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The Case for Fiscal Stimulus

ResponsiblyIrresponsible
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6/20/2015 10:42:45 AM
Posted: 1 year ago
In spite of my numerous rants railing against fiscal stimulus - arguing, primarily, that it was offset by monetary policy - I"ve come to a realization, or a change of heart if you will: it"s necessary, especially now. This isn"t always the case, nor should it always be the case, and that it"s necessary signals a myriad of mistakes that ought never have been made. Nevertheless, we"ve been dealt this unfortunate hand and need to respond accordingly.

To begin, let me flesh out the case I made against it. I made the assumption that the Federal Reserve, the central bank of the United States statutorily mandated by the U.S. Congress to ensure maximum sustainable employment and stable prices, calibrates a reaction function consistent with achieving its objectives. In other words, I thought it "targeted the forecast." To put that into more palpable terms, let"s assume for the sake of argument that trend real GDP growth is at 3 percent (and it"s not, which I"ll get to, though this has been the long-run average for roughly the past century). The Fed participants run their forecasting models in preparation for releasing for the quarterly Summary of Economic Projections releases, and discover that actual real GDP growth will undershoot this target, let"s say, by 150 basis points, in the upcoming year. The Fed, in this worldview and irrespective of policy lags, will aim to equate the forecast with potential, which may require inflation that is transitorily above target. There"s, thus, an implicit target for nominal GDP growth, and deviations therefrom prompt the Fed to immediate recalibrate its reaction function to meet its dual objectives, lest its credibility take a major hit.

This theory of monetary offset - that the Fed is already lasering in on potential, and thus changes in the outlook, such as waning headwinds (one of which, notably, may be fiscal consolidation) - isn"t well-examined in the literature, and would likely be controversial if it were. There are anecdotal examples where large cuts in government spendings and not-insignificant tax hikes, such as the threat of sequestration, prompted the Fed to further action, after which growth accelerated. However, that the Fed actively "sabotaged" fiscal policy measures has never, and will never, be a comfortable subject in academia.

Truth be told, fiscal policy has been quite tight over the last few years. Even now, state and local governments are cutting back sharply even as austerity at the federal level has mellowed out. In other words, fiscal policy is less of a headwind today than it was in years past, but nevertheless it"s restraining growth. That this is the case is actually consistent with the relatively tighter stance of monetary policy - namely the end of QE3, the removal of various forward-guidance language, and the signalling that liftoff and subsequent normalization will begin later this year. However, if the fiscal multiplier were in fact zero, in spite of the destructive and prolonged nature of the crisis (and the fact that research by both Rogoff and Reinhart as well as Romer and Romer finds that downturns following systemic banking crises generally last about five years on average), monetary policy should have become progressively looser. Instead of talking about possible regime changes - a higher inflation target, a transition to a price-level target, etc. - Ben Bernanke should have kicked the can down the road. That he didn"t signals that the Fed simply wasn"t willing to combat the crisis head-on, nor was a credible regime change politically or institutionally feasible. Not to mention, it"s a bit hard to raise or drop the inflation target when a formal, numerical target was only explicitly codified in January 2012.

Let me back up for a moment and defend the Fed: there were a number of persistent and structural impediments that monetary policy could not address in their entirely. For one, financial frictions soared amid the crisis. In other words, credit spreads - the difference between the riskless rate and the rate at which banks, accounting for credit risk, can actually borrow at - soared. The Fed only has direct control over that riskless rate, so by reducing it, it can only imperfectly reduce borrowing costs. A strategy the Fed adopted was, first, to directly provision liquidity to troubled credit markets and to purchase large sums of agency mortgage-backed securities. This helped, in part, but it obviously wasn"t adequate. Second, households were saddled with gobs of debt and home equity evaporated, both of which significantly depress household spending as consumers pay down longstanding debt - or deleverage - in lieu of consuming. The Fed can address this by aiming to boost asset prices per conventional procedures and purchasing mortgage-backed securities to push down mortgage rates, prompting households to refinance their mortgages. However, it can"t forgive mortgage debt, directly rescue underwater homeowners, or force people to spend money irrespective of the fact that the value of their largest asset has just disintegrated. Third, households and businesses became far more risk-averse in the aftermath of the crisis. This uncertainty, estimates by Leduc and Liu show, increased the unemployment rate by 1 percentage point since 2008 and acts as a de-facto aggregate demand shock. Surely the Fed can lean against demand shocks, but it again is limited in terms of the psychological games it can play in prompting people to pursue riskier decisions with their money. Fourth, demographic factors and ongoing structural factors - global savings glut, rising inequality, falling relative cost of capital, and more - have pushed the Wicksellian equilibrium real rate negative, perhaps forever. These are part and parcel of what Harvard economist, Lawrence Summers, calls "secular stagnation." In the case where the market-clearing rate is negative, it may be institutionally and operationally impossible for the Fed to hit it with its mere 2 percent inflation target due to the constraint of the zero lower bound. That we now know, about six and a half years removed from the downturn, that nominal rates can in fact go negative can"t exactly change our treatment of this issue back in 2008 and 2009.

So, now that we"ve covered the basics, I want to review four major reasons that we ought to pass some sort of fiscal expansion. The first is that, with nominal interest rates pinned at the zero lower bound and the Fed maintaining record holdings of Treasury securities, there"s no threat of a "crowding out" effect. During normal times, we expect budget deficits, which require that the U.S. Government increase the supply of Treasury bonds in circulation, to reduce private investment via raising interest rates. However, the rules of the game change once interest rates reach zero, and will for even a considerable time looking forward. The Fed isn"t expect to completely unwind its balance sheet until 2020, so there"s room to run ever larger budget deficits until then, as the "stock effect" holds down interest rates.
~ResponsiblyIrresponsible

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RevNge
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6/20/2015 10:44:28 AM
Posted: 1 year ago
At 6/20/2015 10:42:45 AM, ResponsiblyIrresponsible wrote:
In spite of my numerous rants railing against fiscal stimulus - arguing, primarily, that it was offset by monetary policy

*snickers*
ResponsiblyIrresponsible
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6/20/2015 10:44:52 AM
Posted: 1 year ago
Second, the Wicksellian equilibrium real rate - or the market-clearing rate - is negative and will likely remain negative due to structural factors, and thus we can"t reach it absent a regime change. A credible regime change isn"t at the moment possible or probable, especially with the likelihood of policy firming later in the year. Ideally, fiscal policy ought not be used to close an output gap; monetary policy, generally, is far more equipped, reversible, and costless than blowing hundreds of billions or even trillions of dollars. However, there"s considerable evidence that, because the Fed fears inflation risk in the near future, in spite of the fact that inflation on an annual basis has fallen far below its longer-run objective, as have market-based expectations, it will tighten policy far earlier than it ought to, irrespective of the fact that we have, easily, another half a percentage point to shave off the conventional U3 unemployment rate prior to reaching the "natural rate," after which inflationary pressures will build - and adding changing Phillips-curve dynamics holding down inflation only makes the case bleaker. If the Fed refuses to act, Congress has to take the wheel, lest potential output fall further: i.e., prolonging the end of the malaise will only keep unemployment durations heightened, and thus exacerbate hysteresis .

Third, potential output, again, has fallen appreciably amid the crisis. This is easily the most salient point in this discussion, and that"s because the LRAS is entirely outside the purview of monetary policy. It"s based on education, skills, labor, capital, and resources, and represents the rate at which the economy would grow sustainably at benchmark levels of resource utilization. Historically, this was close to 3 percent. However, there"s reason to think this has fallen substantially in the wake of the crisis, and that declines in trend productivity, productive investment, and business formation as well as elevated credit standards and the ongoing deleveraging process could prolong it. We"re looking, roughly, at trend growth close to 2 to 2.3 percent by FOMC projections, though some estimates are as dire as 1.5 to 2 percent. There"s no good reason to simply accept that, and by investing in jobs training, education, research, and infrastructure - or, even, by slashing marginal tax rates or investment tax rates - the federal government can easily ameliorate this problem.

Finally, there"s the elephant in the room: inequality. It goes without saying that a rising tide - which, ideally though not always, is secured by monetary policy - need not lift all boats. Rising NGDP growth doesn"t necessitate distributional optimization, and that inequality has reached levels not seen since the 1920s should concern everyone. Indeed, some level of inequality is not only "fair" to people who undoubtedly work hard, but we need to cede at least some ground to John Rawls: that rates of social mobility in the U.S. are far lower than in Western Europe, and that your future income is contingent not necessarily on your skill set or on how hard you work, but on your parent"s income, is a travesty. The issue, though, isn"t just moral in nature: there are dire economic consequences, the first of which is a lower market-clearing real interest due to the fact that rich people are more likely to save each additional dollar earned than is a poor person, which renders monetary policy (again, absent a regime change) a blunt tool. Second, asymmetries in educational opportunities could have dire implications for long-run growth and for future productivity capacity, exacerbating the already-backward shift in the LRAS. Third, more money in the hands of speculators could exacerbate the already volatile boom-bust cycle, as could relying too heavily on monetary policy to close output gaps as investors begin to underprice risk and asset prices begin to deviate from fundamentals. Fourth, inequality feeds on itself via political influence. A notable study out of Princeton and Northwestern found that, over the past thirty years, the whims of the affluent overshadowed those of the bulk of the country when it comes to shaping public policy. Primarily, that"s because a slew of horrid Supreme Court decisions have afforded the rich the unmitigated power to legally bribe politicians via campaign contributions, accelerating and prolonging an endless stream of quid-pro-quos. Failure to adequately address this gap could create - if we don"t already have one - a plutocracy.

As much as it pains me to say it, we need to get serious about stimulus spending at this present juncture. Unlike many, I think fears of budget deficits are misguided, at least at this present juncture, and thus there's substantial room to both slash tax rates and increase spending on productive investments. Frankly, we haven't much time to waste.
~ResponsiblyIrresponsible

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ResponsiblyIrresponsible
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6/20/2015 10:45:10 AM
Posted: 1 year ago
At 6/20/2015 10:44:28 AM, RevNge wrote:
At 6/20/2015 10:42:45 AM, ResponsiblyIrresponsible wrote:
In spite of my numerous rants railing against fiscal stimulus - arguing, primarily, that it was offset by monetary policy

*snickers*

Damnit, Rev, I hadn't even finished posting my rant, lol.
~ResponsiblyIrresponsible

DDO's Economics Messiah
RevNge
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6/20/2015 10:45:56 AM
Posted: 1 year ago
At 6/20/2015 10:45:10 AM, ResponsiblyIrresponsible wrote:
At 6/20/2015 10:44:28 AM, RevNge wrote:
At 6/20/2015 10:42:45 AM, ResponsiblyIrresponsible wrote:
In spite of my numerous rants railing against fiscal stimulus - arguing, primarily, that it was offset by monetary policy

*snickers*

Damnit, Rev, I hadn't even finished posting my rant, lol.

Oh, there was more? I would've thought that the first post was more than enough.
ResponsiblyIrresponsible
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6/20/2015 10:46:33 AM
Posted: 1 year ago
At 6/20/2015 10:45:56 AM, RevNge wrote:
At 6/20/2015 10:45:10 AM, ResponsiblyIrresponsible wrote:
At 6/20/2015 10:44:28 AM, RevNge wrote:
At 6/20/2015 10:42:45 AM, ResponsiblyIrresponsible wrote:
In spite of my numerous rants railing against fiscal stimulus - arguing, primarily, that it was offset by monetary policy

*snickers*

Damnit, Rev, I hadn't even finished posting my rant, lol.

Oh, there was more? I would've thought that the first post was more than enough.

No, lol. It's a complex case. I actually scrapped it for topic of the week because I soon learned I couldn't get it under 8,000 characters.
~ResponsiblyIrresponsible

DDO's Economics Messiah
RevNge
Posts: 13,835
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6/20/2015 10:50:41 AM
Posted: 1 year ago
At 6/20/2015 10:46:33 AM, ResponsiblyIrresponsible wrote:
At 6/20/2015 10:45:56 AM, RevNge wrote:
At 6/20/2015 10:45:10 AM, ResponsiblyIrresponsible wrote:
At 6/20/2015 10:44:28 AM, RevNge wrote:
At 6/20/2015 10:42:45 AM, ResponsiblyIrresponsible wrote:
In spite of my numerous rants railing against fiscal stimulus - arguing, primarily, that it was offset by monetary policy

*snickers*

Damnit, Rev, I hadn't even finished posting my rant, lol.

Oh, there was more? I would've thought that the first post was more than enough.

No, lol. It's a complex case. I actually scrapped it for topic of the week because I soon learned I couldn't get it under 8,000 characters.

You would go past 50,000 if you wanted to.
ResponsiblyIrresponsible
Posts: 12,398
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6/20/2015 10:52:11 AM
Posted: 1 year ago
At 6/20/2015 10:50:41 AM, RevNge wrote:
At 6/20/2015 10:46:33 AM, ResponsiblyIrresponsible wrote:
At 6/20/2015 10:45:56 AM, RevNge wrote:
At 6/20/2015 10:45:10 AM, ResponsiblyIrresponsible wrote:
At 6/20/2015 10:44:28 AM, RevNge wrote:
At 6/20/2015 10:42:45 AM, ResponsiblyIrresponsible wrote:
In spite of my numerous rants railing against fiscal stimulus - arguing, primarily, that it was offset by monetary policy

*snickers*

Damnit, Rev, I hadn't even finished posting my rant, lol.

Oh, there was more? I would've thought that the first post was more than enough.

No, lol. It's a complex case. I actually scrapped it for topic of the week because I soon learned I couldn't get it under 8,000 characters.

You would go past 50,000 if you wanted to.

I could indeed, but then my contributions to the site would be asymmetrically productive as opposed to Misc spam that recklessly eats up the site's bandwidth, or so I've been told. We can't have that!
~ResponsiblyIrresponsible

DDO's Economics Messiah
RevNge
Posts: 13,835
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6/20/2015 11:05:06 AM
Posted: 1 year ago
At 6/20/2015 10:52:11 AM, ResponsiblyIrresponsible wrote:
At 6/20/2015 10:50:41 AM, RevNge wrote:
At 6/20/2015 10:46:33 AM, ResponsiblyIrresponsible wrote:
At 6/20/2015 10:45:56 AM, RevNge wrote:
At 6/20/2015 10:45:10 AM, ResponsiblyIrresponsible wrote:
At 6/20/2015 10:44:28 AM, RevNge wrote:
At 6/20/2015 10:42:45 AM, ResponsiblyIrresponsible wrote:
In spite of my numerous rants railing against fiscal stimulus - arguing, primarily, that it was offset by monetary policy

*snickers*

Damnit, Rev, I hadn't even finished posting my rant, lol.

Oh, there was more? I would've thought that the first post was more than enough.

No, lol. It's a complex case. I actually scrapped it for topic of the week because I soon learned I couldn't get it under 8,000 characters.

You would go past 50,000 if you wanted to.

I could indeed, but then my contributions to the site would be asymmetrically productive as opposed to Misc spam that recklessly eats up the site's bandwidth, or so I've been told. We can't have that!

Speaking of which, I'm still winning that, btw.
ResponsiblyIrresponsible
Posts: 12,398
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6/20/2015 11:09:44 AM
Posted: 1 year ago
At 6/20/2015 11:05:06 AM, RevNge wrote:
At 6/20/2015 10:52:11 AM, ResponsiblyIrresponsible wrote:
At 6/20/2015 10:50:41 AM, RevNge wrote:
At 6/20/2015 10:46:33 AM, ResponsiblyIrresponsible wrote:
At 6/20/2015 10:45:56 AM, RevNge wrote:
At 6/20/2015 10:45:10 AM, ResponsiblyIrresponsible wrote:
At 6/20/2015 10:44:28 AM, RevNge wrote:
At 6/20/2015 10:42:45 AM, ResponsiblyIrresponsible wrote:
In spite of my numerous rants railing against fiscal stimulus - arguing, primarily, that it was offset by monetary policy

*snickers*

Damnit, Rev, I hadn't even finished posting my rant, lol.

Oh, there was more? I would've thought that the first post was more than enough.

No, lol. It's a complex case. I actually scrapped it for topic of the week because I soon learned I couldn't get it under 8,000 characters.

You would go past 50,000 if you wanted to.

I could indeed, but then my contributions to the site would be asymmetrically productive as opposed to Misc spam that recklessly eats up the site's bandwidth, or so I've been told. We can't have that!

Speaking of which, I'm still winning that, btw.

Naw.

Let's take this conversation there, though.
~ResponsiblyIrresponsible

DDO's Economics Messiah
THEBOMB
Posts: 2,872
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6/20/2015 4:10:24 PM
Posted: 1 year ago
fiscal stimulus offset by monetary policy

The crowding out effect is only seen when the LM curve is steep. So, you imply a steep LM curve meaning that interest rates are react highly to fiscal policy (an increase in G would cause a rise in interest rates, but no expansion in output, absent a shift in LM). An increase in interest rates will decrease investment spending (Investment = auto-investment minus - the slope of the investment curve times the interest rate). This scenario isn't necessarily false for the United States. Although it implies that fiscal policy - expanding/contracting the IS curve - is ineffective without monetary policy - expanding/contracting the LM curve.
ResponsiblyIrresponsible
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6/20/2015 4:14:44 PM
Posted: 1 year ago
At 6/20/2015 4:10:24 PM, THEBOMB wrote:
fiscal stimulus offset by monetary policy

The crowding out effect is only seen when the LM curve is steep. So, you imply a steep LM curve meaning that interest rates are react highly to fiscal policy (an increase in G would cause a rise in interest rates, but no expansion in output, absent a shift in LM). An increase in interest rates will decrease investment spending (Investment = auto-investment minus - the slope of the investment curve times the interest rate). This scenario isn't necessarily false for the United States. Although it implies that fiscal policy - expanding/contracting the IS curve - is ineffective without monetary policy - expanding/contracting the LM curve.

None of this really has any bearing on anything I said. I don't reason in terms of IS-LM because I think there are *a lot* of flaws in the model, particularly the focus on interest rates, but if I did, then you're effectively mirroring what I already noted: that interest rates are at the zero lower bound implies a flat LM curve, or a "liquidity trap," in which case crowding out is *not* an issue. I stated as much, and that actually my first argument in favor of fiscal stimulus, though it seems to me that you haven't read through the entire post.

Second, I think you're confusing offset with crowding out. That isn't the argument at all, nor must the Fed "offset" a stimulus via raising interest rates. That'a fatal mistake that a lot of people make, but consider that interest rates have been pinned at zero since late 2008, and yet the Fed has loosened, and subsequently tightened, policy without even adjusting interest rates. Again, I think there are a lot of problems with IS-LM, and actual policy simply does not fit within that narrow framework.
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THEBOMB
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6/20/2015 4:15:20 PM
Posted: 1 year ago
with nominal interest rates pinned at the zero lower bound and the Fed maintaining record holdings of Treasury securities, there"s no threat of a "crowding out" effect.

The LM curve can still be steep which is what determines if there is or isn't a crowding out effect in the IS-LM model.

During normal times, we expect budget deficits, which require that the U.S. Government increase the supply of Treasury bonds in circulation, to reduce private investment via raising interest rates.

Budget deficits place upward pressure on interest rates regardless of the current interest rate. Expansionary monetary policy always places downward pressure on the interest rate, even if the current interest rate is at 0.
ResponsiblyIrresponsible
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6/20/2015 4:21:04 PM
Posted: 1 year ago
At 6/20/2015 4:15:20 PM, THEBOMB wrote:
with nominal interest rates pinned at the zero lower bound and the Fed maintaining record holdings of Treasury securities, there"s no threat of a "crowding out" effect.

The LM curve can still be steep which is what determines if there is or isn't a crowding out effect in the IS-LM model.

Again, this has *zero* bearing on what I said. Crowding out takes place when Congress increases the supply of bonds, which pushes up rates. I was clear that this is *not* the case right now, though I don't reason in terms of IS-LM because I think the framework is highly flawed.

Please, for goodness' sake, read the entire post.

During normal times, we expect budget deficits, which require that the U.S. Government increase the supply of Treasury bonds in circulation, to reduce private investment via raising interest rates.

Budget deficits place upward pressure on interest rates regardless of the current interest rate.

Totally wrong. Once rates reach zero - even using your framework - the LM curve flattens out. The intuition from the way in which I'm communicating it - and I'll try to say this once more - is that rates can't possible move upward at the ZLB because the Fed has perfect control over short rates: via IS-LM, budget deficits apply *upward pressure* on rates, but don't actually move rates upward. Because short rates don't move, long rates don't move, especially because the Fed continuously bought up Treasury bonds

Expansionary monetary policy always places downward pressure on the interest rate, even if the current interest rate is at 0.

Now you just sound robotic... because (a) I never attempted to deny that this was so and (b) in my post, I even directly reference Europe and Australia, which have *negative* nominal interest rates, though I noted that we didn't know this was possible back in 2008 and 2009.

The Fed obviously sets a target range for nominal rates, and calibrates policy accordingly. Expansionary policy would apply downward pressure on long-term rates, sure, though the mechanism for that is jaded (i.e., it doesn't operate in line with a standard IS-LM or money demand framework), and is based on market expectations of the future for monetary policy. You're right that, generally speaking, expansionary policy *should* shift out market expectations such that long-term real rates fall, though I never once denied that was the case. I merely said that, absent a regime change, it's inadequate to closing an output gap.
~ResponsiblyIrresponsible

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ResponsiblyIrresponsible
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6/20/2015 4:34:35 PM
Posted: 1 year ago
@TheBomb:

The entire point of my post was that Fed policy, conceivably, could close the entirety of the output gap by itself, but to do so it would need to (and, yes, this is entirely independent of IS-LM) push real interest rates far below what the zero lower bound constraint would allow. A credible regime change would b required, and because that's not institutionally or politically feasible, the only other option is fiscal expansion.

And, before I forget to mention this, the implication of expansionary monetary policy isn't simply to apply downward pressure on nominal rates: it's to, during conventional times at least, adjust the supply of reserves held by banks to hit some target rate. Now, when they throw trillions of dollars of reserves into the system, as they did with QE, rates will tend to gravitate downward further, but the Fed started paying interest on reserves back in October 2008 precisely so that nominal short rates wouldn't fall even further. The argument was that money market mutual funds, conventionally deemed safe, would take on excessive risk that would threaten the well-being of the financial system.

So, in theory, you're right that nominal rates would tend to fall further, though the Fed has installed checks to directly combat that. Of course, the ability of GSE's to trade in the fed funds market below IOR does push the effective short rate down so it's a permeable floor, but still well within the target range set by the Fed back in December 2008. I'm saying that *real rates* would need to fall further to hit the Wicksellian natural rate, and that's not institutionally possible at the moment.
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THEBOMB
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6/20/2015 5:11:23 PM
Posted: 1 year ago
The first is that, with nominal interest rates pinned at the zero lower bound and the Fed maintaining record holdings of Treasury securities, there"s no threat of a "crowding out" effect. During normal times, we expect budget deficits, which require that the U.S. Government increase the supply of Treasury bonds in circulation, to reduce private investment via raising interest rates. However, the rules of the game change once interest rates reach zero, and will for even a considerable time looking forward. The Fed isn"t expect to completely unwind its balance sheet until 2020, so there"s room to run ever larger budget deficits until then, as the "stock effect" holds down interest rates.

If budget deficits are directly related to interest rates (increase in deficit leads to increased interest rate, and vic versa), we would expect to see a greater investment in capital as budget deficits have fallen since 2009-2010. Capital good orders have peaked around 2010 and have fallen ever since. The interest rate has been at the 0 mark since then and the economy has, overall, stayed relatively flat. Since, we expect greater lending during times of recovery (when assets are being requipped to serve other purposes) and when interest rates are low, this implies a microeconomic reason: banks are less willing to lend money to anybody, including business due to what can either be greater uncertainty, or greater risk in the economy (or less greed on the part of the banks, which I find unreasonable" they're banks).

Second, the Wicksellian equilibrium real rate - or the market-clearing rate - is negative and will likely remain negative due to structural factors, and thus we can"t reach it absent a regime change.

W.R. = natural rate of money - money rate of interest. In broad strokes, the cost of capital exceeds the return from capital (natural rate of money = returns from money investment in the market, money rate of interest = cost to borrow). The cost of borrowing is should not be purely monetary though, it must also include transaction costs, uncertainty, and risk. While the rate of interest is supposed to take these additional costs into account, like you've said the FED has manipulated the interest rate to a place that's been unheard of. Perceptions of risk and uncertainty change at the 0 interest level which would lead to a higher risk and uncertainty and transaction costs over market risk, uncertainty and transaction costs. How do we solve this, well" you said it, increased fiscal policy to increase liquidity and returns on capital for business. But, the issue is that much of the lag has been in sectors like housing/construction and automotive which require mortgages and bank loans to finance them. Fiscal policy won't solve that problem. Heavy equipment manufacturing (used to create cars, buses, planes, heavy machinery to build buildings, etc.) is many steps away from the final product (another laggard), so investment in heavy equipment is used to form goods which could be bought several years from manufacturing. Businesses aren't investing in these heavy things because banks aren't providing the funds for consumers to buy those things now. Such an investment would be extremely risky.

Third, potential output, again, has fallen appreciably amid the crisis. This is easily the most salient point in this discussion, and that"s because the LRAS is entirely outside the purview of monetary policy. It"s based on education, skills, labor, capital, and resources, and represents the rate at which the economy would grow sustainably at benchmark levels of resource utilization. Historically, this was close to 3 percent. However, there"s reason to think this has fallen substantially in the wake of the crisis, and that declines in trend productivity, productive investment, and business formation as well as elevated credit standards and the ongoing deleveraging process could prolong it. We"re looking, roughly, at trend growth close to 2 to 2.3 percent by FOMC projections, though some estimates are as dire as 1.5 to 2 percent. There"s no good reason to simply accept that, and by investing in jobs training, education, research, and infrastructure - or, even, by slashing marginal tax rates or investment tax rates - the federal government can easily ameliorate this problem.

This is a microeconomic problem. Banks need to see greater certainty and less risk from both the economy and government regulatory agencies. There's still tremendous backlash from government agencies over the recession (I know my parent is working on a bunch of lawsuits brought by the SEC against Citigroup, Goldman Sachs, whoever is responsible for Bear Sterns and Lehman Brother, etc.) Nobody even knows who is responsible legally yet. The effects of the recession on bank's balance sheets is still lingering. There has been greater scrutiny of the stock market. There are greater hurdles for banks to jump through to lend money to anybody.

Overall: the main problem isn't in the macro sphere (yes, there are issues), it's in the micro sphere. We expect that pushing the rate of interest lower and lower would increase investment spending, but it hasn't: capital goods formation has been dropping since 2010 (it dropped from 2007 - 2008 began recovering between 2009-2010 and fell thereafter). Consumer confidence is generally going up and there is greater consumer spending. We should expect that capital goods to be formed. They aren't because the necessary funds are unavailable. So, macro policy could be to further decrease the cost of borrowing by forcing the money rate of interest into the negatives (although, then savings accounts would become depleted and consumer debt would begin to rise both of which could set up another crisis), but this could have the micro effect of further increasing risk and uncertainty within the economy precisely because consumer and producer debt would rise.

What we have to look at is this:

W.R. = N.R. - MRI
W.R. = N.R. - (MRI + Risk + Uncertainties + transaction costs) - how to quantify risk, uncertainty and transaction costs and whether it is as simple as adding is a topic for another day

If a FED policy pushes the MRI down past a certain bound, perhaps risk, uncertainty and transaction costs skyrocket leading to a much lower W.R. than expected, but also much less lending.
THEBOMB
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6/20/2015 5:15:13 PM
Posted: 1 year ago
I also see it as a trade issue relating to greater investment by the Chinese in the United States. Greater and greater liquid financial resources are flowing back to China and being used in China. The US is seeing greater nonliquid capital resources. It may be something you want to look into.
ResponsiblyIrresponsible
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6/20/2015 5:25:11 PM
Posted: 1 year ago
At 6/20/2015 5:11:23 PM, THEBOMB wrote:
If budget deficits are directly related to interest rates (increase in deficit leads to increased interest rate, and vic versa),

They're not, by any means, especially when interest rates are zero, so this counterfactual already doesn't follow.

we would expect to see a greater investment in capital as budget deficits have fallen since 2009-2010.

Again, the counterfactual doesn't follow, though it *could* be the case that budget deficits have shrunk as a byproduct of endogenous changes to fiscal policy (i.e., stronger growth, higher tax receipts, lower spending on stabilizers, etc.) and that would tend to be correlated with higher capital investment. Investment has been crap over recent months because of transitory factors, but if you draw a trend line it's much higher than it was at the heart of the crisis.

Capital good orders have peaked around 2010 and have fallen ever since.

That's just not true. Look at the graph - there's been a slight drop-off recently because of falling oil prices, which is where much of the capital investment actually takes place, but it's been trending up.

https://research.stlouisfed.org...

The interest rate has been at the 0 mark since then and the economy has, overall, stayed relatively flat.

Also not true. I could point you to a myriad of indicators - NGDP accelerated over the past two years, the unemployment rate fell from 10 percent in 2009 to 5.5 percent now, consumption and investment are doing better (see the above graph), inflation was trending up for a while but fell due to transitory factors, etc. That just isn't true. Not to mention, last year was the best year of job growth since 1999.

Since, we expect greater lending during times of recovery (when assets are being requipped to serve other purposes) and when interest rates are low, this implies a microeconomic reason: banks are less willing to lend money to anybody, including business due to what can either be greater uncertainty, or greater risk in the economy (or less greed on the part of the banks, which I find unreasonable" they're banks).

I actually discussed this at length in my post, and I think this is generally true: banks have become more risk averse amid the crisis (I don't think it's "greed," but I digress) and uncertainty is in fact high, particularly when it comes to the future of policy. The one point I'd take issue with is the notion that investment is high when rates are low: in fact, I'm with Milton Friedman on this - interest are low *because* the economy sucks and because policy was too tight. High investment means the economy is doing well, the Wicksellian rate rose, etc., and that would be correlated with higher interest rates.

Will respond to the rest in a moment.
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6/20/2015 5:41:06 PM
Posted: 1 year ago
Second, the Wicksellian equilibrium real rate - or the market-clearing rate - is negative and will likely remain negative due to structural factors, and thus we can"t reach it absent a regime change.

W.R. = natural rate of money - money rate of interest. In broad strokes, the cost of capital exceeds the return from capital (natural rate of money = returns from money investment in the market, money rate of interest = cost to borrow).

I couldn't make out what in the world this meant. I know you're trying to lecture me - which is really silly, since the piece you quoted has *nothing* to do with what your saying. It's true that the cost to borrow - i.e., the actual real rate of return on investments - is much higher than the market-clearing rate and the riskless rate because of the constraint of the zero lower bound and financial frictions, respectively. The rest of this is just gibberish that means nothing. The cost of capital *is* the return on capital. It's literally the same interest rate but from different vantage points, absent I suppose transaction costs.

The cost of borrowing is should not be purely monetary though, it must also include transaction costs, uncertainty, and risk.

Sure, and that's why I took care to note financial frictions in my post.

While the rate of interest is supposed to take these additional costs into account, like you've said the FED has manipulated the interest rate to a place that's been unheard of.

It does - the Fed can only target the riskless rate. Actual real rates are much higher because of these costs.

Perceptions of risk and uncertainty change at the 0 interest level which would lead to a higher risk and uncertainty and transaction costs over market risk, uncertainty and transaction costs.

This is again gibberish, and it isn't that these byproducts *result* from rates falling to zero: that's reasoning from a price change. It's that these factors result from an economy in the dumpster, which also causes rates to gravitate downward as the Wicksellian real rate falls.

How do we solve this, well" you said it, increased fiscal policy to increase liquidity and returns on capital for business.

No, that wasn't what I said. I said I wanted to fund productive investments to directly employ people and increase productive capacity, whilst raising the Wicksellian real rate so that it's reachable by monetary policy. Banks are *flooded* with liquidity. We actually may need to drain it in the near futures as rates rise. Trust me when I say that my intention is not to increase liquidity.

But, the issue is that much of the lag has been in sectors like housing/construction and automotive which require mortgages and bank loans to finance them. Fiscal policy won't solve that problem.

I'm going to partly agree and then disagree entirely. It's true that obviously these sectors would be inhibited by high interest rates, and thus if monetary policy tightens too fast we'll have issues. I'm not advocating for that: I'm merely trying to get those dollars into circulation, and irrespective of a deluge of liquidity in the banking system, it's not going anywhere. Not to mention, monetary policy cannot address longstanding debt on consumer balance sheets: fiscal policy can. Heck, fiscal policy can fund loan guarantees if you really thought financial frictions were the issue, though I think the Fed has leaned against those adequately thus far.

Heavy equipment manufacturing (used to create cars, buses, planes, heavy machinery to build buildings, etc.) is many steps away from the final product (another laggard), so investment in heavy equipment is used to form goods which could be bought several years from manufacturing. Businesses aren't investing in these heavy things because banks aren't providing the funds for consumers to buy those things now. Such an investment would be extremely risky.

The last sentence of this is totally right, but you're getting the causation wrong: they're not investing in this equipment not because banks aren't willing to lend, but because those investments aren't profitable at current real interest rates (again, the Wicksellian real rate is further negative). Much of that is also due to uncertainty and a dearth of productive capacity, but all of those can be addressed via fiscal policy.

This is a microeconomic problem.

This is just completely false. I'm referring, in the bit you quoted, to the LRAS: the long-run AGGREGATE supply curve. this isn't even close to a microeconomic problem. It's as Macro as it gets.

Banks need to see greater certainty and less risk from both the economy and government regulatory agencies.

I don't think regulation has much to do with bank lending, nor do I think it's the banks that are the victims in this case. But even if this were the case, this is inherently a Macro problem. Again, fiscal policy can deal with uncertainty.

There's still tremendous backlash from government agencies over the recession (I know my parent is working on a bunch of lawsuits brought by the SEC against Citigroup, Goldman Sachs, whoever is responsible for Bear Sterns and Lehman Brother, etc.)

Since when? I haven't heard of a significant backlash. Quite the contrary, in fact.

Nobody even knows who is responsible legally yet. The effects of the recession on bank's balance sheets is still lingering. There has been greater scrutiny of the stock market. There are greater hurdles for banks to jump through to lend money to anybody.

Again, this is totally wrong, and that was the *intention* of liquidity provision from the Fed: to lean against assymetric information problems brought on by the financial crisis. $3.7 trillion in QE later, I think we can declare "mission accomplished."

Overall: the main problem isn't in the macro sphere (yes, there are issues), it's in the micro sphere.

No, it isn't, because every single problem you cited - some of which are valid, and which were underscored in my post - was Macro in nature.

We expect that pushing the rate of interest lower and lower would increase investment spending, but it hasn't:

No, I don't expect that, and no one should reason from a price change.

capital goods formation has been dropping since 2010 (it dropped from 2007 - 2008 began recovering between 2009-2010 and fell thereafter).

Wrong, see the above great.

Consumer confidence is generally going up and there is greater consumer spending.

True, and that's a good thing - but it's a recent development. It was crap in the earlier months of the year, due mostly to transitory factors.

Still a bunch of stuff to get to... another post is coming.
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6/20/2015 5:48:20 PM
Posted: 1 year ago
We should expect that capital goods to be formed. They aren't because the necessary funds are unavailable.

The funding is there, but productive capacity has been depleted and demand for credit is crap. That's why interest rates are low - they aren't low because policy is super-accommodative.

So, macro policy could be to further decrease the cost of borrowing by forcing the money rate of interest into the negatives (although, then savings accounts would become depleted and consumer debt would begin to rise both of which could set up another crisis),

You just said the problem was Micro, lol. Make up your mind.

The Fed could reduce nominal rates to negative rates, but at some point people will start holding cash. We don't know where that rate is, but because it costs money to actual store cash, we do know that rate is negative - but that's hardly a be-all-end-all because even then we're shy of the Wicksellian natural rate.

The second part.... is just a trainwreck. The idea that boosting total income would *deplete* savings accounts, or that this itself would spur another crisis when in reality stable NGDP growth would preempt another systemic downturn is just a complete and utter trainwreck. Do you actually think Fed policy is responsible for the downturn? Because it couldn't be further from the truth.

but this could have the micro effect of further increasing risk and uncertainty within the economy precisely because consumer and producer debt would rise.

One, that's a Macro problem.

Two, taking on debt wouldn't cause uncertainty - if that were the case, consumers wouldn't take on debt. If they did, it was the direct byproduct of higher levels of *certainty.* We're starting to see household liabilities rise a little as consumer confidence rises, and we can use that as a proxy for falling levels of uncertainty.

I mean, I don't buy rational expectations either, but taking on debt to induce higher levels of uncertainty? That's a trainwreck.

What we have to look at is this:

W.R. = N.R. - MRI
W.R. = N.R. - (MRI + Risk + Uncertainties + transaction costs) - how to quantify risk, uncertainty and transaction costs and whether it is as simple as adding is a topic for another day

You mentioned something similar to this above. I really have no idea what any of these are corresponding to. You responded to my paragraph on the Wicksellian real rate with something that was demonstrably wrong - and, for that matter, which had nothing to do with my post - and I really have no idea what this is, either. It would be really helpful if you actually respond to the things in my post.

If a FED policy pushes the MRI down past a certain bound, perhaps risk, uncertainty and transaction costs skyrocket leading to a much lower W.R. than expected, but also much less lending.

In theory that's possible, though people would just hold cash, anyway, which would directly lean against these "uncertainty" problems. Again, I'm just not seeing the point. If precautionary cash holdings rise, interest rates on balance rise.
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6/20/2015 5:48:46 PM
Posted: 1 year ago
At 6/20/2015 5:25:11 PM, ResponsiblyIrresponsible wrote:
At 6/20/2015 5:11:23 PM, THEBOMB wrote:
If budget deficits are directly related to interest rates (increase in deficit leads to increased interest rate, and vic versa),

They're not, by any means, especially when interest rates are zero, so this counterfactual already doesn't follow.

we would expect to see a greater investment in capital as budget deficits have fallen since 2009-2010.

Again, the counterfactual doesn't follow, though it *could* be the case that budget deficits have shrunk as a byproduct of endogenous changes to fiscal policy (i.e., stronger growth, higher tax receipts, lower spending on stabilizers, etc.) and that would tend to be correlated with higher capital investment. Investment has been crap over recent months because of transitory factors, but if you draw a trend line it's much higher than it was at the heart of the crisis.

Capital good orders have peaked around 2010 and have fallen ever since.

That's just not true. Look at the graph - there's been a slight drop-off recently because of falling oil prices, which is where much of the capital investment actually takes place, but it's been trending up.

https://research.stlouisfed.org...

I apologize, the rate of increase has been decreasing since around 2010. It's now hovering around the 0% increase mark.

http://research.stlouisfed.org...

The interest rate has been at the 0 mark since then and the economy has, overall, stayed relatively flat.

Also not true. I could point you to a myriad of indicators - NGDP accelerated over the past two years,

Sure. There is more money flowing through the economy, but that doesn't mean more things are purchased/being made.

the unemployment rate fell from 10 percent in 2009 to 5.5 percent now,

And less people are looking for work. Unemployment indicators only count those who are currently looking for a job.

consumption and investment are doing better (see the above graph),

Don't disagree necessarily. But, they are becoming less better, if you will.

inflation was trending up for a while but fell due to transitory factors, etc. That just isn't true. Not to mention, last year was the best year of job growth since 1999.


Since, we expect greater lending during times of recovery (when assets are being requipped to serve other purposes) and when interest rates are low, this implies a microeconomic reason: banks are less willing to lend money to anybody, including business due to what can either be greater uncertainty, or greater risk in the economy (or less greed on the part of the banks, which I find unreasonable" they're banks).

I actually discussed this at length in my post, and I think this is generally true: banks have become more risk averse amid the crisis (I don't think it's "greed," but I digress)

Yea. I don't think banks are becoming less greedy. If anything they are more greedy and are just shuffling around money rather than creating new sources of money.

and uncertainty is in fact high, particularly when it comes to the future of policy. The one point I'd take issue with is the notion that investment is high when rates are low: in fact, I'm with Milton Friedman on this - interest are low *because* the economy sucks and because policy was too tight. High investment means the economy is doing well, the Wicksellian rate rose, etc., and that would be correlated with higher interest rates.

I think market interest rates are a past and future indicator. They take into account how the economy did, will did, etc. Low interest rates would indicate, yes, a bad economy. But, they also indicate how the economy is expected to do meaning what demand for money/capital (to use a rather inadequate term) is expected to be in the future.
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6/20/2015 5:49:25 PM
Posted: 1 year ago
At 6/20/2015 5:15:13 PM, THEBOMB wrote:
I also see it as a trade issue relating to greater investment by the Chinese in the United States. Greater and greater liquid financial resources are flowing back to China and being used in China. The US is seeing greater nonliquid capital resources. It may be something you want to look into.

How do you see this issue materializing? It's true that Treasury markets in particular are illiquid, though I can't imagine how foreign investment from China is the cause of this.
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6/20/2015 5:58:06 PM
Posted: 1 year ago
At 6/20/2015 5:48:46 PM, THEBOMB wrote:
I apologize, the rate of increase has been decreasing since around 2010. It's now hovering around the 0% increase mark.

http://research.stlouisfed.org...

In nominal terms, yes, though that's a deceptive measure. A better gauge if the shadow rate which factors in unconventional policy measures - and *that* has been rising: https://www.frbatlanta.org...

Sure. There is more money flowing through the economy, but that doesn't mean more things are purchased/being made.

But it does - if it's flowing through the economy, it's literally being spend. GDP has been rising and employment is nearing the natural.

I mean, do I need to pull a GDP series? lol

the unemployment rate fell from 10 percent in 2009 to 5.5 percent now,

And less people are looking for work. Unemployment indicators only count those who are currently looking for a job.

The U6 has been falling as well, though BLS estimates for the LFPR are around 61.6 percent by the end of the decade. Not to mention, the participation rate has been hovering around the same 30-basis-point window for the past year (and, for the matter, the U3 rose last month because the LFPR ticked up). Estimates from, for instance, Aaronson et al. suggest that 3/4 of the LFPR decline in structural in nature, and much of that is a byproduct of hysteresis. I don't see them returning - unless, of course, a federal jobs training program push the LRAS out and reduced the natural rate to lean against negative duration dependence. That's my plan, but the whole point is that estimates of potential have fallen in part *because* these workers aren't coming back.

consumption and investment are doing better (see the above graph),

Don't disagree necessarily. But, they are becoming less better, if you will.

Less better? I don't know what that means. It isn't really a matter of "disagreeing," either. I can show you the data series - they're increasing. Now, if trend growth is lower, "normal" levels of consumption and investment are necessarily lower, but that's my point: the decline in the potential growth rate is a problem, and the Fed can do little, if anything, about it (other than promising to overheat, though that isn't the least bit feasible).

inflation was trending up for a while but fell due to transitory factors, etc. That just isn't true. Not to mention, last year was the best year of job growth since 1999.

Yea. I don't think banks are becoming less greedy. If anything they are more greedy and are just shuffling around money rather than creating new sources of money.

They're not doing that either: they're sitting on it because there's a dearth of productive investment at current real interest rates. It's literally sitting in a (metaphorical) vault somewhere garnering dust and earning a quarter point of interest from the Fed.

I think market interest rates are a past and future indicator. They take into account how the economy did, will did, etc. Low interest rates would indicate, yes, a bad economy. But, they also indicate how the economy is expected to do meaning what demand for money/capital (to use a rather inadequate term) is expected to be in the future.

I couldn't agree with this more. This is right on point, in fact. Look at longer-term Treasury bonds: out to a 30-year maturity, real rates are startlingly low. I think there's actually a lot of merit to the "Great Stagnation" argument which is, again, an argument for fiscal stimulus because the Fed can't do anything about potential growth.
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6/20/2015 6:06:35 PM
Posted: 1 year ago
At 6/20/2015 5:48:20 PM, ResponsiblyIrresponsible wrote:
We should expect that capital goods to be formed. They aren't because the necessary funds are unavailable.

The funding is there, but productive capacity has been depleted and demand for credit is crap. That's why interest rates are low - they aren't low because policy is super-accommodative.


So, macro policy could be to further decrease the cost of borrowing by forcing the money rate of interest into the negatives (although, then savings accounts would become depleted and consumer debt would begin to rise both of which could set up another crisis),

You just said the problem was Micro, lol. Make up your mind.

There can be macro solutions for micro problems.

The Fed could reduce nominal rates to negative rates, but at some point people will start holding cash. We don't know where that rate is, but because it costs money to actual store cash, we do know that rate is negative - but that's hardly a be-all-end-all because even then we're shy of the Wicksellian natural rate.

The second part.... is just a trainwreck. The idea that boosting total income would *deplete* savings accounts, or that this itself would spur another crisis when in reality stable NGDP growth would preempt another systemic downturn is just a complete and utter trainwreck. Do you actually think Fed policy is responsible for the downturn? Because it couldn't be further from the truth.

If interest rates are negative, the present value of assets exceeds the future value of assets leading people to spend their liquid assets now. That savings account is worth more today than it will be in a year. Why save when I will be able to buy less later?


but this could have the micro effect of further increasing risk and uncertainty within the economy precisely because consumer and producer debt would rise.

One, that's a Macro problem.

Risk and uncertainty are problems in the micro economy.


Two, taking on debt wouldn't cause uncertainty - if that were the case, consumers wouldn't take on debt. If they did, it was the direct byproduct of higher levels of *certainty.* We're starting to see household liabilities rise a little as consumer confidence rises, and we can use that as a proxy for falling levels of uncertainty.

Greater levels of debt causes uncertainty for financial institutions. More debt means they rely on people to pay back that debt. If people don't pay back their debt, financial institutions lose big time.

I mean, I don't buy rational expectations either, but taking on debt to induce higher levels of uncertainty? That's a trainwreck.

What we have to look at is this:

W.R. = N.R. - MRI
W.R. = N.R. - (MRI + Risk + Uncertainties + transaction costs) - how to quantify risk, uncertainty and transaction costs and whether it is as simple as adding is a topic for another day

You mentioned something similar to this above. I really have no idea what any of these are corresponding to. You responded to my paragraph on the Wicksellian real rate with something that was demonstrably wrong - and, for that matter, which had nothing to do with my post - and I really have no idea what this is, either. It would be really helpful if you actually respond to the things in my post.

I'm talking about his differential. The differential tells the difference between costs and returns on capital. Net returns on capital have been relatively flat If not falling.


If a FED policy pushes the MRI down past a certain bound, perhaps risk, uncertainty and transaction costs skyrocket leading to a much lower W.R. than expected, but also much less lending.

In theory that's possible, though people would just hold cash, anyway, which would directly lean against these "uncertainty" problems. Again, I'm just not seeing the point. If precautionary cash holdings rise, interest rates on balance rise.

Or they could also immediately spend and hold their cash in goods, if you will.
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6/20/2015 6:14:37 PM
Posted: 1 year ago
At 6/20/2015 5:49:25 PM, ResponsiblyIrresponsible wrote:
At 6/20/2015 5:15:13 PM, THEBOMB wrote:
I also see it as a trade issue relating to greater investment by the Chinese in the United States. Greater and greater liquid financial resources are flowing back to China and being used in China. The US is seeing greater nonliquid capital resources. It may be something you want to look into.

How do you see this issue materializing? It's true that Treasury markets in particular are illiquid, though I can't imagine how foreign investment from China is the cause of this.

I'll respond to the rest later, but as China owns more capital, financial returns from the capital aren't being used in the U.S., but in China. Increased Chinese ownership of US capital will increase U.S. Goods production, employment, etc. But, the returns from capital which would, normally, be reinvested in the U.S. Economy a re much more likely to be invested in the Chinese economy. China owns US capital X which makes Y. People buying Y increases the returns to X. X's revenues from Y are "trapped" within the Chinese economy due to various legal stuff.
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6/20/2015 6:21:20 PM
Posted: 1 year ago
At 6/20/2015 6:06:35 PM, THEBOMB wrote:
There can be macro solutions for micro problems.

Sure, but it's normal - at least to me - to view bank lending through a macro lends because the implications are inherently macro.

If interest rates are negative, the present value of assets exceeds the future value of assets leading people to spend their liquid assets now. That savings account is worth more today than it will be in a year. Why save when I will be able to buy less later?

That assumes a constant negative discount rate. It's true that a negative rate of interest would incentivize investment over savings, but by no means should we assume negative rates in perpetuity.

Not to mention, again, you could hold cash.

Risk and uncertainty are problems in the micro economy.

And the macroeconomy, but the main manifestations - credit spreads and de-facto AD shocks - are macro in nature, and the ramifications (raising the U3 100 basis points, per the Leduc and Liu paper I cited earlier) are macro.

Greater levels of debt causes uncertainty for financial institutions. More debt means they rely on people to pay back that debt. If people don't pay back their debt, financial institutions lose big time.

It isn't greater *levels* of debt, because if that were the case they simply wouldn't lend. It's the nature of the debt and of the health of the financial system generally speaking.

Not to mention, adverse selection falls as rates fall, so generally speaking expansionary policy and liquidity provisioning is directly designed to lean against this problem.

I mean, I don't buy rational expectations either, but taking on debt to induce higher levels of uncertainty? That's a trainwreck.

What we have to look at is this:

W.R. = N.R. - MRI
W.R. = N.R. - (MRI + Risk + Uncertainties + transaction costs) - how to quantify risk, uncertainty and transaction costs and whether it is as simple as adding is a topic for another day

You mentioned something similar to this above. I really have no idea what any of these are corresponding to. You responded to my paragraph on the Wicksellian real rate with something that was demonstrably wrong - and, for that matter, which had nothing to do with my post - and I really have no idea what this is, either. It would be really helpful if you actually respond to the things in my post.

I'm talking about his differential. The differential tells the difference between costs and returns on capital. Net returns on capital have been relatively flat If not falling.

Do you have a series on that? I have a hard problem buying that, even if it were the case, why exactly should I care? I.e., what are the ramifications of that?


If a FED policy pushes the MRI down past a certain bound, perhaps risk, uncertainty and transaction costs skyrocket leading to a much lower W.R. than expected, but also much less lending.

In theory that's possible, though people would just hold cash, anyway, which would directly lean against these "uncertainty" problems. Again, I'm just not seeing the point. If precautionary cash holdings rise, interest rates on balance rise.

Or they could also immediately spend and hold their cash in goods, if you will.

Sure, they can do that - exact same effect on rates, though.
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6/20/2015 6:23:14 PM
Posted: 1 year ago
At 6/20/2015 6:14:37 PM, THEBOMB wrote:
At 6/20/2015 5:49:25 PM, ResponsiblyIrresponsible wrote:
At 6/20/2015 5:15:13 PM, THEBOMB wrote:
I also see it as a trade issue relating to greater investment by the Chinese in the United States. Greater and greater liquid financial resources are flowing back to China and being used in China. The US is seeing greater nonliquid capital resources. It may be something you want to look into.

How do you see this issue materializing? It's true that Treasury markets in particular are illiquid, though I can't imagine how foreign investment from China is the cause of this.

I'll respond to the rest later, but as China owns more capital, financial returns from the capital aren't being used in the U.S., but in China. Increased Chinese ownership of US capital will increase U.S. Goods production, employment, etc. But, the returns from capital which would, normally, be reinvested in the U.S. Economy a re much more likely to be invested in the Chinese economy. China owns US capital X which makes Y. People buying Y increases the returns to X. X's revenues from Y are "trapped" within the Chinese economy due to various legal stuff.

Okay, that I buy, I don't see it as an issue - a rising China (as opposed to a China in decline, like China as late) is generally speaking a good thing economically. It's not as though we rely on the Chinese for capital, so I hardly see this as an issue.
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6/20/2015 8:59:27 PM
Posted: 1 year ago
At 6/20/2015 5:58:06 PM, ResponsiblyIrresponsible wrote:
At 6/20/2015 5:48:46 PM, THEBOMB wrote:
I apologize, the rate of increase has been decreasing since around 2010. It's now hovering around the 0% increase mark.

http://research.stlouisfed.org...

In nominal terms, yes, though that's a deceptive measure. A better gauge if the shadow rate which factors in unconventional policy measures - and *that* has been rising: https://www.frbatlanta.org...

I posted a graph showing that new capital orders are increasing at a declining rate (less better), your graph shows the federal fund rate has been decreasing at the same time. I haven't ran any statistical tests (and too be honest with you, I probably won't at least for now... although if one can find a correlation between decreases in the shadow rate and changes in capital formation using a time series, that would probably be useful), but it at a glance, it looks as though there would be a positive correlation between the two measures.


Sure. There is more money flowing through the economy, but that doesn't mean more things are purchased/being made.

But it does - if it's flowing through the economy, it's literally being spend. GDP has been rising and employment is nearing the natural.

I mean, do I need to pull a GDP series? lol


the unemployment rate fell from 10 percent in 2009 to 5.5 percent now,

And less people are looking for work. Unemployment indicators only count those who are currently looking for a job.

The U6 has been falling as well, though BLS estimates for the LFPR are around 61.6 percent by the end of the decade.

I strongly question any predictions past 3 or 4 years. Too many things will change, not only in the United States, but the world (supply chains are spread across the entire world... overall, South East Asia specializes in parts production, China in assembly, US in consumption and services.)

Not to mention, the participation rate has been hovering around the same 30-basis-point window for the past year (and, for the matter, the U3 rose last month because the LFPR ticked up). Estimates from, for instance, Aaronson et al. suggest that 3/4 of the LFPR decline in structural in nature, and much of that is a byproduct of hysteresis. I don't see them returning - unless, of course, a federal jobs training program push the LRAS out and reduced the natural rate to lean against negative duration dependence. That's my plan, but the whole point is that estimates of potential have fallen in part *because* these workers aren't coming back.

The fact that we have workers who aren't coming back isn't good (as you've said). It may be a structural change, but it's a structural change for the worse. There needs to be more long term capital investment and savings, but that's the problem we have now lol.


consumption and investment are doing better (see the above graph),

Don't disagree necessarily. But, they are becoming less better, if you will.

Less better? I don't know what that means. It isn't really a matter of "disagreeing," either. I can show you the data series - they're increasing.

Capital investment is increasing, yes. But, it's increasing at a somewhat slower rate when compared to 2010-11. Interestingly enough, the trend looks similar to the 1990s (which ended in the dot com crash.) We'll see how things look over time.

Now, if trend growth is lower, "normal" levels of consumption and investment are necessarily lower, but that's my point: the decline in the potential growth rate is a problem, and the Fed can do little, if anything, about it (other than promising to overheat, though that isn't the least bit feasible).


inflation was trending up for a while but fell due to transitory factors, etc. That just isn't true. Not to mention, last year was the best year of job growth since 1999.

Yea. I don't think banks are becoming less greedy. If anything they are more greedy and are just shuffling around money rather than creating new sources of money.

They're not doing that either: they're sitting on it because there's a dearth of productive investment at current real interest rates. It's literally sitting in a (metaphorical) vault somewhere garnering dust and earning a quarter point of interest from the Fed.

You're right, excess reserves are dramatically rising. That's not for a lack of demand for money: individuals want cash to buy houses and cars and stuff even if companies well don't.


I think market interest rates are a past and future indicator. They take into account how the economy did, will did, etc. Low interest rates would indicate, yes, a bad economy. But, they also indicate how the economy is expected to do meaning what demand for money/capital (to use a rather inadequate term) is expected to be in the future.

I couldn't agree with this more. This is right on point, in fact. Look at longer-term Treasury bonds: out to a 30-year maturity, real rates are startlingly low. I think there's actually a lot of merit to the "Great Stagnation" argument which is, again, an argument for fiscal stimulus because the Fed can't do anything about potential growth.

Low yields on long term treasury bonds suggests that there is an increase in demand for bonds from pension funds and other long term investments which increase their price, but lower returns (the U.S population is becoming older on average.) Too many entities want the long term investment. It is good, at least, that short term treasuries don't have higher yields than long term treasuries.

Honestly, I think the low yields on long term treasuries is a symptom of the US population becoming older: https://upload.wikimedia.org...

http://money.usnews.com...

Interesting site for yield curves, if you're interested (I'm assuming the underlying data is accurate since it's not that difficult to cut and paste from the treasury department's website): http://stockcharts.com...
ResponsiblyIrresponsible
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6/20/2015 9:17:55 PM
Posted: 1 year ago
At 6/20/2015 8:59:27 PM, THEBOMB wrote:
I posted a graph showing that new capital orders are increasing at a declining rate (less better), your graph shows the federal fund rate has been decreasing at the same time. I haven't ran any statistical tests (and too be honest with you, I probably won't at least for now... although if one can find a correlation between decreases in the shadow rate and changes in capital formation using a time series, that would probably be useful), but it at a glance, it looks as though there would be a positive correlation between the two measures.

I think we were linking to different data series for capital order, but both showed a rather sharp rebound in them. I didn't show a graph for the FFR, but generally I think the opposite is true. It's true that cutting rates tends to induce investment, but if the FFR is low it's because the economy is bad, and thus investment by definition is low.

I strongly question any predictions past 3 or 4 years. Too many things will change, not only in the United States, but the world (supply chains are spread across the entire world... overall, South East Asia specializes in parts production, China in assembly, US in consumption and services.)

Surely there are problems with forecasting models, but there isn't anything better that we can readily use - and it's generally consistent with the bulk of the literature suggesting that *most* of the decline is structural. Heck, we have data going back 60 years showing a secular decline in workforce participation amongst prime-age man.

The fact that we have workers who aren't coming back isn't good (as you've said). It may be a structural change, but it's a structural change for the worse. There needs to be more long term capital investment and savings, but that's the problem we have now lol.

I couldn't agree with this more, and that's why I want to bring them back. Federal jobs training programs and investments in research, education, etc. can actually accomplish this end.

Less better? I don't know what that means. It isn't really a matter of "disagreeing," either. I can show you the data series - they're increasing.

Capital investment is increasing, yes. But, it's increasing at a somewhat slower rate when compared to 2010-11. Interestingly enough, the trend looks similar to the 1990s (which ended in the dot com crash.) We'll see how things look over time.

I agree with that, though I think the reason, primarily, is that trend growth is lower, so by definition productive investment per given real interest is far lower than it would be otherwise. I don't see it culminating in a crash, but I do think there are serious LRAS issues that need to be addressed.

You're right, excess reserves are dramatically rising. That's not for a lack of demand for money: individuals want cash to buy houses and cars and stuff even if companies well don't.

I wouldn't say they're rising currently - in fact, they fell a little bit, but are still extremely elevated: about $2.5 trillion as of May, which is astounding. That actually be a good explanation for it: credit standards are such that large companies can actually access funds, whereas smaller businesses or consumers cannot.

Low yields on long term treasury bonds suggests that there is an increase in demand for bonds from pension funds and other long term investments which increase their price, but lower returns (the U.S population is becoming older on average.) Too many entities want the long term investment. It is good, at least, that short term treasuries don't have higher yields than long term treasuries.

That could be at least part of the case, though I tend to think it's based on the market assessment that (a) the Fed won't hit its inflation target, (b) that it won't unwind policy, and (c) that the long-run natural rate is permanently lower. It could factor in that some investors, perhaps pension funds amongst them, are more risk averse.

Honestly, I think the low yields on long term treasuries is a symptom of the US population becoming older: https://upload.wikimedia.org...

http://money.usnews.com...

I think so too, but I see it as an indirect cause: an aging population means a shrinking labor force, and a shrinking labor force shifts the LRAS backward, which reduces trend growth and pushes the natural rate of interest down, and as that falls - and as people expect it to fall further - rates across the board generally fall because long rates are an aggregate of expected future short rates.

Interesting site for yield curves, if you're interested (I'm assuming the underlying data is accurate since it's not that difficult to cut and paste from the treasury department's website): http://stockcharts.com...

Looks good. I usually use the St. Louis Fred site. I have a dashboard of indicators already set up, lol.
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THEBOMB
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6/20/2015 9:40:42 PM
Posted: 1 year ago
At 6/20/2015 6:21:20 PM, ResponsiblyIrresponsible wrote:
At 6/20/2015 6:06:35 PM, THEBOMB wrote:
There can be macro solutions for micro problems.

Sure, but it's normal - at least to me - to view bank lending through a macro lends because the implications are inherently macro.

Agree to disagree. I see anything having to do with risk and uncertainty being inherently micro. Only individual economic units react to risk, changing the risk (or reactions to risk) and thus their reactions is micro. The implications of their reactions on the overall economy is where macro comes in.


If interest rates are negative, the present value of assets exceeds the future value of assets leading people to spend their liquid assets now. That savings account is worth more today than it will be in a year. Why save when I will be able to buy less later?

That assumes a constant negative discount rate. It's true that a negative rate of interest would incentivize investment over savings, but by no means should we assume negative rates in perpetuity.

I mean even if rates are held negative for 5 years, a significant portion of the population may say en masse "I'm not going to save anymore" after the first 2. Most people aren't studying economics. If stated interest rates become negative, I think people will just start buying things rather than invest or stuff money under the mattress. I see it as a psychological rather than economic question; that negative sign could mean a lot.


Not to mention, again, you could hold cash

True. I can always stuff money under my mattress. I don't see many people willing to do that though (too risky, someone might steal my mattress.)


Risk and uncertainty are problems in the micro economy.

And the macroeconomy, but the main manifestations - credit spreads and de-facto AD shocks - are macro in nature, and the ramifications (raising the U3 100 basis points, per the Leduc and Liu paper I cited earlier) are macro.

Yes. The implications of banks lending more is macro. But, the reasons banks lend - to make profit profit, low risk/uncertainty (for conservative banks), etc. - is micro.


Greater levels of debt causes uncertainty for financial institutions. More debt means they rely on people to pay back that debt. If people don't pay back their debt, financial institutions lose big time.

It isn't greater *levels* of debt, because if that were the case they simply wouldn't lend. It's the nature of the debt and of the health of the financial system generally speaking.

As bank assets expand (a loan/debt is an asset for the bank), banks can afford to be riskier since they are insured - ideally - by the nonrisky portion of their balance sheet (e.g. if the nonrisky portion - say Debt-Income ratio of 10% and .1 chance of no repayment - equals $100 in assets (expected value of $90), then perhaps they make $20 in loans to people with a debt-income ratio of .4 and a .5 of no repayment (expected value of $10.) The riskier loans have higher yields (naturally there is a higher interest rate). There is also a bunch of insurance companies who allow banks to take more risk. The problem is they often take it too far and increase their risk too much. Even if every bank has sheets where only .15 won't repay, that's still significant in the macroeconomy, even if each bank stays solvent with the .15 non-repayment.

Interesting study of EU banks which found that greater loans lead to more risk taking: https://www.bundesbank.de...

Another fun filled article (25% or so of all housing loans are to people with debt-income ratios of 43% or higher - which is quite high): http://www.housingwire.com...

Not to mention, adverse selection falls as rates fall, so generally speaking expansionary policy and liquidity provisioning is directly designed to lean against this problem.


I mean, I don't buy rational expectations either, but taking on debt to induce higher levels of uncertainty? That's a trainwreck.

What we have to look at is this:

W.R. = N.R. - MRI
W.R. = N.R. - (MRI + Risk + Uncertainties + transaction costs) - how to quantify risk, uncertainty and transaction costs and whether it is as simple as adding is a topic for another day

You mentioned something similar to this above. I really have no idea what any of these are corresponding to. You responded to my paragraph on the Wicksellian real rate with something that was demonstrably wrong - and, for that matter, which had nothing to do with my post - and I really have no idea what this is, either. It would be really helpful if you actually respond to the things in my post.

I'm talking about his differential. The differential tells the difference between costs and returns on capital. Net returns on capital have been relatively flat If not falling.

Do you have a series on that? I have a hard problem buying that, even if it were the case, why exactly should I care? I.e., what are the ramifications of that?

Of returns on capital falling? Value is created when returns on capital are positive and destroyed when negative. Falling returns on capital implies the rate of increase for value creation by companies is falling. Falling returns on invested capital implies that profits are going down relative to invested capital.

Here's a technical piece on the topic: http://www.mit.edu...



If a FED policy pushes the MRI down past a certain bound, perhaps risk, uncertainty and transaction costs skyrocket leading to a much lower W.R. than expected, but also much less lending.

In theory that's possible, though people would just hold cash, anyway, which would directly lean against these "uncertainty" problems. Again, I'm just not seeing the point. If precautionary cash holdings rise, interest rates on balance rise.

Or they could also immediately spend and hold their cash in goods, if you will.

Sure, they can do that - exact same effect on rates, though.