28 Shadow FOMC statement

The members of the Shadow FOMC would like to apologize for our extended absence; we were held under house arrest by the agents of Stanley Fisher.

Release Date: January 28, 2015

For immediate release

Information received since the Shadow Federal Open Market Committee met in September suggests that economic activity has been expanding at a pretty reasonable pace. Labor market conditions have improved further, with strong job gains and a lower unemployment rate, and the employment to population ratio has improved, albeit off a low base. The end of extended unemployment insurance seems to have significantly boosted employment; we suggest that the federal government would benefit from privatizing and making optional the remaining unemployment insurance. On balance, a range of labor market indicators suggests that underutilization of labor resources continues to diminish. Household spending is rising moderately; recent declines in energy prices have boosted household purchasing power, though we worry they may have been caused by a fall in global aggregate demand. Business fixed investment is advancing, though recent profitability among industrial companies has been disappointingly weak. The recovery in the housing sector remains slow. House prices remain well below the net present value of avoided future rent payments, probably due to regulation hindering the supply of mortgage financing, though recent data there has been encouraging. Inflation has declined further below the Light Committee’s longer-run objective, as predicted by the Shadow FOMC, and they should not blame energy: while energy prices have fallen dramatically, inflation ex. shelter has been running below target for years, due to the unconsciously tight monetary policy the light committee has followed. Market-based measures of inflation expectations have declined substantially in recent months, and are now indicating that the Light Committee will miss its target for the next 10 years. We are highly disappointed that the Light Committee chose the Orwellian step of renaming them ‘inflation compensation’ instead of ‘inflation expectations’, ignoring the enormous predictive power the market gives us. Yes, survey-based measures of longer-term inflation expectations have remained stable, but who cares? These surveys have been awful forecasters in the past.

The recent rise in the value of the dollar against a trade-weighted basket of other currencies (or, indeed, virtually any other currency other than the Swiss Franc) shows the high level of global demand for the USD. Since this is a product that can be created at basically zero cost, the Shadow Committee would accommodate this demand and print some more USD.

Inconsistent with its statutory mandate, the Light FOMC is failing to foster maximum employment and price stability. Unemployment is low, so the Light Committee’s actions could be justified if it was targeting that… but it is ostensibly targeting employment instead. Employment is still pretty awful; both employment and inflation suggest the need for loser monetary policy. The Shadow Committee expects that, even with a lack of appropriate policy accommodation, economic activity will expand at a moderate pace, as free markets have a tendency to grow. As the economy is kind of like a martingale; risks to the outlook for economic activity and the labor market will always be nearly balanced. Inflation is anticipated to decline further in the near term, and though the Committee expects inflation to rise gradually as energy is a one-time shock and the oil forward curve is very steep, we have no idea why the Lighties expect it to reach the target at any point in the foreseeable future. The Shadow Committee continues to monitor inflation developments closely; evidently more closely than the Light FOMC!

To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. However, we wish to remind people that this by no means represents a lower bound on interest rates; in the event the economy deteriorates further, we would be willing to lower interest rates further, or to deploy an array of other policy tools. In determining how long to maintain this target range, the Committee will assess progress–both realized and expected–toward its objective of a certain NPGDP level, which increases by 6% a year. This assessment will take into account a wide range of information, including market indicators, what people say on facebook, and the behaviour of our cats.

We regret that the Light Committee completed the taper of its bond holdings, though we believe that resuming the program now could be destabilizing and reduce the credibility of the Bed. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.

When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and NPGDP of 6 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Shadow Committee views as more consistent with the fundamental level of human time preference, which implies long-run real rates of around 3-4%. Over the longer term, the Shadow remains concerned about value drift resulting in a future devoid of moral significance.

Voting for the SFOMC monetary policy action were: everyone, because I rule with an Iron Fist.

Betting the House, not the Economy

Òscar Jordà, Moritz Schularick and Alan Taylor recently put out an interesting paper on the relationship between interest rates, the housing market and financial crises. It’s been reviewed very positively, for example here and here. They take advantage of the macroeconomic trilemma – countries with fixed exchange rates and open capital markets ‘import’ the monetary policy of other countries – by treating these imported interest rates as exogenous, providing them with an independent random variable.

People seem to be interpreting it as saying that loose monetary policy causes financial instability through the transmission mechanism of a housing bubble.

To be fair, the opening line of the abstract does give that impression:

Is there a link between loose monetary conditions, credit growth, house price booms, and financial instability?

as does the first paragraph’s use of ‘thus’:

Do low interest rates cause households to lever up on mortgages and bid up house prices, thus increasing the risk of financial crisis?

So one could be forgiven for thinking their conclusion was basically

Loose Monetary Policy -> Mortgage & Housing Bubble -> Financial Instability

… Well, one could be forgiven for thinking that unless one was going to write about the article. If you were going to do that, you should actually read the article. Then you would realize they in fact show two separate things:

Loose Monetary Policy -> Lower Long-term interest rates + Mortgage & Housing Increases
- (with reasonable p-values in general)

and

Mortgage & Housing Market Bubble -> Financial Instability
- (with ok p-values, and some suspicion about how canonical their independent variable was)

Despite having a clever way of treating monetary policy as an independent variable, they never directly test

Loose Monetary Policy -> Financial Instability

even though this would be a major victory for the ‘low interest rates caused the bubble and crisis’ crowd.

Why not test this directly? The authors don’t say, but I suspect it’s because the test would fail to yield significant results. Absence of evidence of such a connection is evidence of its absence. And looking at the significance levels of the two results they did provide, I suspect that combining them would cease to be significant (unless their is another, parallel causal mechanism).

Which is a shame! Their independent variable looked really cool, as did their data set.

I think there’s an underlying theoretical reason to not expect it to work, however (quite apart from nothing ever working in macroeconomics. They rightly make much of their finding that exogenous low interest rates cause increases in housing prices. But this is not necessarily caused by increased demand ‘bidding up’ the value of housing in a bubble.

Rather, consider what sort of an asset housing is. Houses allow you to avoid paying rent in the future; their value is the capitalized value of avoided future rent. When interest rates are low, those future rent payments are discounted at a lower rate, so are more valuable: low interest rates increase the inherent value of housing. House prices rising when rates are low isn’t a bubble unless the interest rates themselves are a bubble; it’s rational cross-asset pricing. So we should expect exogenous falls in interest rates to increase house prices.

But wait there’s more!

Exogenous falls in interest rates probably mean rates are now too low (from a Taylor Rule perspective, or similar), or at least not-as-excessively-high as before. This will tend to increase inflation. And as home ownership represents a hedge against rent inflation, higher inflation yet again increases the value of home-ownership. So once again we have a non-bubble based reason to expect exogenous falls in interest rates to increase house prices.

So we have two reasons to think that low interest rates should cause non-bubble increases in house prices, and journal article that is mildly supportive of this thesis.

2014 Shadow FOMC Statement

Firstly I would like to thank the FOMC for allowing the creation of the Shadow FOMC. In these times of controversial monetary policy, it seems only prudent to have a loyal opposition. And with the increased importance of the Shadow Banking System, whose ranks have been swelled by refugees fleeing the forces of Genghis Frank and Khan Dodd, it is vital that said loyal opposition should be a Shadow FOMC.

We intend to issue quarterly statements, coinciding with the releases of the Light FOMC .

Release Date: September 19, 2014.

For immediate release.

Information received since the Shadow Federal Open Market Committee last met, which was never, suggest that the early universe rapidly expanded due to cosmic inflation. However, the expansion was disjointed due to quantum fluctuations. The effects of these imbalances continue to have a major effect on the universe, as they are the cause of all variation, including galaxies, planets, and the fractional reserve banking system. More recently, fear of another kind of inflation lead to mistakenly tight monetary policy during 2008, a key cause of the recession, from which the economy has now partially recovered. Private Sector GDP is running at a trend rate almost as high as during the Clinton and Bush II bull years, though many analysts miss this due to a mistaken focus on total NGDP, which includes government spending at cost. Industrial production rose. The S&P500, which appeared on the verge of mass bankruptcy, is now at record levels, seeing a 30% rise in 2013. Unemployment, painfully high for a very long time, has started to accelerate downwards. Employment figures, however, have been very disappointing; partly because of demographics, many of the unemployed have simply given up looking for a job. Only recently have we seen the employment/population ratio begin to rise.

More recently, since the Light FOMC met in July incremental data suggests that economic activity is expanding at a moderate pace. On balance, labor market conditions improved somewhat further; however, the employment rate has only improved slightly and wage inflation is muted, suggesting there remains significant underutilization of labor resources. The minimum wage continues to distort labor markets, suggesting a need for higher inflation to reduce its effects. Household spending appears to be rising moderately and business fixed investment is advancing, while the recovery in the housing sector remains slow. Restrained fiscal policy is encouraging true economic growth, although it is confusing accountants who mistakenly assume government spending is by definition useful activity. 10-year breakevens have recently fallen back to 2%, and 5-year breakevens are below 1.7%, slightly below the Light Committee’s longer-run objective. The US government has not issued NGDP-linked bonds, so we lack market implied growth figures, but trailing Nominal Private Sector GDP (NPGDP) growth has been trending around 5%, almost at our 6% target – and substantially closer than the irrelevant NGDP, which is closer to 4%.

If it was acting consistently with its somewhat misguided statutory mandate, the Light FOMC would not have initiated tapering, as low employment and low inflation both suggest a need for lose monetary policy. The Shadow Committee agrees that, with current mediocre policy, economic activity will expand at a moderate pace. The Light Committee thinks that the likelihood of inflation running persistently below 2 percent has diminished somewhat since early this year, which is very strange, given that breakevens have fallen since then. Maybe the Light Committee could not afford a Bloomberg terminal.

The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions, but that this does not excuse irresponsible monetary policy. In light of the hugely reduction in the employment/population ratio since 2006, but improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to maintain the pace of its asset purchases. In October, the Shadow Committee will continue to add to its holdings of agency mortgage-backed securities at a pace of $10 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $15 billion per month. Both Light and Shadow Committees are maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that NPGDP, over time, is at the rate most consistent with the Shadow Committee’s mandate.

The Committee will monitor incoming information on economic and financial developments in coming months as closely as it can be bothered, and will continue its purchases of Treasury and agency mortgage-backed securities, until the outlook for the labor market has improved substantially in a context of NPGDP growth. If incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and the Committee’s optimistic hope of NPGDP moving back toward its longer-run objective, the Shadow Committee will end its current program of asset purchases at sometime in early 2015. However, asset purchases are not on a preset course, and the Shadow Committee’s decisions about their pace will remain contingent on the Shadow Committee’s outlook for the labor market and broader economy, as well as its assessment of the likely efficacy and costs of such purchases.

To support continued progress toward maximum employment and price stability, the Shadow Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate, and suggests that the Light Committee might like undertake one, rather than merely talking about it. In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 6% NPGDP growth. This assessment will take into account a wide range of information, including market indicators, what witty people say in our twitter feed, and patterns we see in clouds. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected NPGDP growth continues to run below the Committee’s 6 percent longer-run goal, and provided that longer-term NPGDP expectations remain well anchored.

When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and NPGDP of 6 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Shadow Committee views as more consitant with the fundamental level of human time preference, which implies long-run real rates of around 3-4%. Over the longer term, the Shadow remains concerned not only about technological stagnation but also about the risks from Superintelligent Artificial Intelligence.

Voting for the FOMC monetary policy action were: everyone, because of the Aumann Agreement Theorem.