Lån blir inte dyrare om räntan stiger

Cornucopia skriver att inflationen inte amorterar lånen. Inflation är ett dumt mått att använda eftersom den kan komma från ändringar i antingen AS eller AD. Ändringar i AS är så klart inte intressant i den här diskussionen, så jag kommer använda nominell tillväxt i stället. Om man betalar hela räntan så kommer en högre nominell tillväxt göra att kvoten lån/lön minskar. Och det är samma sak som att amortera på lånet under lägre nominell tillväxt. Här är ett enkelt exempel:

Räntan är rörlig och lika med nominell tillväxt + 1 procentenhet. Vi har en lön på 50000. Lånet är på 1 miljon. Oavsett vad den nominella tillväxten är så betalar vi bara 1% på lånet, ingen amortering. Resten av räntan lägger vi på lånet.

Oavsett vad den nominella tillväxten än blir så kommer kvoten lån/lön att vara konstant eftersom lånet och lönen ökar med samma faktor. Från början är kvoten 20. Om vi har konstanta löner (noll i nominell tillväxt) så betalar vi all ränta på lånet och kvoten förblir då 20. Om vi har 10% i löneökningstakt så får vi 55000 i lön efter ett år, samt 1,1 miljon i lån. Kvoten blir även då 20.

Om vår lön inte ökar lika mycket som genomsnittet får vi så klart problem. Om vi bara betalar 1% i ränta kommer kvoten att öka. Kvoten kommer dock att öka lika mycket oavsett vad den nominella tillväxten är.

Det är helt ointressant hur många kronor vi har lånat, på samma sätt som statsskulden i kronor är helt ointressant. Vad vi bör titta på är lånet i förhållande till vår lön (eller förväntad framtida lön), på samma sätt som vi tittar på statsskulden i förhållande till BNP. Ett litet praktiskt problem med högre tillväxt är att skattenivån kan bli högre om inte Riksdagen höjer gränsvärdena i samma takt.


Minutes from Riksbanken's latest policy meeting

Riksbanken published the minutes from their latest policy meeting on October 26. There were a few interesting details in it. As I wrote about earlier, Ekholm and Svensson wanted to lower the rate, while the decision went against them and the rate was left at two percent.

Both Ekholm and Svensson questioned why Riksbanken's official prediction for policy rates abroad were a lot higher than market predictions and why there were no explanation for this large difference. Here's Svensson:
As he had demonstrated with the aid of a figure at the monetary policy meeting in July, the forecast for policy rates abroad has systematically been too high for several years, with the outcome systematically lower than the forecast. A too high forecast for policy rates abroad leads to a bias towards a too high repo-rate path, all else being equal.
Later on, we have a weird comment about balance sheet recessions.
Deputy Governor Lars Nyberg commented on Mr Ingves’s observation that a few years after the property crisis the United States has come quite a long way in managing the ”balance sheet recession” that hit households in particular. In this type of recession monetary policy is not very effective, as households want to pay off their debts and tidy their balance sheets before increasing their consumption again. Many European countries, on the other hand, are just at the beginning of this process and in addition, companies and banks also have large debts. This indicates that the adjustment will take some time.
Does Lars Nyberg not believe that a central bank can increase nominal GDP in balance sheet recessions? Or does he claim that higher nominal GDP wont lower the unemployment rate?

Svensson had three argument for lowering the repo rate.
Firstly, as he has said, an unjustified high forecast for policy rates abroad gives a bias towards a too high repo-rate path. Secondly, there is a bias towards overestimating resource utilisation. Thirdly, even if one accepts the high forecast for policy rates abroad and the high estimate of resource utilisation and the sustainable unemployment rate of 6.5 per cent, one can still show that a lower repo-rate path stabilises CPIF inflation better around 2 per cent and unemployment better around a level of 6.5 per cent. Regardless of how one views it, the main scenario thus entails monetary policy that is not well balanced.
Svensson wasn't impressed by the reasons given for maintaining the repo-rate at two percent.
So why isn’t the repo-rate path being lowered further? Mr Svensson went on to say that a few muddled reasons are given at the end of Chapter 2. It is claimed that economic activity will fall because companies and households will postpone consumption and investment due to the uncertainty over future developments. In such a situation, it is doubtful whether monetary policy will have the same immediate effect as indicated by the historically-estimated links. It would require a more uneven repo-rate path to stimulate the economy.

This appears to be speculation and has no foundation. The arguments are not convincing and raise several questions. Why is it increased uncertainty and not lower expectations of future income and demand that will make households and companies reduce their consumption and investment? And if it is increased uncertainty, why should this mean that monetary policy has less impact? And why should a specially-uneven repo-rate path be necessary in this situation? Why wouldn’t a lower, relatively smooth repo-rate path provide a better and acceptable outcome? And how can one discuss these issues without showing how the various repo-rate paths would look? Where is the analysis that supports these claims? As far as Mr Svensson could see there was no such analysis. It all gives an impression of excuses added on afterwards.

If, in this situation, the repo rate were really to have less effect on inflation and resource utilisation than usual, it would be a reason to cut the repo rate further, not less, to have the same effect. In autumn 2008 and later, following Lehman, in a situation with maximum uncertainty and minimum confidence among economic agents, it was by acting forcefully and making large interest-rate cuts that enabled central banks around the world to contribute to ensuring that the crisis did not develop into the Great Depression II.
The second reason was that a lower repo-rate might cause house prices to increase too much and households to take on too much debt. Svensson's argument was that monetary policy is the wrong tool to handle such issues.

Svensson then explained why he only wanted to lower the repo-rate to 1.75 percent.
According to this analysis, target fulfilment could be even better if the repo-rate path was lowered further. However, as Mr Svensson mentioned at the previous meeting, it requires considerable resources and there are a number of technical difficulties that have not yet been resolved when it comes to making forecast calculations for repo-rate paths that are far from the main scenario and then determining which path is best. This repo-rate path does, however, entail a much improved target fulfilment relative to the main scenario, so it will have to suffice on this occasion.
Svante Öberg made a reference to the Taylor rule for why two percent was appropriate.
The Taylor rule based on a long-run normal repo rate of 4 per cent, the current CPIF inflation rate and various measures of current resource utilisation presently point to a repo rate of 2.8-3.5 per cent. This would indicate that the repo rate is currently too low. In the forecasts it remains unchanged for a while, and then rises to 3.5 per cent towards the end of the forecast period. This also seems reasonable, said Mr Öberg, who said that on the basis of his overall assessment he supported the proposed direction for monetary policy
Öberg was the only one mentioning the Taylor rule. It's obviously not very useful at the moment.


Rubber band, take 2

Blake Johnson replied in a comment on the Market Monetarist blog to my previous rubber band post. I realize that my previous post wasn't very clear, so I'll try to be more specific this time.

Let's do this with the MV = NGDP equation (where M is base money). If the central bank is initially credible in its level targeting (it doesn't matter whether it's price or NGDP targeting) and market expectations make sure that NGDP stays on the path no matter what the central bank does with M, they wont get any feedback at all as to what is a good size for M. If they keep M constant, V will grow 5% each year. Since the market expects NGDP to stay on the path, there wont be any signs in asset prices or TIPS spreads that the central bank is making M grow too fast or too slow. This is what I was referring to with the circularity problem. Perhaps I'm using that concept the wrong way.

Let's say the central bank keeps M constant. How much can V continue to increase? Surely there must be some limit. One USD can't give you 100 trillion USD of NGDP. So eventually the market will have to protest to this abuse and the central bank will have to increase M.

If they increase M enough, NGDP will return to the target path. There's no doubt about that. But the central bankers might not be 100% sure that NGDP level targeting works. This is the first time that they are in trouble. Everything was so easy previously, when they didn't have to do anything at all. So perhaps there is some limit to how much they are willing to increase M before they give up and switch back to the good old inflation target.

What if the market fears that this is the case? What if V has increased so much that the central bank wont be willing to increase M enough? What if NGDP keeps on falling due to this fear? And then, when the central bank has reached its increase-M-threshold, they abandon the level target.

Well, there sure seems to exist an easy fix to this problem. Just increase M at the same rate as NGDP. Problem solved?


Rubber bands and nominal GDP level targets

I've been reading Lars Christensen's excellent blog posts on Friedman's exchange rate advice. Friedman claimed that fixed exchange rates are bad, partly since the market can never be sure that the country would not later devalue their currency. This makes the currency a target for speculative attacks that might cause the exchange rate to be abandoned. A monetary union, on the other hand, doesn't have this problem.

While reading those blog posts I started to wonder if NGDP level targeting could be vulnerable to a similar problem. Let's say the Fed announces that it will do whatever it takes to keep NGDP on the historical growth path. The market believes the Fed is credible and base velocity increases sharply over the coming months so that NGDP returns to that path.The Fed keeps on fiddling with their funds rate, but no matter what they do, NGDP keeps following the path. The Fed, not wanting to admit that they aren't important anymore, keeps on adjusting the funds rate and keeps on patting their backs for being so amazingly good. What really happened, though, is that the market expected NGDP to stay on the path, so the economy kept on growing at the expected rate.

However, after many years without any slowdowns, the economy took a nose dive (initiated by a war in some oil producing country). NGDP fell by one percent. Well, this shouldn't be a problem. The Fed will get NGDP back on the path. No need to worry. But there was something the market worried about. What if this recession got big enough that the Fed decided that NGDP level targeting didn't work? And since the market fears this, NGDP might fall even more, making the shift away from NGDP targeting even more likely. So NGDP kept on falling and eventually the Fed announced that NGDP level targeting didn't work and switched back to inflation targeting.

I don't think NGDP futures convertibility suffers from this problem. That's a bit like a monetary union. But do we need convertibility to make NGDP level targeting work? The problem, as I see it, is that the central bank might let the monetary base grow too slowly since the market expectations make NGDP stay on the path (the circularity problem). Eventually, the rubber band is stretched too much and snaps back.

So what's the flaw? I hope some competent market monetarist can tear this down.

Also, is this a problem even with an inflation target? Can market expectations keep inflation close to the target even if central bank keeps the monetary base growing too slowly? Did the rubber band cause the current recession?

Update: One big difference between the exchange rate defense and the defense of the NGDP level target is that the exchange rate case leads to tighter policy (Sweden raised its rates to 500% in 1992), while the NGDP case leads to easier policy. This should make the NGDP level target a lot easier to defend. Just increase the monetary base until the market is satisfied. Still, the circularity problem makes this situation so weird.


Central bank transparency

Nick Rowe has very good post on central bank transparency.
One sentence in Fed vice-chair Janet Yellen's speech caught my eye:
"Indeed, I believe that the Federal Reserve qualifies as one of the most transparent central banks in the world."
That is total bullshit. The Fed is one of the least transparent central banks in the world.
The complaint Nick has is that the goal of the Fed is very far from transparent and that this is the most important area for a central bank to be transparent in. The reason for this is that market expectations of future monetary policy has a huge impact on the economy today. If the central bank refuses to reveal its goal, the market is forced to guess by carefully reading anything the central bank releases. A good example of how this guessing game can cause bad effects on the economy can be found in a recent Bloomberg article.
At BNP Paribas SA’s New York trading desk, Julia Coronado, the bank’s chief North America economist, watched as three words helped undermine the Federal Reserve’s latest attempt to aid the U.S. economy: “significant downside risks.”
The phrase, tucked into a seven-paragraph policy statement about the Fed’s plans to move $400 billion into long-term debt from short-term bonds, warned about the economic outlook while offering no clue on the risks’ severity. The Sept. 21 statement said Fed officials expected “some pickup” in the pace of recovery, though unemployment would “only gradually” decline.
Bloomberg continues.
Without such specifics, Fed watchers like Coronado, who keeps a rubber Bernanke doll taped atop her computer screen, are left to parse the qualitative language of Fed statements. Last month, investors decided the words meant it was time to buy bonds and sell stocks; the Standard & Poor’s 500 Index closed 3 percent lower that day.
This isn't directly about the Fed's goal. The market wanted to know exactly what the downside risks were and why the Fed had reached that conclusion. What model had they used, and so on. It still shows how big effect three simple words from the Fed can have. How much easier wouldn't it be if the Fed's goal were clear? And if they also published all the details for their predictions, well, that would be the icing on the cake.

The Bloomberg article also has a nice little tidbit from Bernanke.
He has argued in favor of providing “quantitative guidance” on the Fed’s inflation goal and once criticized central banks that engage in “Marcel Marceau” monetary policy, “allowing its actions to convey all its intended meaning” like the French mime.
But let's get back to transparency about the goal. Both the Fed, Bank of Canada (BoC), and Riksbanken has some sort of dual mandate. They are not only supposed to keep inflation low, but also to keep unemployment low. The Fed has made no official statement as to what level of inflation they aim at. The BoC and Riksbanken, on the other hand, has officially stated that they see two percent inflation as their goals. But none of them has said which inflation figure is supposed to be kept at two percent. Is it CPI or core CPI (or CPIF in Sweden's case)? BoC and Riksbanken are more transparent than the Fed, but they too could improve in this regard.

Another problem is that neither BoC nor Riksbanken has any official goal for the unemployment part or how they weigh inflation compared to unemployment. Is one percent too high inflation equally bad as one percent too high unemployment? Lars Svensson recently proposed that central banks should make all of this official.
Furthermore, an inflation index, a measure of resource utilization, and a measure of stability need to be specified. It is important not to confuse measures of resource utilization to be used as an indicator of inflationary pressure and as a target variable. As the latter, the unemployment gap between unemployment and the sustainable unemployment rate seems to be more reliable and transparent than the alternatives. I am convinced that the framework is more effective if only one inflation index and only one measure of resource utilization is chosen. With multiple inflation and resource-utilization measures, the framework becomes more opaque and accountability becomes difficult to enforce. With many measures, policymakers can often find at least one or two that are close to the desired level and thus motivate quite different policies.
Even if he doesn't go so far as to propose an official exact weighting of inflation versus unemployment, I'll borrow his objective function (from the same paper).

L = (p - p*)^2 + lambda (u - u*)^2,

where p-p* is the deviation of inflation from its target and u-u* the deviation of unemployment. lambda is a positive constant that the central bank should decide. L is the loss function that the central bank will try to minimize. What if the central bank officially adopted this function as their goal? How's that for transparency of the goal? Bernanke could wear a t-shirt with this equation printed on both sides (with p*, u*, and lamda replaced with the official figures).

Well, there's an even better option. How about an official growth path for nominal GDP? That would make the future effects of monetary policy on the economy even more transparent. It would also make the goal itself a bit more transparent since u* can change over time, while the NGDP growth path lasts forever.

Riksbanken leaves the rate at two percent

Riksbanken decided today to leave the repo rate at two percent (as I guessed in an earlier post). The prediction for the future repo rate (räntebanan) was lowered. It was interesting to see that both Svensson and Ekholm (the two academics) made a reservation and had preferred to lower the rate to 1,75 percent.

My preference would have been to lower the rate like Svensson and Ekholm suggested, since the nominal GDP gap is still too large.

Read more at DN or SVD (both in Swedish only).



Börsutveckling jämfört med BNP

This blog post is in Swedish.

Jag har tagit OMXSPI och delat med nominell BNP (multiplicerat med en konstant så att indexet är 100 i början). Dotcom-bubblan ser självklar ut, så här i efterhand. Frågan är dock om det här indexet är användbart för att spå börsutvecklingen i framtiden. Troligtvis inte. Och även om det fungerar just nu, så lär marknaden snappa upp det och se till att det inte fungerar i framtiden.

OMXSPI nominell BNP

Jag tog medelvärdet av OMXSPI för varje kvartal och delade med nominell BNP för motsvarande kvartal samt de tre föregående (ej säsongsrensad data). Jag fick dock inte med OMXSPI för 2010-07-01 och framåt. För den sista punkten i grafen tog jag fredagens OMXSPI på 300 och delade med BNP för 2010 Q3 - 2011 Q2.

Om nån vill ta fram egna indexvärden för att jämföra med grafen, ta OMXSPI och dela med nominell BNP (3411512 just nu) och multiplicera med 1994839.

Bernard Madoff to the rescue

Several MM bloggers have recently likened central banks to Chuck Norris. Now comes the Onion and suggests that Bernard Madoff might be able to save the economy that even Chuck Norris could not manage to save.

After determining the current economic emergency could not be resolved "within conventional means," Treasury Department agents reportedly confronted the notorious Madoff in his solitary confinement cell and proposed a mutually beneficial arrangement that will make the 73-year-old a free man if he can safely "get in and out" and turn the failing financial system around by Friday.
"We told him the situation—how our country can't seem to generate wealth and investment nationwide has hit rock bottom—and then we asked him, point-blank, 'Can you help us?'" Treasury Secretary Tim Geithner said of Madoff, known to fellow prisoners at Butner Federal Correctional Complex as "Mad Dog." "Believe me, no one wants to do this monster any favors, but he's the only man in America with the skills to rally investor confidence and conjure money out of thin air. This time, though, he'll be using his talents for good—if we can keep him on a tight enough leash, that is."
If only we had a central bank that could conjure money out of thin air and rally investor confidence that nominal GDP will rise sharply over the next few years.


Yellen: QE3 might be warranted

Bloomberg reports:

Federal Reserve Vice Chairman Janet Yellen said a third round of large-scale securities purchases might become warranted if necessary to boost a U.S. economy challenged by unemployment and financial turmoil.
The central bank should also give “careful consideration” to Chicago Fed President Charles Evans’s proposal to tie the near-zero interest-rate pledge to specific levels of unemployment and inflation, Yellen said today in a speech in Denver.
QE3 would be nice and a pledge to keep the funds rate low until unemployment or inflation reaches some thresholds likewise. But if the Feds goal is to get unemployment down to, say, 7% unless inflation goes up to, say, 5%, why not just say that that's their goal and they will do whatever it takes until we get there? Why limit the actions to a low interest rate?

The Fed should also give careful consideration to the other option Evans mentioned: nominal GDP level targeting. The number of proponents keeps on growing.

The remarks signal Fed officials may be prepared to delve further into unprecedented monetary territory and take criticism inside and outside the central bank for expanding the balance sheet.
The Fed has increased its balance sheet to about 15% of GDP while the Swedish central bank expanded to 25% of GDP. So why is the Fed receiving so much critisism for its balance sheet?