Tuesday, September 25, 2012

Catch up...

Long time, no post, so a bit of catch up:

1. I am obviously glad that Mario Draghi has finally caught on to (or managed to persuade other ECB members of) the idea I (and FT Alphaville, not to take too much credit) voiced earlier that the monetary transmission mechanism in Europe is broken and decided to do something about it. I am less miffed than others about the vagueness of ECB's OMT targets because at this point I am somewhat agnostic about what will ultimately prove to be more effective. The important thing is that the ECB now cares - and if the chosen mechanism proves inadequate for the job, they'll change the mechanism.

2. I am also glad Scott Sumner gets to do his victory dances about open ended QE, etc. I am, however, generally of a view that he suffers from the base money confusion syndrome and that QE as an instrument is not very effective because it has little to do with actually getting the money out into the economy.

I mean, try to spot the flaw in the logic below:

(a). The Fed and only the Fed controls the quantity of base money;
(b) Base money determines NGDP (in the absense of supply shocks) or generally the amount of final demand in the economy;  <----- It's this one right here!!!
(c) ==> The Fed controls NGDP (in the absense of supply shocks) or generally the amount of final demand in the economy.

So, anyway, the main effect through which the new policy works is the expectation channel and the whole "policy is from now on contingent on outcomes" thingy. That's not to be underestimated. I disagree with Paul Krugman who seems to say that this is not really a new policy because if you follow the Taylor rule that should get you to the same place. That would be a fair criticism, but the Fed never expressly said it'll follow the Taylor rule!

3. Looking at a cool chart comparing how we're faring relative to other financial crisis, Yglesias makes a point that we could be doing better, but, somewhat unexpectedly, points to the time from 2006 to 2008 when (1) asset prices were falling BUT (2) there was no financial crisis (Yet!) and (3) Unemployment was steady and low. What's odd here is the claim that we were really DOING better. What specific policy changes, I'd like to know, occurred in 2008 that turns our economic performance froom "Great!" to "Downright awful?" I mean, I'd love to be corrected here - but I really can't remember any.

This really goes to the main gripe I have with Market Monetarists. Sumner likes to say that the reason crisis happen is that the Fed policy was too tight at least in the 2nd half of 2008. But it's never quite clear to me what it is that made the stance too tight and how that something fits into the monetarist story. I mean, if the Fed truly controls the final demand, then it must have caused it to go down by active mismanagement in 2008 - it cannot have been just some exogenous event, right? But there is nothing that springs to mind that the Fed has done in 2008 that would amound to a tightening of that kind of magnitude. And if it was an exogenous event (at least exogenous from Fed's point of view - everything is endogenous if you cast a wide enough net) that caused the demand shortfall - then the Fed does not fully control final demand. Maybe it can push, poke and prod though.

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