"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

Monday, February 25, 2013

"high demand" not "excess demand" and "reaching for yield."


What is an "excess demand for money"? by Nick Rowe

(via Thoma)

What's the debate between DeLong/Beckworth and Rowe/Waldmann?

Alan Blinder spoke of a bond bubble alongside the housing bubble. What happened?

Safe assets are now in high demand. This is signified by the fact that people with money (institutional investors, China, etc.) are willing to lend money to the U.S. at zero interest rates. 

Beckworth speaks of "market segmentation." During the bond bubble, there was no segmentation as mortgage-backed-securities earned higher interest rates than they deserved. The demand for money was met even as we had a savings glut with interest rates above the zero lower bound. ???

Since there is no bond bubble, people with money don't have places to park it where it earns interest (reaching for yield). But as Waldmann correctly points out, there isn't an "excess" demand as people can buy as many Treasuries as they want. Rowe concurs. 

But people with money would pay more for safe assets if they had to and send interest rates negative. But they can't and so what do they do with the extra money? They sit on it? Excess reserves at the central bank.

DeLong writes "Brad DeLong [says]… "John Stuart Mill… saw that excess demand for some particular set of assets in financial markets was mirrored by excess supply of goods and services in product markets, which in turn generated excess supply of workers in labor markets. If you relieved the excess demand for financial assets, you also cured the shortfall of aggregate demand" [for a recent formulation of these arguments, see Ricardo Caballero and Emmanuel Farhi]."

(I think I'll just recycle the comment that I left Robert Waldman on DeLong's original post, because I think it might apply here as well.) 
"Excess Supply (or Demand)" has more than one meaning. Those meanings are non-identical, but related. 
Waldman and you focus on the micro-economic meaning; in a single market for a homogenous good we can see whether supply for that good is greater than or less than demand when we hold prices fixed. That's a precise definition and probably the most common one. 
Macroeconomists have a related and different definition. They're comparing aggregate supply (i.e. potential output) and aggregate demand. Now, in some simple models it is possible that the two meanings correspond; aggregate demand equals aggregate supply if the aggregate price level is right. That equivalence goes away in more complicated macroeconomic models. 
I think another way of saying that last sentence is to say that "potential output" is not necessarily the same as the sum of a bunch of price-based supply functions.

Prices during and after bubble. Prices of safe assets were lower during the bubble as people were parking their money in riskier assets which paid higher interest rates. So demand of safe assets was lower. Or rather the supply of safe assets was much much higher as per Blinder's bubble many unsafe assets were treated as safe assets.

Post bubble prices of safe assets are much higher - as are the demand - as people are willing to lend to the Treasury at zero interest rates.

So Mill and DeLong are saying we need more safe assets? QE is supposed to lower the demand and price of riskier assets as the Fed buys them. Waldmann is skeptical of QE.

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