Wednesday, July 6, 2011

A few monetary thoughts

I just read through Hamilton, Pruitt, and Borger's new piece in the AEJ:Macro. They come up with a method for estimating people's daily expectations both of economic outcomes and Fed policy. Sadly, they stop just short of the recent financial crisis. That would really have been the most interesting use: to see how people's expectations of Fed responses adjusted during the crisis. Ah well. Their more modest results for the 1994-2007 show that people do not expect the Fed to react as quickly to changing economic news but that when it does react, the reaction will be larger. Putting the two together makes the Fed's gradual policy changes destabilizing.

Quantitative Easing in the Great Depression - Five Second Beckworth
This QE program was put in motion by FDR telling the public he wanted to return the price level to its pre-crisis level.  In other words, FDR was signalling a price level target.
Among the measures taken were a devaluing of the price of gold from $20.57/ounce to $35.
Ryan Avent recently summed up QE2 very nicely.  He said QE2 changed the direction of monetary policy, but it didn't set the destination.  That is the problem.
Sumner added: QE did start in 1932, but Hoover opposed dollar devaluation and didn't set a higher price level target. Hence the policy was not credible. … The Fed was worried about inflation by 1936, and raised reserve requirements. Perhaps that could be viewed as an "exit strategy." This policy was similar in spirit to the IOR program. The Fed has indicated they might raise IOR as an exit strategy. And yes, the zero bound problem existed throughout much of this period, with T-bill yields near zero.

Romer’s wonderful analysis of what it means to have a “strong” dollar, recommended to me by economists on both the left and the right (yes, this is old, but I've been out for a while)
And a high price for the dollar, which is what we mean by a strong dollar, is not always desirable. …. Strangely, every politician seems to understand that it would be desirable for the dollar to weaken against one particular currency: the Chinese renminbi. For years, China has deliberately accumulated United States Treasury bonds to keep the dollar’s value high in renminbi terms. The United States would export more and grow faster if China allowed the dollar’s price to fall. Congress routinely threatens retaliation if China doesn’t take steps that amount to weakening the dollar.
But in the very next breath, the same members of Congress shout about the importance of a strong dollar. If a decline in its value relative to the renminbi would be beneficial, a fall relative to the currency of many countries would help even more in the current situation.
Conservative economists have been raising alarms for months about the Federal Reserve's second quantitative-easing program, QE2. They argue it has lowered the dollar's value, leading to higher oil and commodity prices—a precursor to broader, more damaging inflation.
Yet the man many of them regard as their monetary guru—supply-side economics pioneer and Nobel Laureate Robert Mundell—says dollar weakness is not his main concern. Instead, he fears a return to recession later this year when QE2 ends and the dollar begins its inevitable rise. Deflation, not inflation, should be the greater concern.

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