I attended a recent Fed conference in Chicago, which was charged with the task of re-evaluating the monetary policy regime. I had very mixed feelings about the conference. On the plus side:
1. It’s a very good thing that the Fed is taking seriously the need to re-think policy in light of the zero bound problem.
2. The quality of the presentations and discussion was almost uniformly high.
Thus in an objective sense I had a very positive reaction. Subjectively, I was less pleased. Listening to the discussion reminded me of the heterodox nature of my own views:
1. Monetary policy was mostly evaluated through the lens of interest rate control, which I view as a big mistake.
2. There seemed to be an assumption (either implicit or explicit) that the economy was often hit by “shocks” that disrupted aggregate demand, and that the Fed’s task was to fix the problem by adjusting interest rates (or doing QE). In my view, these “shocks” are actually caused by the Fed holding interest rates stable for an excessive period when the equilibrium market rate is changing (as in mid-2008.) The Fed is more arsonist than fireman.
Perhaps my favorite comment was a remark made by UC Berkeley professor Annette Vissing-Jorgensen, discussing the market reaction to Jay Powell introductory speech at the conference. I don’t recall the exact words, but she suggested something to the effect that the stock market reaction to monetary policy communication is often more informative than the bond market reaction. I found this in her Powerpoint slides:
• If a promise of a lower policy rate in the bad state lowers probability of bad state:
o You may not see the accommodation in futures rates: They could increase, since the policy rate in the good state is high.
o The stock market unambiguously goes up: Removal of the bad state is good for stocks via both lower risk premium and higher expected cash flows.
In the week since Jay Powell’s June 4th remarks, there has been a dramatic change in market sentiment, but only in one market:
While Powell’s dovish comments seemed to trigger a stock market surge, 10-year bond yields show little change, and indeed edged up slightly:
This supports Vissing-Jorgensen’s claim that the stock market provides a less ambiguous signal of market reaction to monetary shocks, a point I’ve made on a number of occasions. Of course a highly liquid NGDP futures market would be even better.
Here’s Yahoo.com:
Where have all the recession headlines gone? Have the analysts predicting the recession all gone into hiding? It’s pretty easy to predict a recession when Treasury yields are plunging every day. It’s pretty easy to talk about doom and gloom when the yield curve inverts. All that talk seemed to disappear when Federal Reserve Chairman Jerome Powell opened his mouth last week and said, “…we will act as appropriate to sustain the expansion.”
Poof!
Just wondering how you feel about a recession now.
Just to be clear, I believe that we still face a somewhat heightened risk of recession. At the same time, the recent surge in equity markets suggests the risk is considerably less than 50-50, at least for the next year or so.
I should add that the resolution of the Mexican tariff issue also helped the market, but much of the surge in stock prices occurred last week, before the tariff crisis was resolved. I suspect that worry over monetary policy plays a bigger role than most pundits assume and trade worries are relatively less important than they assume. Trade wars are easier to see than a divergence between the policy interest rate and the equilibrium rate, and pundits tend to focus on highly visible shocks. Trade wars are unwise in my view, and do hurt the economy, but I don’t see them as the dominant factor driving the business cycle.
I wonder what proponents of MMT, post-Keynesianism, Fiscal Theory of the Price Level, etc., make of the powerful market reactions to seemingly minor comments by Jay Powell. It’s pretty obvious that the market believes that the Fed drives the nominal economy, not Congress. So do I. But then I have to believe whatever the market believes, as I’m a market monetarist.
If market monetarists ever set up a clubhouse, I’d post this on the entrance: “Alpha males not allowed entry.” 🙂
READER COMMENTS
Brian Donohue
Jun 11 2019 at 2:04pm
Good post, but I think the bond market is more reliable than the stock market.
Anyway, surely your club would make room for Chuck Norris, no?
Scott Sumner
Jun 11 2019 at 3:04pm
Brian, Well then it’s not a good post, it’s wrong.
And yes, alpha male policymakers get a pass.
Brian Donohue
Jun 11 2019 at 4:08pm
Well, if this is your main claim:
“This supports Vissing-Jorgensen’s claim that the stock market provides a less ambiguous signal of market reaction to monetary shocks, a point I’ve made on a number of occasions.”
Then allow my to withdraw my approval. The stock market is always jumping around all over the place- way more noise than the bond market. 2% moves (up or down) happen in the stock market routinely these days.
When I observer an across the board downward shift in the yield curve of 0.35% since April 30 (0.2% for expected CPI, 0.15% for TIPS), that’s meaningful data.
YMMV.
Benjamin Cole
Jun 11 2019 at 8:08pm
I agree with this post.
I would add that if we live in globalised capital markets, then recent dovish commentary from the European Central Bank, the Bank of Japan and possibly from The People’s Bank of China, also play a role in the recent stock-market revivals around the world.
The financial headline obsession with Trump’s tariffs is perhaps understandable as it is a change in policy and Trump is a lightning rod for news coverage. But the heavy emphasis on Trump’s tariffs may also reflect the influence of multinationals and media allies and underlings. Some headlines and articles seriously suggest that the trade dispute between China and the US, just two countries, will trigger a global recession.
Foxconn said yesterday it can produce the iPhone entirely outside of mainland China. Trump’s tariffs on China may or may not be a good idea depending on your political views. As a practical matter, the globe will easily adjust to less trade between China and the US. As Sumner points out, the role of central banks is key and also domestic politico-economic policies within each nation. You can have all the free trade you want, but Mexico, Nigeria, Venezuela and Afghanistan et al will be a mess for reasons largely internal to those countries.
Benjamin Cole
Jun 11 2019 at 10:02pm
Add on: There is still a bugaboo, a taboo, a faith in the financial-media-right-wing (even some libertarians) that central banks are always “easy.”
You cannot read a story about the Bank of Japan without its monetary policy being described as “hyper-accommodative” or “super-stimulative,” etc. It never seems to occur to even better financial media publications that they have cast the Bank of Japan as wildly profligate for 10 years, but inflation in Japan is again on the threshold of deflation.
To say out loud that the world’s central banks “have been too tight” is just not done in many circles, the same circles that, unfortunately, are very prominent in monetary policy discussions.
Ergo, the slowing global economy must be laid at the doorstep of some other house—US-China tariffs!
I will say it out loud: The world’s major central banks are too tight. Growth is slowing, and inflation is dead.
Yes, every nation has internal structural impediments that should be fixed. The US, for example, should end property zoning, wipe out the USDA, and cut military outlays in half. No nation practices free trade, and indeed there probably is no such thing as “free,” “fair” or “foul” international trade. What is subsidy and what is not?
Get over it. You make monetary policy in the world we have.
Thaomas
Jun 12 2019 at 6:17am
Not everyone thinks central banks have been too easy. People like Krugman and Summer s have been saying that the Fed’s increase in rates was wrong since 2015 and were not among those who criticized the Fed’s modest QE operations in 2009-10. [Sure their message was muddled with talk of fiscal “stimulus” when all that was necessary was for fiscal policy to follow an NPV rule, but that did not put them among the critics that said the Fed was too “easy.”]
Benjamin Cole
Jun 13 2019 at 7:48pm
Thaomas—you are correct. There are a few who have been calling for easier money including Paul Krugman, Larry Summers, and President Trump.
Thaomas
Jun 12 2019 at 6:11am
Could you draw that out? It is obviously true in late 2008 that rates should have gone to at most zero and non-limited QE have started, but — absent a market in NGDP futures — what were the market indicators earlier on that the Fed should have cut rates (or done something else) earlier?
Brian Donohue
Jun 12 2019 at 11:18am
Should the Fed cut rates on June 18-19?
I say yes, absolutely, 0.25%. You?
Charles Fox
Jun 12 2019 at 11:30am
It’s unfortunate that the rate/equity hybrid option market is not more liquid and transparent. The pricing of a put option on a stock+bond portfolio relative to the pricing of put options on stock and bonds individually would provide information about the market’s perception of the likelihood of a stocks down, rates up (bonds down) scenario.
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