I realize that when I’m being too cutesy, it’s not clear what my overall purpose is. So let me first state the overall situation, and then proceed to the (narrow) point of this particular post.
Overall: Recently, David Beckworth wrote a post defending Ted Cruz’s remarks about the Fed in 2008. David had two main empirical arguments: First, if we look at the spread between 1-year and shorter-term Treasury yields, we see that it increases going into the fall of 2008. There is a line of argument saying that that spread indicates how much the market expects short rates to rise in the future, and hence (David concluded) that was one piece of evidence that the market expected the Fed to tighten in the future, as 2008 rolled on. Second, if we look at professional forecasters’ views on T-bill yields, these went up as 2008 passed. So (David concluded) we have two lines of evidence that “the market” expected the Fed to raise nominal short-term rates later in 2008, and their views on this rate hike increased as time passed from spring of 2008 into later seasons, so isn’t this just what Ted Cruz was getting at?
Now, I think both of those points–when properly analyzed–go against David. In other words, using the very criteria he himself chose to make his case, I will show (I claim) that they both go against him, and provide evidence that the market, over time, expected the Fed to have a looser and looser policy as 2008 rolled on. In particular, using David’s criteria, I will show (I claim) that the Fed announcements in June, August, and September all made “the market” expect looser Fed policy in December 2008.
However, some of this stuff gets tricky, and so to make sure I don’t lose you guys, I want to start with baby steps and work my way up.
So in this opening post, let’s all agree on what we mean when we say that people expect a future tightening (or loosening) of policy. We need to start with simple, unambiguous examples, because David in the comments here was digging his heels in when I went right for the punchline. So I’m guessing that if even David–a professional economist–is not immediately seeing what my point was in the FRED chart I posted here, then a bunch of you guys didn’t really get how decisive (I claim) my demonstration was.
Now then, there are two employees, Bobby and Davie, and they each normally earn $120,000 per year. They get paid once per month. Normally, therefore, they get $10,000 per paycheck. In October they each get their normal, $10,000 paycheck. They each expect that they will likewise get paid $10,000 in November and then again in December.
But now the boss makes an announcement: “We are having a great 4th quarter, so we’re giving bonuses out. In November, you will have $1,000 added to your paychecks. In December, you will have $700 added to your paychecks. Good work people!”
Now there is a disagreement between Bobby and Davie on how to interpret this announcement. Bobby argues that relative to the original expected paychecks, they are now getting more. Specifically, they thought they’d be getting $10,000 in November, but actually they now expect to get $11,000. And they originally expected to get $10,000 in December, but now expect to get $10,700. Thus, relative to the expected path of wages before the announcement, the boss’ statement clearly signifies a “looser” or “more generous” wage policy path.
Davie thinks the exact opposite. He points out that before the announcement, he expected no change in wages in the future, going from November to December. But now, after the announcement, he is anticipating a tightening of wage policy, specifically a $300 cut in wages going from November to December. Thus, he classifies the boss’ announcement as a “tight” (less generous, stingy) wage policy.
With whom do you agree? I think it is crystal clear that Bobbie wins this argument. In general Davie’s shortcut might make sense, but in this particular situation it is clearly flawed and generates the exact opposite result from what we want.
Do any of you have a problem with this, in my silly wage story? I want you to pipe up now. If you don’t tell me why I’m wrong in the above at this point, I don’t want you to later re-litigate this point once you see how it proves fatal to the real-world David Beckworth’s argument about Fed policy in 2008.
But a request: Please DO NOT simply launch into why you think my example here is not analogous to the Fed situation. I want everyone who participates in the comments here to either say explicitly, “No Bob I think your hypothetical Bobbie is wrong and here’s why…” OR you agree that yes, Bobbie is right in this particular argument and Davie is wrong. Later on, when I try to move from this discussion to the Fed in 2008, you can dig your heels in if you want, but right now let’s make sure we all agree on what “tightening of expected future policy” means.