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.

Ethics in business schools

I'm with Zingales here: an ethical dimension should be added as an orthoganal line of thought to the profit-maximising dimension when it comes to business school instruction. However, I am a bit more skeptical on a claim by Yglesias  that the unethical/criminal behavior in business has been on the uptic in the wake of Milton Friedman's ideas. This is just a general view I have: mores and morals do change, but they do so slowly and the basic reality of human nature stays relatively constant over extended periods of time. Certainly, I would not expect that the propensity of humans to cheat and steal would change over as little as 30 years because of some thought that some guy had.

I think, rather, that what we see is confirmation bias at work. That is, when a particular industry or a political unit (city, state, country, whatever) is embroilled in deep economic trouble and/or is on the verge of collapse, evidence of corrupt, unethical, dishonest and illegal practices tends to come to the surface. When things are going swimmingly for everyone, on the other hand, people just tend not to notice these things. When the tide recedes, all sorts of flotsam, jetsam and other junk is bared for all to see. Consider this:

- the securities industry of the late 1920s is associated in our minds with - crudely put - snake oil salesmen being everywhere. Not coincidentally, the biggest financial and economic crisis of the 20th century followed and 1933 and 1934 were seminal years for the federal regulation of banking and securities sectors.

- the next set of scanal-prone bankers came upon us in late 1980s and early 90s, culminating in the Savings and Loan crisis and a bunch of said bankers ending up behind bars.

- as minor distractions compared to what followed 6 years hence, the WorldCom and Enron scandals roughly coincided with a recession of the early 2000s that followed the dotcom bust.

- we're currently living through the next set of scandals, which, predictably enough came hot on the heels of the biggest financial clusterfuck catastrophe in 80 years.

Now, do we really think that the financial industry professionals have been living open, honest and modest lives between the 1930s and 1990, between 1990s and 2002 and between 2002 and 2008? I suppose it could be that prevailing regulatory regime at the time and/or the overall profitability of the industry just squeezed the lying cheats into other sectors of the economy as between 1930 and 1990. But the lying cheats are always with us. And always have been. And always will be. With or without Milton Friedman's encouragement. We just need to try to make their lives very difficult where it matters.

Is QE a monetary easing

Or is it just an asset swap?

It's an important question and one that's been debated a bit on the blogosphere. QE seems to be the only monetary policy instrument that the Fed is capable (and claims to be legally allowed) of deploying at this point, whilst currently refusing to do so for reasons unknown. But nevermind the present action/inaction dilemma. Is QE actually effective as an instrument - in other wors, does it ease monetary policy - by which (I think) we all mean "increase base money."

As evidence that this is not, consider this. FT Alphaville implies that Polish yields are being driven negative by SNB in its continued quest of keeping the Euro/Swissie at 1.20. Well, without any evidence to back this - suppose that this is indeed what's happening. Is the Swiss National Bank now acting to ease monetary policy in Poland? If not, what is the difference between what SNB is doing and what ECB could be doing via QE?

Banks as Pariahs

This here by Izabella Kaminska is by far my favorite blog post in a long while.  My hat's off.


I am going to try to supplement this loveliness with a very simple bottom line. In the world we're in right now, the banks are completely failing in their function as trasmittors of monetery policy. In fact, they have become pariahs on the real economy.
 
This is why monetary stimulus has been ineffective - because the CBs continue to work through the banking system, rather than through the real economy.
 
This is also why in order to be effective, the CBs need to avoid the banking system and inject money directly into household budgets via helicopter drops or what have you.
 
Finally, this is also why, in the absense of helicopter drops by the CBs, fiscal expansion (whether via tax cuts or boosted spending) will remain a more effective tool - because the state can return us to the state of scarcity of real resources relative to money in relatively short order. For those in doubt - see World War II.
 
I will go even further. With rate curves as flat as they are, much of the government debt in countries like U.S., UK, Japan and Germany has become entirely money like. Anything from cash to treasuries up to 2 years duration can be described as a "government obligation bearing zero nominal interest rate". Under these circumstances, the distinction between creation of money by the central banks and creation of additional debt instrument by the state is moot. The key question is solely whether this new "money" or "money-like debt" is actually exchanged for goods and services (i.e., invested in real economy).

Meanwhile, in la-la land...

I do not know at this point how anyone can listen to/read about the ECB and not go absolutely apeshit mad.

FT:

Mario Draghi, ECB president, warned last week that the bank could not “fill the vacuum” created by politicians’ inactivity.

...Ahem... Mr. Draghi: the "vacuum" that Southern Europe now faces is that they don't have enough money. You represent the only instutution on the face of the planet that can actually remedy that situation. That is, indeed, your job. WTF?

And this:

The ECB president notes most of the problems befalling the eurozone having “nothing to do with monetary policy”.

WTF? WTF???

And finally:

He also notes that rate cuts would have very little immediate effect because of the breakdown in the monetary transmission mechanism, ie, the benefits wouldn’t be felt by businesses and households.

Let me translate that. "The ECB has failed at its job to keep the monetary transmission mechanism of the EU zone functioning like it's supposed to. We have, in fact, completely lost control. We will not try to take steps to restore the fuctioning of the transmission mechanism. That requires us to do stuff, and we generally don't like to do stuff. We'd much rather do nothing. Wouldn't you? I mean, say you're a doctor and your patient is dying from a curable desease: wouldn't you rather just wait for him to die than try to save him? Exactly... Before you know it you people are going to start asking us to actually work at work."

Germany: Stimulus + Misc. thought

Two points:

1. Stimulus. With the 2-year bond yields falling to 0.07, how do you justify to yourself NOT doing a giant stimulus program. I don't care what it is: tax cuts, infrastructure spending, whatever. People are literally giving you money for free. Forget real yields, which have been negative for a long time, now even nominal yields are at zero. I mean, WTF??? What even remotely plausible, argument could there be for not borrowing more money? You could put the money in a sock drawer and still come out ahead in two years time. Is the German infrastructure so good that they literally can't think of anything that needs doing? Or are German taxes so low that they can't lower them any further? Or does Merkel thinks that, say, a 1000 euro tax rebate check to every german household would harm her re-election chances? The basic situation that Germany finds itself in right now is that if there is anything you can think of that the German government can do with extra money, now is the time to do it. Later won't be as good* Seize the day!

As far as the rest of Europe goes, a German stimulut would also be an unmitigated good.** If done in the form of a tax cut, people mind spend extra money vacationing in Spain, Italy or Portugal (Greece is an unlikely destination for Germans at this point). Yay! If done in the form of infrastructure spending, at least some of it will spillover in increased demand for raw materials or just plain labor from the poorer parts of Europe. In any event, given that unemployment in Germany is not that high, inflation in Germany just might pick up a tick** (again), helping the unit labor cost problem that people are trying to wrap their heads around.

2. Misc. Just an observation: how does this nation can manage to come out looking like total a**holes so often in its history is beyond me. It's like a genetic decease. Take this FT sub-heading: "Berlin deaf to pleas from IMF and OECD ahead of summit". Great, innit? Pretty sure that if Europe falls apart and shit totally hits the fan the press will lay this down at Germany's feet. And not entirely without merit.

_____________
*Unless nominal yields continue to fall into negative territory, which Citi thinks they just might. Crazy times, right?
**Unless, as per the Sumner Critique, the ECB offsets all effects of stimulus with tighter money. But I kinda doubt they will, because I don't think there is a real chance of pan-European inflation rising even a tick above 2%. It'll probably continue to go down below the 2% ceiling. Which, as history shows, doesn't make the ECB do anything. Contra Sumner, the ECB has a very assymetric response function.

When your country doesn't have enough money...

...you go and make some.

Here is a cute story about an Irish town using old Irish currency to boost demand. Now, let's be clear on what they are actually doing: they are indroducing a new medium of exchange (Irish punt just happens to be conveniently recognizable as such by most people in Ireland, but in its absence, other things would serve), a.k.a., "money."

Obviously, this is illustrative of a macro point that Europe as a whole and peripheral Euro countries in particular are suffering from an acute problem: they don't have enough Euros. When you are at a point where commerce grinds to a halt for lack of specie, what you expect to happen in the age where actual specie has been replaced by fiat currency, is that your Central Bank will go and make some more. I mean... giving people money is by far and away the most obvious solution to a problem of them having none, right?

Right...

Next up: a return to blood-letting as a cure to most ailments.