2011-11-10

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.

2011-11-01

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?