30 June 2012

The Great Macroeconomics Experiment

Today's economists should count themselves lucky. Thanks to the Federal Reserve, they are living through the greatest macroeconomics experiment of recent times. Already the Fed's gigantic monetary expansion is causing many old shibboleths to be abandoned. At the end of it, whenever that happens, many unanswered questions will be answered. In what shape the subject of the experiment, the US economy, will emerge is of course another question. But heck, what's the razing of the US economy compared with the advancement of science!

After the Fed expanded its balance sheet by a previously-unheard-of amount beginning 2007, Robert Murphy, a senior economist of the Austrian school, predicted high inflation. (I use inflation here in the sense of rising prices, not as the Austrians term it, a high growth in money supply.) In March 2009 he wrote: "At this stage nothing is certain, but the country is currently headed straight into a period of very rapid price hikes and a very bad recession. It would not surprise me at all if the national unemployment rate and the annualized rate of consumer price inflation both broke through into double digits by the end of 2009. Moreover, regardless of when it actually starts, I predict that things will get much worse before they get better, and that the United States will be mired in a malfunctioning economy for at least a decade, with price inflation in the double-digits (possibly higher) the entire time. We can call this condition 'hyper-depression'." See The Threat of Hyper-Depression.

The inflation that Murphy predicted hasn't come about. One result has been a crack in the Austrian theory. A paper by Vijay Boyapati titled Inflation: An Austrian overview of the inflation versus deflation debate argues that the Austrians were wrong to predict high inflation. Boyapati is a former Google engineer turned Austrian economist who devoted a lot of time to Ron Paul's presidential campaign. In the paper he abandons the idea of the money multiplier, an idea that he notes "is common to both Austrian economics and neoclassical economics". This paper was written in 2010. In recent months I cannot recall any Austrians writing about the threat of high prices.

So Round One, it would seem, has gone to Paul Krugman and the Keynesians. But the Fed should soon help us resolve whether the match will be won by them. For several years they have been calling for more expansion. In their opinion the low inflation is a sign that the Fed can loosen up much more. If the Fed does decide to heed their call and loosen up even further we should see a smart recovery. On the other hand, if the Fed decides not to loosen up then the US economy should move back into a recession in a gradual, slow spiral. In either case there can be no doubt that the redoubtable Dr Krugman was right after all.

The third prediction is one that I am making. This says that monetary expansion is at an all-time high right now and if it is not showing much of a positive effect on the real economy it is because the increased money has gone to inflate the prices of one or more financial assets. When those financial asset markets collapse, banks will find themselves in trouble and cut back lending, and the final effect will be a severe recession.

May the best theory win. Too bad about the patient!

Category: Economics

23 June 2012

Has the Great Contraction Begun?

This month has brought bad news from all over. And many must be wondering whether the next Great Contraction has begun. Below is a very interesting and very simple graph. It adds M1 (seasonally adjusted) to sweeps and subtracts Industrial and Commercial Loans at all Commercial Banks (seasonally adjusted).

It captures the recession of 2007-2009 very well and shows that the contraction began much earlier. One can also argue that the recession was caused by the very large expansion earlier.

Another interesting feature was that it shows the period from about 1994 to 1999 was indeed a Great Moderation.

Incidentally, the latest period shows a contraction.

Category: Economics

20 June 2012

The Fed stops publishing sweeps data

On 2 May 2012 the Board of Governors of the Federal Reserve System discontinued the publication of its retail deposit sweeps data.

This is what the announcement said: "The existing data will continue to be hosted on this website, however no new observations will be reported. The Federal Reserve Bank of St. Louis is currently exploring the costs and benefits associated with revising this data series. Once a decision has been made, a further announcement will be posted here." See the Fed Sweeps Data Page

It is true that sweeps have scarcely changed for the past few years. But that is exactly what one would expect in an environment of near-zero interest rates and poor bank lending. When the economy recovers these data will change and the Fed will have destroyed monetary data that is vital in calculating monetary aggregates.

The Fed does not seem to be aware of its own history. This is what it once said: "Since January 1994, hundreds of banks and other depository financial institutions have implemented automated computer programs that reduce their required reserves by analyzing customers' use of checkable deposits (demand deposits, ATS, NOW, and other checkable deposits) and 'sweeping' such deposits into savings deposits (specifically, MMDA, or money market deposit accounts). Under the Federal Reserve's Regulation D, MMDA accounts are personal saving deposits and, hence, have a zero statutory reserve requirement. ... Retail sweep programs have substantially distorted the growth of M1, total reserves and the monetary base, as Chairman Greenspan noted in his July 1995 Humphrey-Hawkins Act testimony to the Congress."

Category: Economics

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