution costs to allow the reemergence of a competitive industrial America... What they didn't expect was that exponential growth in debt and securitization would hold prices high, while deregulation would enable historic levels of fraud and corruption.
America needs two things- lower price levels allowing industrial competition (deflation), and lower debt levels freeing up credit and capital for new expenditures. The FED and Washington have undertaken a policy of SLOWLY letting the air out of the balloon. From the money side, policy is successful. The dollar is slowly sinking against other currencies... on the debt side, progress is glacial. The argument could be made that policy is pumping in as much air as is being vented...
Bankruptcy laws need to be liberalized to shake the Shylocks loose from the living dead, and the banking system needs to be dismembered to reduce concentration, size and systemic risk.
I'm not going to hold my breath for change. The finance industry has bought and paid for their congressmen, senators, and president. They own the central bank. Who could possibly mount a successful opposition? The rabble in the streets?
Posted by: MarkS at September 8, 2011 08:26 AM
What happens if China or Japan or the ECB decides to retaliate in the same manner? Does it become a currency war? It is mathematically impossible for all currencies to devalue simultaneously.
Posted by: Joseph at September 8, 2011 08:28 AM
Wright must be reading MMT (Mosler, Wray, Mitchel). The MMT guys have said this since QE1. Only problem is it will not work to boost demand. First: banks don't need excess reserves in order to lend. Second: business is not going to invest in new production no matter how low interest rates go unless there is demand for the new production. Third: consumers are not going to fuel demand by going deeper in debt when they are already too deep in debt (most are not qualified to go deeper in debt). That leaves fiscal stimulus. Too bad wright doesn't read (or understand) the MMT view on stimulus.
Posted by: markg at September 8, 2011 09:02 AM
Did somenone call me?
Posted by: Rabble at September 8, 2011 09:05 AM
Of course, there is the issue of constrained global net oil exports.
Following is a range of scenarios for Available Net Exports (ANE, i.e., Global Net Exports, or GNE, less Chindia's net imports).
The observed GNE 2005 to 2010 net export decline rate was 1.3%/year (BP + Minor EIA data, top 33 net oil exporters in 2005). The observed rate of increase in Chindia's net imports was 7.7%/year for 2005 to 2010.
For the low case, we assume a GNE net export rate of change of -1.3%/year and a Chindia rate of change in net imports of +5.0%/year.
For the middle case, -2.5%/year and +7.7%/year respectively.
For the high case, -5.0%/year and +10%/year respectively.
Historical ANE and Projections to 2015:
The low case is basically a continuation of the volumetric ANE decline rate that we saw from 2005 to 2010, i.e., about one mbpd per year.
Posted by: Jeffrey J. Brown at September 8, 2011 09:20 AM
Professor Wright has the right idea - currency depreciation is the only venue left for monetary policy. But he misses the big point that competitive devaluation against currencies that play by the floating exchange rate rules is a nonstarter. In my opinion, short-sighted Fed polices have already set in motion a collapse of the euro, which may not have happened had Ben not pushed the euro to over $1.40. With Asian currencies pegged to the dollar, the result was a big loss in AD for the euro area. The right thing to do would have been to stop Asian currency pegs. In fairness to Ben, that arrow was never in his quiver - that policy can only be undertaken by Timmy at Treasury.
And I'm not convinced that monetary-induced inflation at this time would do anything more than speed up a downward adjustment in real wages, which would make worse the debt load problem.
Posted by: don at September 8, 2011 11:01 AM
don, the US$ has fallen 85% against the CPI- and US$-adjusted price of gold (POG).
In IMF SDR and trade-weighted major currency terms, the US$ is 40% below par in nominal terms. Historically, one rarely sees currencies depreciate more than 30-40% without hyper-inflation and collapse; but these conditions are even more rare during debt-deflationary regimes for reserve currencies.
How much more should the US$ be depreciated in nominal and gold terms? 50% and 90%? 60% and 95%? 70% and 100%?
And how high might the price of oil (POO) rise were the US$ to depreciated another 20-25% to 50%? Do I hear Brent at $200? $250? $500?
And how might that affect pass-through costs to US producers and consumers? What about real incomes and spending for the bottom 90%? Profits for domestic firms? Investment? Payrolls?
Note that the US$ has not fallen principally because of policy makers' or central banksters' policies, per se, but because US supranational firms have been investing hundreds of billions of US$'s abroad in China-Asia and elsewhere since the late '80s to early to mid-'90s, causing an increase in deposits in foreign currencies (and requirement for foreign central banks to hold US$-denominated assets against the covnerted US$ deposits) and a dramatic increase in demand for oil and oil imports in Asia for US subsidiaries and contract producers.
As the demand for oil increases at a given supply and an increasing supply of US$'s lent and deposited, the POO rises, requiring more US$'s to purchase the oil, causing the US$$ to decline more or less proportionally to the increase in the POO.
To the professor's point, the Fed moving out the yield curve was a given, as price inflation will continue to decelerate or decline in a debt-deflationary regime with decelerating nominal GDP and contracting 10-yr. avg. real private per capita GDP for years ahead.
The Fed reserve expansion will serve merely to shore up banksters' balance sheets to allow banksters in part to fund incremental gov't deficits, the net of which will eventually go just to service the net interest on the public debt.
Additional reserve expansion will not encourage additional lending (and deposits) by banks, especially as the yield curve flattens at low and negative real interest rates, charge-offs and delinquencies remain around 10% of loans, and shrinking net interest margins and ROA for banks, insurers, and non-bank conglomerates.
Eventually the stock and junk bond markets will recognize that the Fed and administration can do next to nothing to prevent or postpone the ongoing debt-deflationary effects of the slow-motion Long Wage depression.
Ah, but they will surely try, so much so that we could see fiscal deficits approaching 100% of gov't receipts and nearing the level of M1, coincident with money velocity and the multiplier continuing to plunge.
Posted by: Bruce at September 8, 2011 03:02 PM
Pearson: the way I read the Swiss announcement, they implicitly threaten a moving target.
Posted by: benamery21 at September 8, 2011 05:53 PM
I don't think the Fed is out of ammunition. Nobody uninvented the printing press. If the Fed released a statement along the lines of "we are prepared to buy unlimited quantities of *whatever* until inflation is X% and we will continue this policy until the NGDP level returns to trend", people would take notice. But unlike the SNB, the Fed has seriously damaged its credibility by consistently missing targets. I suspect that means the Fed would actually have to do more than it would otherwise, but once they skooled the punks who diss them, everyone would fall in line.
Posted by: Patrick at September 8, 2011 08:45 PM
John Haskell seems right. The Swiss were rebalancing against the EUR because they realized they cannot decouple and need to maintain balance-of-trade equilibrium. We need to rebalance trade with China, and also with the energy sector. So the correct answer to "Following the Swiss lead" would be for the Fed to peg the USD at a different level of RMB than China would prefer. But the second answer would be to either peg a higher oil price (forcing energy trade balance) or to take less draconian (slower) measures to eliminate the trade deficit from oil imports. It is worth noting that balancing trade would also enable halting the net growth in U.S. indebtedness through the fundamental accounting identity... foreign sellers would no longer be reprocessing large dollar flows into Treasuries, RMBS, etc.
Posted by: Wisdom Seeker at September 9, 2011 01:24 PM
So, the Fed promises to "buy" unlimited quantities of debt (they have to jump through major legal hoops to monetize anything other than debt). Debt leaves the market in general to take up residence in a filing cabinet at the Fed. Dollars flood into banks. Bank owners have to make a profit...so they invest the dollars in *whatever* that produces a return. This, you propose, goes on until the inflation rate reaches X% and will then be modulated to keep inflation at X% until NGDP level returns to trend.
Well, inflating NGDP back up to trend is certainly one way to get back to normalcy...but, I will leave that cheap shot aside and look towards your goal. For GDP to return to trend levels we either grow the population making things at the current level of productivity, increase productivity, or both. We increase productivity by investment that promotes productivity. Some of that can be government spending on research, education, and infrastructure...but the bulk of it comes from private investment.
Sooo...the Fed monetizing debt only works if the money gets invested in things that enhance productivity (because, let's face it, population growth is not the answer for the next two to three decades). Buying more government bonds at the expense of crowding out private investment is not the road to prosperity but it is a very likely outcome of the Fed trying to monetize debt.
Investors want safe havens right now and the Fed will take US Treasury debt out of circulation in preference to other debt. This will make it easier to fund more government deficits. If that government spending gets directed towards infrastructure...less harm done. If that government spending gets directed towards consumption (e.g. Soc.Sec., Medicare, NPR, crop supports, wars, Wall Street bailout, etc.), it just makes matters worse.
In short, monetizing debt (or not monetizing debt) isn't really the issue if you are trying to grow GDP. To my way of thinking, the best way to promote demand is to promote productivity. When you are more productive, you end up with something left over that you didn't have when you were less productive...whereupon you spend or invest that difference. This creates real new demand rather than reallocating existing demand to new areas.
Posted by: JFK at September 9, 2011 02:09 PM
If the issue is a threat of deflation, then by all means the Fed has to do something. But when the huge bad mortgage debt problem is weighting down the economy, perhaps all of the financial tricks in the book are like shooting arrows at Gulliver.
The number of renters is climbing, which means that demand for rental housing is steadily increasing. But it is difficult to invest in rental housing when you know that a whole slew of foreclosures is waiting to flood the market. Then there is commercial real estate, the other shoe.
The Fed got a second mandate to jack up employment during the Depression. But just mandating something doesn't make it feasible.
Posted by: colonelmoore at September 9, 2011 07:12 PM
Really? In an econ blog?
The Swiss move works as long as no one with big enough pockets sees a profit in arbitraging against it. Granted maybe people with pockets that deep don't want the Swiss angry at them, so it may take a while (arguably it's a similar situation that is propping up US treasuries).
Mandating prices that are more properly set by a market is not usually a trivial business. It is costly and distorts the markets to a point where unlocking the prices may lead to unpredictable results. Ask the Chinese bankers and politicians that are trying to figure out what actually would happen if they let the dollar fix go, and how long they are willing and able to put up the dough to keep it fixed.
I find it hard to think of a better way to undermine the dollar and the financial reputation of the US than for the US government to explicitly muck with the treasuries markets. But it looks like there's hope. Maybe some other guest blogger can come up with a worse one?
Posted by: endorendil at September 13, 2011 04:02 PM