"It is easy to confuse what is with what ought to be, especially when what is has worked out in your favor."
- Tyrion Lannister

"Lannister. Baratheon. Stark. Tyrell. They're all just spokes on a wheel. This one's on top, then that's ones on top and on and on it spins, crushing those on the ground. I'm not going to stop the wheel. I'm going to break the wheel."

- Daenerys Targaryen

"The Lord of Light wants his enemies burned. The Drowned God wants them drowned. Why are all the gods such vicious cunts? Where's the God of Tits and Wine?"

- Tyrion Lannister

"The common people pray for rain, healthy children, and a summer that never ends. It is no matter to them if the high lords play their game of thrones, so long as they are left in peace. They never are."

- Jorah Mormont

"These bad people are what I'm good at. Out talking them. Out thinking them."

- Tyrion Lannister

"What happened? I think fundamentals were trumped by mechanics and, to a lesser extent, by demographics."

- Michael Barone

"If you want to know what God thinks of money, just look at the people he gave it to."
- Dorothy Parker

Thursday, November 17, 2011

Through the Zero Bound
(maybe this is the way to get back to my "real" timeline)

Wikipedia entry on the Fisher equation.

Irving, Maynard and Me (Wonkish) by Krugman

I know Krugman has discussed Fisher favorably before.

Why Hasn't the Fed Lowered the Rate It Pays on Reserves? by Mark Thoma

Ryan Avent tweets: "Maybe the Fed should open retail banking locations branded "The Discount Window", offering loans to individuals at negative interest rates."

Deflation and the Fisher Equation by William T. Gavin, Vice President and Economist at the St. Louis Fed (Oct. 2010)

[St. Louis Fed President] Bullard Warns Additional Stimulus Risks Emergence of 1970s-Style Inflation
If [Europe] blows up in a big disorderly way, which is what everybody is worried about, then that could come back to haunt the U.S.," he told CNBC. "If it just kind of tumbles along for a long period of time, which is the most likely outcome, then I am not sure you would get much feedback to the U.S.”
So Europe could blow up but the Fed shouldn't take out insurance? Makes no sense. Richmond Fed President Lacker also see risk of runaway inflation where none exists.

Republican candidate Herman Cain and President of Godfather's Pizza was on the Kansas City Fed's board of directors which explains a lot.

Why does Missouri get two Federal Reserve Banks? Because at the creation of the Fed, the Susan Collins / Olympia Snow holdout was from Missouri.

"You Say "Fischer Effect Under Delfationary Expectations," I Say "Liquidity Trap" by Daniel Kuehn
One thing I've been pondering more and more lately is "how long do you keep spending time discussing this with people who don't get it?". There are lots of people who get it who just have a problem with the whole Keynes packaging and perhaps some of the politics that go along with Keynesianism - many of the NGDP targeters are like this. But I read this post by Glasner, and I know he is worried about the same problem as I am, and that he has basically the same solution. But many people don't get it - do we still invest time in interacting with them, even if we're heading towards a double dip?? I think you still do.
Tony Crescenzi of PIMCO writes:

Irving Fisher developed a theory about the relationship between nominal and real (inflation-adjusted) interest rates determined by borrowers and lenders. When borrowers and lenders agree upon a nominal interest rate, they have an expectation of inflation but do not know what inflation will be realized over the term of their agreement. As inflation is assumed to be unknown, the nominal interest rate has therefore a component of an expected real interest rate and expected inflation rate. This became known as the “Fisher equation” that says when expectations of real rates and inflation change, nominal market and contractual rates change.
Recently, St. Louis Fed President Bullard used the Fisher equation to identify two combinations of nominal rates and inflation known as “steady states,” one of which occurs in the absence of any shocks, where nominal rates remain in a “steady state.” In cases where the inflation rate is either very low or negative, nominal short-term rates can move to an “unintended steady state.” Figure 1 from the St. Louis Fed shows these steady states occurring where the Fisher relationship crosses the line representing the Taylor rule.   
With the policy rates near zero percent in the developed world and inflation expectations now at around 3% (as measured by the five-year break-even rate on inflation-indexed bonds five years forward – a fancy way of looking past current inflation to where markets believe inflation expectations will be in five years looking five years out) global central bank rates (except for Japan) are currently in-between steady states as depicted in Figure 1. However, unlike what the Fisher equation would describe, even with firmer inflation expectations it has become less natural for nominal policy rates to adjust higher. When the sovereign debt crisis intensified, the construct of the policy rate became further embedded into the real interest rate demanded on government bonds. Since the debt crisis enforces severe austerity onto economies, a risk of deflation remains high and could increase expectations of higher future real borrowing costs. According to the Fisher theory, the borrower and lender would have to agree to a new nominal rate that could be significantly higher. With much higher debt levels and lower growth, higher nominal rates may carry greater risk of insolvency and cause financial instability.
Izabella Kaminska at FT Alphaville on September 14:
Why cutting IOER Could Be Suicidal

As we’ve noted, the introduction of the FDIC fee in April eliminated a very well exploited arbitrage for banks, which saw them borrowing cheaper than 25bps (the IOER rate) from Agencies, who did not have access to IOER, and parking the cash at 25bps at the Fed. The difference was a risk-free profit, and helped to keep the Fed funds in and around 25bps. The FDIC fee ate into those profits, however, discouraging banks from conducting the trade — a fact which immediately put negative pressure on repo rates.

The FDIC fee, however, doesn’t apply to foreign banks, which means they are the main ones left exploiting the IOER arbitrage. Cut the IOER, and that kills that trade, says RBC:
To think of it another way, it would introduce a cost on money.

Which of course is possibly what the Fed wants to do to encourage the money to flow into the real economy — but it also runs the risk of kicking off a deflationary spiral that will be impossible to stop, especially if market expectations catch up with Fed thinking as regards deflation risks.

As Lars Svensson, deputy governor of Sweden’s Riksbank,  noted in a paper in December 2003:

Nominal interest rates cannot fall below zero, since potential lenders would then hold cash rather than lend at negative interest rates. This is the socalled “zero lower bound for interest rates.”
The problem is that the economy is then satiated with liquidity and the private sector is effectively indifferent between holding zero-interest-rate Treasury bills and money.

In other words, money loses the unique characteristic that makes it the optimum liquid instrument for exchange. It loses velocity and instead becomes a store of value.

People don’t differentiate between it and zero-interest-rate Treasury bills.

Vaults of the stuff would accumulate, leading to legislation possibility prohibiting stockpiling or a ban on reserve convertibility into banknotes (a ban which never happened during the Great Depression, and which 
some say made the crisis worse).
"Sterilization" is basically the Fed keeping the money supply or velocity of money unchanged even though it's is giving money to the banks and providing liquidity it is cancelling it out at the government level. The private market becomes more liquid, the government less so as it "retires" debt so the overall liquidity level of the economy remains unchanged?

No comments: