monetary policy introduction
TRANSCRIPT
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
AN INTRODUCTION TO MONETARY POLICY
Yichuan Wang
Michigan Interactive InvestmentsUniversity of Michigan
December 5, 2013
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
OUTLINE
1 INTRODUCTIONMotivation
2 THINKING ABOUT GOLD
3 MODELINGNominal RigiditiesTimingMisconceptions
4 MONETARY POLICY, QE, AND INTEREST RATESThinking About Interest RatesQE Specifics
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
OUTLINE
1 INTRODUCTIONMotivation
2 THINKING ABOUT GOLD
3 MODELINGNominal RigiditiesTimingMisconceptions
4 MONETARY POLICY, QE, AND INTEREST RATESThinking About Interest RatesQE Specifics
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
MOTIVATION
OUTLINE
1 INTRODUCTIONMotivation
2 THINKING ABOUT GOLD
3 MODELINGNominal RigiditiesTimingMisconceptions
4 MONETARY POLICY, QE, AND INTEREST RATESThinking About Interest RatesQE Specifics
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
MOTIVATION
WHAT IS MONETARY POLICY?
MY DEFINITION
A set of rules for how to adjust the money supply in response to economicconditions
Key ideas:Raising rates 6= Policy, the framework is crucialFocus on M, not r.
Examples:Gold standard – adjust money supply so that price of gold is constantInflation targeting – tighten M if inflation is high, expand if inflation is toolow
Lingo:Tight money – very harsh against inflationEasy money – “tolerant”
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
MOTIVATION
NOMINAL AND REAL VARIABLES
Real variables:How much stuff can I buy?
RGDP, Industrial Production, Initial Claims
Nominal variables:How many dollars does it cost?Two key aggregates
Nominal GDP – total dollar value of all goods and servicesPrice Level – price index of all goods
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
MOTIVATION
NOMINAL AND REAL VARIABLES
Real variables:How much stuff can I buy?RGDP, Industrial Production, Initial Claims
Nominal variables:How many dollars does it cost?Two key aggregates
Nominal GDP – total dollar value of all goods and servicesPrice Level – price index of all goods
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
MOTIVATION
NOMINAL AND REAL VARIABLES
Real variables:How much stuff can I buy?RGDP, Industrial Production, Initial Claims
Nominal variables:How many dollars does it cost?
Two key aggregatesNominal GDP – total dollar value of all goods and servicesPrice Level – price index of all goods
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
MOTIVATION
NOMINAL AND REAL VARIABLES
Real variables:How much stuff can I buy?RGDP, Industrial Production, Initial Claims
Nominal variables:How many dollars does it cost?Two key aggregates
Nominal GDP – total dollar value of all goods and servicesPrice Level – price index of all goods
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
MOTIVATION
MONEY SUPPLY AND INFLATION
Key driver of inflation
AFG
ALB
DZA
ATG
ARG
ABWAUSBHS
BHRBGD
BRBBLZ
BEN
BTNBOL
BIH
BWA
BRN
BGR
BFA
BDI
KHMCMR
CAN
CPVCAF
TCD CHLCHN
COL
COM
COG
CRI
CIV
HRVCYP
CZE
DNK
DJIDMA
DOM
ECU
EGY
SLV
GNQ
ERI
EST
ETH
FJI
FIN
GAB
GMB
GHA
GRD
GTM
GIN
GNB
GUY
HTI
HND
HKG
HUN
ISL
IND
IDN
IRN
IRQ
IRL
ISR
ITA
JAM
JOR
KEN
KOR
KSV
KWT
KGZ
LAO
LVA
LBN
LSO
LBR
LBY
LTU
MAC
MKD
MDG
MWI
MYSMDV
MLI
MLT
MRT
MUS
MEX
FSM
MDA
MNG
MNE
MAR
MOZ
MMR
NAM
NPL
NLD NZL
NIC
NER
NGA
NOR
OMN
PAK
PAN
PNG
PRY PER
PHL
POL
QAT
ROM
RWA
WSM
STP
SAUSEN
SRB
SYC
SLE
SGP
SVK
SLBZAF
LKA
KNA
LCAVCT
SDN
SUR
SWZ
SWECHE
SYR
TZA
THA
TMP
TGO
TON TTOTUN
TUR
UGA
ARE
GBRUSA
URY
VUT
VEN
VNM
WBG
YEM
ZMB
ZWE
0
10
20
30
40
50
0 10 20 30 40 50Average Annual Percent Growth in Broad Money
Ave
rage
Ann
ual P
erce
nt C
hang
e in
the
GD
P D
efla
tor
Money Supply Growth and Inflation (1992−2012)
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
OUTLINE
1 INTRODUCTIONMotivation
2 THINKING ABOUT GOLD
3 MODELINGNominal RigiditiesTimingMisconceptions
4 MONETARY POLICY, QE, AND INTEREST RATESThinking About Interest RatesQE Specifics
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
MONETARY POLICY UNDER A GOLD STANDARD
If our economy were based on gold, what happens to output of goodsand services if there were a gold rush?
It goes up!People buy goods with newfound money, firm not quick enough to raiseprices
Does output rise forever?No!Eventually, firms adjust
David Hume: “On Money”
Money // Quantities // Prices
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
MONETARY POLICY UNDER A GOLD STANDARD
If our economy were based on gold, what happens to output of goodsand services if there were a gold rush?
It goes up!People buy goods with newfound money, firm not quick enough to raiseprices
Does output rise forever?
No!Eventually, firms adjust
David Hume: “On Money”
Money // Quantities // Prices
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
MONETARY POLICY UNDER A GOLD STANDARD
If our economy were based on gold, what happens to output of goodsand services if there were a gold rush?
It goes up!People buy goods with newfound money, firm not quick enough to raiseprices
Does output rise forever?No!Eventually, firms adjust
David Hume: “On Money”
Money // Quantities // Prices
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
DAVID HUME - “ON MONEY” (1742)
To account, then, for this phenomenon, we must consider, thatthough the high price of commodities be a necessary consequenceof the encrease of gold and silver, yet it follows not immediatelyupon that encrease; but some time is required before the moneycirculates through the whole state, and makes its effect be felt onall ranks of people. At first, no alteration is perceived; by degreesthe price rises, first of one commodity, then of another; till thewhole at last reaches a just proportion with the new quantity ofspecie which is in the kingdom. In my opinion, it is only in thisinterval or intermediate situation, between the acquisition ofmoney and rise of prices, that the encreasing quantity of gold andsilver is favourable to industry.
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
THE FIRST “QUANTITATIVE EASING” – LEAVING THE
GOLD STANDARD
September 19, 1931: Britian leaves gold standard, high interest ratesnormalized in March of 19321
100
120
140
1930 1931 1932 1933 1934 1935Date
London Security Price Index
1http://www2.warwick.ac.uk/fac/soc/economics/research/centres/cage/
events/conferences/lessons/papers/british_monetary_and_fiscal_policy_in_
the_1930s_ver_1_13.04.10.pdf
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
THE U.S. EXPERIENCE
April 5, 1933: FDR suspends convertibility of gold, “goes off goldstandard”
100
200
300
1930 1932 1934 1936 1938 1940Date
Dow Jones Industrial Index and the Great Reflation
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
OUTLINE
1 INTRODUCTIONMotivation
2 THINKING ABOUT GOLD
3 MODELINGNominal RigiditiesTimingMisconceptions
4 MONETARY POLICY, QE, AND INTEREST RATESThinking About Interest RatesQE Specifics
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
NOMINAL RIGIDITIES
OUTLINE
1 INTRODUCTIONMotivation
2 THINKING ABOUT GOLD
3 MODELINGNominal RigiditiesTimingMisconceptions
4 MONETARY POLICY, QE, AND INTEREST RATESThinking About Interest RatesQE Specifics
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
NOMINAL RIGIDITIES
NOMINAL RIGIDITIES
KEY IDEA
If monetary policy affects the economy, it’s because “nominal shockshave real effects”
Two main explanations:1 Nominal rigidities: contracts are dollar denominated, hence money supply
(not credit supply) plays crucial role in driving the business cycleExamples: Debt, Wages
2 Say’s Law: excess supply (i.e. recession) for goods is matched by excessdemand for money (i.e. money hoarding)
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
NOMINAL RIGIDITIES
WAGE RIGIDITIES
FRBSF Economic Letter, “Why Has Wage Growth Stayed Strong”2011 Distribution of Wage Increases from CPSSudden drop in nominal variables =⇒ new distribution of real wages
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
NOMINAL RIGIDITIES
DEBT
Debt build up – written in terms of nominal ratesWhen nominal variables change, real distribution of debt changes
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
TIMING
OUTLINE
1 INTRODUCTIONMotivation
2 THINKING ABOUT GOLD
3 MODELINGNominal RigiditiesTimingMisconceptions
4 MONETARY POLICY, QE, AND INTEREST RATESThinking About Interest RatesQE Specifics
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
TIMING
TEMPORARY VERSUS PERMANENT SHOCKS
Permanent monetary shocks always result in nominal shocksHistory: going off the gold standard, Eurozone vs U.S. austerity
When perceived as temporary, then no effectExample: Y2K
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
MISCONCEPTIONS
OUTLINE
1 INTRODUCTIONMotivation
2 THINKING ABOUT GOLD
3 MODELINGNominal RigiditiesTimingMisconceptions
4 MONETARY POLICY, QE, AND INTEREST RATESThinking About Interest RatesQE Specifics
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
MISCONCEPTIONS
A LITANY OF BAD ARGUMENTS AGAINST MONETARY
POLICY
“Central Planning”
Business cycle = market failure – nominal rigiditiesMonetary policy gone wrong: what did FDR do in response to GreatDepression, what did Nixon do in response to Great Inflation?
“Malinvestment”Depth of downturn not related to previous boomNo reason why “good” investments need to be sacrificed
Zimbabwe! Weimar Germany!/
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
MISCONCEPTIONS
A LITANY OF BAD ARGUMENTS AGAINST MONETARY
POLICY
“Central Planning”Business cycle = market failure – nominal rigiditiesMonetary policy gone wrong: what did FDR do in response to GreatDepression, what did Nixon do in response to Great Inflation?
“Malinvestment”Depth of downturn not related to previous boomNo reason why “good” investments need to be sacrificed
Zimbabwe! Weimar Germany!/
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
MISCONCEPTIONS
A LITANY OF BAD ARGUMENTS AGAINST MONETARY
POLICY
“Central Planning”Business cycle = market failure – nominal rigiditiesMonetary policy gone wrong: what did FDR do in response to GreatDepression, what did Nixon do in response to Great Inflation?
“Malinvestment”
Depth of downturn not related to previous boomNo reason why “good” investments need to be sacrificed
Zimbabwe! Weimar Germany!/
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
MISCONCEPTIONS
A LITANY OF BAD ARGUMENTS AGAINST MONETARY
POLICY
“Central Planning”Business cycle = market failure – nominal rigiditiesMonetary policy gone wrong: what did FDR do in response to GreatDepression, what did Nixon do in response to Great Inflation?
“Malinvestment”Depth of downturn not related to previous boomNo reason why “good” investments need to be sacrificed
Zimbabwe! Weimar Germany!/
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
MISCONCEPTIONS
A LITANY OF BAD ARGUMENTS AGAINST MONETARY
POLICY
“Central Planning”Business cycle = market failure – nominal rigiditiesMonetary policy gone wrong: what did FDR do in response to GreatDepression, what did Nixon do in response to Great Inflation?
“Malinvestment”Depth of downturn not related to previous boomNo reason why “good” investments need to be sacrificed
Zimbabwe! Weimar Germany!
/
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
MISCONCEPTIONS
A LITANY OF BAD ARGUMENTS AGAINST MONETARY
POLICY
“Central Planning”Business cycle = market failure – nominal rigiditiesMonetary policy gone wrong: what did FDR do in response to GreatDepression, what did Nixon do in response to Great Inflation?
“Malinvestment”Depth of downturn not related to previous boomNo reason why “good” investments need to be sacrificed
Zimbabwe! Weimar Germany!/
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
OUTLINE
1 INTRODUCTIONMotivation
2 THINKING ABOUT GOLD
3 MODELINGNominal RigiditiesTimingMisconceptions
4 MONETARY POLICY, QE, AND INTEREST RATESThinking About Interest RatesQE Specifics
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
THINKING ABOUT INTEREST RATES
OUTLINE
1 INTRODUCTIONMotivation
2 THINKING ABOUT GOLD
3 MODELINGNominal RigiditiesTimingMisconceptions
4 MONETARY POLICY, QE, AND INTEREST RATESThinking About Interest RatesQE Specifics
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
THINKING ABOUT INTEREST RATES
RELATIONSHIP WITH TRADITIONAL MODELS
Textbook models will focus on the interest rateNot completely wrong, but misleading
Interest rates: price of creditPrice level: price of money
Not necessarily related“Never reason from a price change”
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
THINKING ABOUT INTEREST RATES
THE SIX “CONTRADICTIONS”
From Scott Sumner’s “How to tell if you understand monetary economics”List of six “contradictions” – I focus on two on interest rates.
CONTRADICTIONS OF INTEREST
1 A move to a more expansionary monetary policy lowers short-terminterest rates.
2 In general, the higher the level of short-term rates, the moreexpansionary the monetary policy.
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
THINKING ABOUT INTEREST RATES
INTEREST RATES
A CONTRADICTION OF INTEREST (I)
A move to a more expansionary monetary policy lowers short-term interestrates.
2
3
4
5
6
0 25 50 75 100Money (M)
Sho
rt T
erm
Inte
rest
Rat
e (r
)
Effect of a Monetary Expansion
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
THINKING ABOUT INTEREST RATES
INTEREST RATES
A CONTRADICTION OF INTEREST (II)
In general, the higher the level of short-term rates, the more expansionarythe monetary policy.
2
3
4
5
6
0 50 100Money (M)
Sho
rt T
erm
Inte
rest
Rat
e (r
)
Effect of a Monetary Expansion
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
THINKING ABOUT INTEREST RATES
LONG TERM INTEREST RATES
Goes to show that “easy money” is typically in periods of high interestrates
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
QE SPECIFICS
OUTLINE
1 INTRODUCTIONMotivation
2 THINKING ABOUT GOLD
3 MODELINGNominal RigiditiesTimingMisconceptions
4 MONETARY POLICY, QE, AND INTEREST RATESThinking About Interest RatesQE Specifics
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
QE SPECIFICS
FRAMEWORK
Thinking in terms of M =⇒ QE is self evident“Zero lower bound” is red herring – permanent shocks can still havereal effect“Pushing down long term rates” is intermediate goal – monetaryexpansion will result in higher long term rates (and that’s good!)
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
QE SPECIFICS
STILL THINK MONEY DOESN’T MATTER? –COMPARISON WITH EUROPE
Similar levels of austerity:
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
QE SPECIFICS
COMPARING WITH EUROPE (II)
Drastically different nominal outcomesFor more, see my Quartz article, “Stop the taper talk—the Fed hasactually done too little”
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
QE SPECIFICS
LONG TERM RATES AND QE
Darda: Rates went up during QE periods
INTRODUCTION THINKING ABOUT GOLD MODELING MONETARY POLICY, QE, AND INTEREST RATES
QE SPECIFICS
CONCLUSIONS
Monetary policy = adjustment of M
Has real effects on economy because of nominal rigiditiesThinking in terms of M makes sure you stay consistent, clearerunderstandingPermanent shocks matterEffects of monetary policy show up in the financial markets.