25 Jun 2013

It’s Easy to Be Right When You Don’t Admit You Were Wrong

Economics, Federal Reserve, Financial Economics, Krugman, Market Monetarism, Scott Sumner 29 Comments

I’m going to be laying into my two favorite bloggers–Paul Krugman and Scott Sumner–for their slippery handling of the recent rise in Treasury yields. As I’ve said several times on this blog, I think Krugman and Scott do this a lot (Krugman is more annoying about it); it’s just that this is a particularly obvious example. However, I don’t want to give the impression that everybody I fight with on this blog, does the same thing. So in the interest of balance, let me officially thank Tyler Cowen for admitting there is a problem, and (dare I say it?) Brad DeLong for being so good about listing ways he botched things in the past.

OK on to the fun stuff:

==> For years, Krugman has been saying that people like the Austrians are wrong for blaming “artificially” low interest rates on Bernanke’s “aggressive” policies. For example, when Bill Gross of PIMCO thought the end of QE2 buying would lead to a spike in Treasury yields, Krugman took him out to the woodshed numerous times, and also said that anybody who invested based on Gross’s views lost a lot of money. (E.g. look here and here.) As usual with Krugman, this wasn’t just a feeling in his belly; he was saying he (Krugman) had a buttoned-down model to explain his views, whereas Gross couldn’t even come up with a good theory to explain his position.

==> For his part, Scott Sumner has also taken me specifically to the woodshed for thinking the Fed is holding down Treasury yields.

==> In that context, the following chart from Justin Wolfers is a bit problematic for my confident blogging friends:

OK, that looks sorta consistent with the perspective coming from my blog and other Austrian-friendly sources, right? Doesn’t mean we have a monopoly on truth, but it sure means that Krugman and Sumner need to either (a) ignore this completely or (b) when commenting on it, do so with some humility and explain why it totally contradicts what they’ve been telling people for years.

In this essay about the Fed’s recent policy shift, Krugman continues with his woe-is-me-I-hate-being-Cassandra narrative. You wouldn’t get even a hint that maybe something is a bit odd here, and that the response to the Fed announcement–according to Krugman’s own explanation of how to interpret swings in stock and bond prices–means the Fed’s buying has been holding down Treasury yields.

(Subtle point made in the interest of fairness: There is a difference between QE2 winding down according to schedule, versus a surprise announcement of a change in the wind-down date of QE3. However, Krugman has in the past gone further than merely criticizing Bill Gross’ specific call; Krugman has more generally said that the Peter Schiff-types are wrong for thinking low interest rates are “artificial” and caused by Bernanke, as opposed to the economic slump.)

Now if Krugman is a bit slippery, Scott Sumner is jaw-dropping in his audacity. In response to Arnold Kling saying the past two weeks present a bit of a problem, Scott writes:

The correlation between nominal interest rates and NGDP (or RGDP) growth is overwhelming positive. Nothing that happened this week contradicts that. Indeed nothing that happened this week contradicts what I’ve been saying for the past 4 1/2 years…

So what have we learned this week? To me this is one data point, indicating tight money is slightly more likely to raise long term rates than I had previously assumed….

PS. The fact that Krugman, Cowen, Kling, myself and many others were surprised by the surge in rates over the past few weeks actually speaks well of our understanding of macro. It shows that we’ve been paying attention, that rates don’t usually behave this way. As for those who “got it right,” you have some “splaining to do” about the surging yields in Japan in response to more QE. [Bold added.]

By all means, go read him in full context to see if I’m distorting his meaning.

Or how about this? Gavyn Davies was complaining in an FT article that the recent jump in interest rates showed that the Fed’s exit (from QE) may be more difficult than we had been led to believe. After all, if just tweaking announcements about the end of the program caused 10-year yields to rise that much, what happens when Bernanke says, “We’re letting our portfolio go back to pre-recession levels”? (That’s my question, not necessarily Davies’ spin.) Davies brought up an historical precedent for his worries:

[A] previous big Fed exit, announced on February 4, 1994, was even more dramatic. It was a day that triggered such turbulence that it is etched in the memory of all bond traders. Working as a Goldman Sachs economist, I was on the bond trading floor when the Fed released an innocuous-sounding statement. The FOMC had decided “to increase slightly the degree of pressure on reserve positions . . . which is expected to be associated with a small increase in short-term money- market interest rates”. Pardon? After a few moments, there was an explosion of noise as realisation set in.

The market was unprepared for the Fed change, Investors were over-leveraged and knee-deep in Mexican debt and mortgages. Equities emerged relatively unscathed. But before the bloodbath ended that November, the survival of the US investment banks was at stake.

Here’s what Scott said in response:

The tipoff is the “equities emerged relatively unscathed” remark. I’ve been around for 58 years and can’t recall a more boring and uneventful year than 1994. That means Fed policy was working. Boring is good! Yes, there was some turmoil in the bond market, but bond markets don’t matter, what matters is NGDP. And that was fine.

The sooner we remove finance from monetary economics the better. All it does is lead to fuzzy thinking, as we also saw in my previous post. [Bold added.]

I’m not offering these quotes to blow up market monetarism. What I’m asking is that my really sharp free-market colleagues who have sided with Sumner over the Rothbardians on this stuff, step back and really think hard about how flippant Scott is being. Are we really willing to throw out microeconomics so much, that “bond markets don’t matter”? Is it really true that the Fed buying trillions of dollars of government debt, hasn’t seriously screwed up the economy in ways that have not yet fully shown their awful consequences?

29 Responses to “It’s Easy to Be Right When You Don’t Admit You Were Wrong”

  1. James in London says:

    Agreed SS’ comments can sometimes sound like a shuffle, but then the market in government bonds can sometimes do that too. From May 22nd until June 19th government bondholders have been fearing a confirmation of taper talk and been gradually selling. The economic news in May hasn’t been too bad after all, do tension was naturally rising too. After all, bondholders aren’t stupid and know long term yields are at long term lows.

    On June 19th they got that confirmation about tapering and began to sell in earnest. A trickle of a liquidity effect became amtorrent, as your chart so clearly shows. Wierdly this really was compounded by a remarkably coincidental PBOC-induced cash crisis in China, see the story and chart for the massive spike (yes, truly massive spike) in overnight money over there on Thursday 20th.
    http://www.nytimes.com/2013/06/21/business/global/china-manufacturing-contracts-to-lowest-level-in-9-months.html?_r=0
    http://www.shibor.org/shibor/web/html/index_e.html

    The US economic news is still gradually improving adding to the cocktail, pressuring those bondholders some more, and making them fear a sudden frenzy of selling based on their fear of a genuine economic recovery.

    So we have an economic recovery raising rates as SS and MMs would expect, but the smooth course of this rise has been interrupted by the Fed potentially becoming a coincidentally powerful confirmation of this situation, allied to China, causing an unusually large liquidity event.

    An NGDP futures market would have confirmed what has been really going on, but it is possible the Fed is just acting in tune with what this market would have been asking for, or ordering, if MMs had managed to take the discretion out of monetary policy.

  2. Adrian Gabriel says:

    Interesting that John Papola thinks Scott Sumner is a good economist. Sometimes I wonder if his Keynes-Hayek video is a correct assessment of Austrian Economics or a shortened pick-and-choose type of rant like the ballyhoo Selgin and White espouse. I would have to say that the latter is more true.

  3. DesolationJones says:

    I still don’t understand how exactly these higher rates proved Krugman wrong. He’s wrong because interest rates went up? Well, that’s what Krugman said would happen.

    (under tougher fed)
    http://krugman.blogs.nytimes.com/2013/05/29/rate-stories/?_r=0

    “(Subtle point made in the interest of fairness: There is a difference between QE2 winding down according to schedule, versus a surprise announcement of a change in the wind-down date of QE3.”
    Okay, that 100% explains difference between the PIMCO situation and recent events.

    “However, Krugman has in the past gone further than merely criticizing Bill Gross’ specific call; Krugman has more generally said that the Peter Schiff-types are wrong for thinking low interest rates are “artificial” and caused by Bernanke, as opposed to the economic slump.)”

    Krugman has a problem with the word “artificial” because the thinks the “unartifcial” rate is the wicksellian natural rate, which he believes is currently negative. So in his framework, it’s odd to call current rates artificial because the market rate should be even lower for full employment. He would only call rates artificially low if they were being held under the natural rate, which he thinks would cause high inflation. (and it isn’t happening) He has never denied Bernanke has helped keep rate down. He wouldn’t be able say things like ” [fed] will keep short rates at zero” if didn’t believe the Fed plays row in the low interest rates. Like you said, his theory is absolutely depends on Bernanke being able to doing this, but he also believes the weak economy has played a larger role in the generally low rates.
    http://krugman.blogs.nytimes.com/2012/04/20/plutocrats-and-printing-presses/
    http://krugman.blogs.nytimes.com/2013/03/26/the-unnatural-rate-hypothesis/

    • Matt Tanous says:

      “the wicksellian natural rate, which he believes is currently negative.”

      Capitalists pay for the privilege of lending now? What nonsense is this?

      “Is this saying that it will ever reach zero? No; because, I repeat it, the principle of a remuneration is in the loan. to say that interest will be annihilated, is to say that there will never be any motive for saving, for denying ourselves, in order to form new capitals, nor even to preserve the old ones. In this case, the waste would immediately bring a void, and interest would directly reappear.

      In that, the nature of the services of which we are speaking does not differ from any other. Thanks to industrial progress, a pair of stockings, which used to be worth six francs, has successively been worth only four, three, and two. No one can say to what point this value will descend; but we can affirm, that it will never reach zero, unless the stockings finish by producing themselves spontaneously. Why? Because the principle of remuneration is in labor; because he who works for another renders a service, and ought to receive a service. If no one paid for stockings, they would cease to be made; and, with the scarcity, the price would not fail to reappear.

      The sophism which I am now combating has its root in the infinite divisibility which belongs to value, as it does to matter.

      It appears, at first, paradoxical, but it is well known to all mathematicians, that, through all eternity, fractions may be taken from a weight without the weight ever being annihilated. It is sufficient that each successive fraction be less than the preceding one, in a determined and regular proportion.

      There are countries where people apply themselves to increasing the size of horses, or diminishing in sheep the size of the head. It is impossible to say precisely to what point they will arrive in this. No one can say that he has seen the largest horse or the smallest sheep’s head that will ever appear in the world. But he may safely say that the size of horses will never attain to infinity, nor the heads of sheep to nothing.

      In the same way, no one can say to what point the price of stockings nor the interest of capitals will come down; but we may safely affirm, when we know the nature of things, that neither the one nor the other will ever arrive at zero, for labor and capital can no more live without recompense than a sheep without a head.” – Frederic Bastiat

      If Krugman believes the natural interest rate is negative, or even COULD BE, I’ve been giving him WAY too much credit.

      • Tel says:

        If you knew that an absolute disaster was coming next week, so bad that it would destroy everything you have (especially your savings, your house, your property, all your friends and family would be gone, and you would die). You have no idea of the nature of this, and there’s nothing you can do to plan a way out of it, you just know it’s gonna be real bad.

        In that case, interest rates would be negative, because every day you don’t go out and party, is a wasted day.

        However, I agree that we aren’t in quite such a bad situation as that right now. We can still make plans to some extent, and none of us are immediately under threat. Thus, the outrageous situation required to create negative interest rates hasn’t happened yet.

        • Major_Freedom says:

          Tel, time preferences can get very high in cases of “end of the world” scenario. But they can never be so high that natural rates go negative.

          This is because to act at all IS to have a positive time preference, which is to say natural rates are always positive.

          Natural rates are NOT the rates of interest on loans. But if you want to mention loan rates, and given that we imagine an end of the world scenario, by what reason would you pay someone to borrow your money, i.e. to take your money off your hands for them to spend, and not you? Wouldn’t you ask for an infinite interest rate in order to part with your money in this scenario? For that would be an example of negative interest rates.

          • Major_Freedom says:

            Sorry, bad order of words. I wrote the sentences not in the order you read them.

            The last sentence should be replaced with the second last sentence.

  4. Transformer says:

    “OK, that looks sorta consistent with the perspective coming from my blog and other Austrian-friendly sources, right? ”

    Can you explain why in your model a tightening of monetary policy would lead to higher interest rates ? Perhaps I’ve not been paying sufficient attention but I thought you believed that loose money policy led to more inflation (and higher nominal rates) and that tightening would lower this risk and lower interest rates.

    I’m guessing that the answer has something to do with the natural rate of interest but would appreciate a clarification.

    • Transformer says:

      “Is it really true that the Fed buying trillions of dollars of government debt, hasn’t seriously screwed up the economy in ways that have not yet fully shown their awful consequences?”

      Also can you clarify what you think these “awful consequences” are ?

      The main reason for the purchases were not to bail out the government from the consequences of its debt but simply to increase the money supply in a time of heightened demand for money (this would very likely have happened in a different way in a totally free market). Its not clear to me why this will have awful consequences.

      • Ken P says:

        “Also can you clarify what you think these “awful consequences” are ?”

        It has resulted in large investments overseas as cheap money sought high returns. When money tightens, many of these investments will be unsustainable, causing uncompleted projects in emerging markets.

        It has encouraged investors to make leveraged bets, borrowing short term and loaning long term. Deleveraging is a risk, as are the resulting high rates.

        • Transformer says:

          “it has resulted in large investments overseas as cheap money sought high returns.”

          Can you give some examples of or data on these “large investments overseas” ?

          • Ken P says:

            It’s been all over the news for a couple years now that policy makers in emerging markets have been complaining that US Fed QE is causing excess global liquidity, resulting in inflated asset prices. China and Brazil have been especially vocal.

            A European bank study concluded that QE was increasing asset prices and liquidity in emerging market economies:
            http://www.ecb.int/pub/pdf/scpwps/ecbwp1557.pdf

            We are transitioning from concerns about excess global liquidity due to QE to insufficient global liquidity due to the potential withdrawal of QE.

            Two weeks ago, the World Bank warned of problems as global liquidity is withdrawn. Private credit in China is up to 160% of GDP.

            None of this proves anything, but it sure fits the Austrian story better than the Keynesian story.

    • Matt Tanous says:

      “Perhaps I’ve not been paying sufficient attention but I thought you believed that loose money policy led to more inflation (and higher nominal rates)”

      Inflation would lead to lower monetary interest rates due to an increase in the supply of nominal loanable funds.

      • Transformer says:

        It should lead to lower real rates due to increased supply but higher nominal rates due to inflation. Plus lots of other things related to expectations could cause it move in an indeterminate way.

        It isn’t clear to me why Bob is claiming that bond prices falling as a result of fed tightening is a vindication of his model, unless he is just claiming that the price of bonds will fall when the fed stops buying them – which seems a bit simplistic and not consistent with what actually happens on most occassions.

    • skylien says:

      Does tightening lower the risk immediately? Is the mere act of changing monetary policy setting the economy in a sustainable healthy condition?

  5. DesolationJones says:

    Questions for austrians: At what point did interest rates become “artificial low”? If you somehow know when they’re artificially low in a Federal Reserve monetary regime, presumably you should also know when they become artificially high. At what point do interest rates start to become artificially high? Also, how do you know when rates are artificially low and when they’re artificially high?

    • Innocent says:

      Then what was the point of QE3 other than to change the bond rates. Was that not the stated purpose, ergo it is ‘artificially lowered’ is it not?

    • Major_Freedom says:

      “Questions for austrians: At what point did interest rates become “artificial low”?”

      Among other possible reasons, at the point the central bank lowers them via non-market intervention (what you might call OMOs that increase the supply of loans beyond the rate of real savings). We can’t OBSERVE this empirically, because we can’t observe the counter-factual world without central bank intervention when the intervention occurs.

      It would be like asking “How can you observe the event characterised by an information signal that is an accurate representation of what the sender intended, as opposed to what they didn’t intend, given that you can’t read their mind?”

      “If you somehow know when they’re artificially low in a Federal Reserve monetary regime, presumably you should also know when they become artificially high. At what point do interest rates start to become artificially high?”

      Same as above.

      “Also, how do you know when rates are artificially low and when they’re artificially high?”

      Not sure how this question constitutes an “also.” Seems like you’re just reasking the same questions.

  6. Ken Pruitt says:

    I still can’t understand why professional economists are using measurements such as “Nominal GDP”, “Nominal Interest Rates”, etc.. All of these things rely on, or are themselves, Nominal Prices, and as Frederic Bastiat warns us regarding Nominal Prices:

    “Do you desire to be in a situation to decide between liberty and protection? Do you desire to appreciate the impact of an economic phenomenon? Inquire into its effects upon the abundance or scarcity of commodities, and not upon the rise or fall of prices. Distrust nominal prices; they will only land you in an inextricable labyrinth.”

    Bastiat, Frederic (2011-04-13). The Bastiat Collection (LvMI) (Kindle Locations 4386-4388). Ludwig von Mises Institute. Kindle Edition.

    • AD says:

      It doesn’t mean we can rely on nominal changes for standard of living, but if there were no nominal/real interaction, we wouldn’t be talking about recessions, no matter what your preferred economic theory.

  7. macroman1 says:

    The Fed’s share of marketable securities: http://research.stlouisfed.org/fred2/graph/?g=jKu

    Not that much different than before the crisis.

  8. AD says:

    But Sumner is right and has said this before: “Interest rates are a lousy indicator of the stance of monetary policy, because they reflect both liquidity effects and longer term effects.”

    What happens if interest rates fall now? You’re going to reverse the win for the Austrians? You can do this every day with market fluctuations.

    • Tony says:

      Pathetic. As I note in my other reply here, there are MANY factors affecting the prices of bonds.

      Ex: +2-4=-2
      Remove the +2
      -4=-4

      Now use the mindset of “all else equal”. What is the individual affect of each input factor on bond prices/yields?

      Easy enough. You can look no further than 1930’s and 40’s America. Deflationary depressions help bond prices. It is a very strong effect. (assuming no default)

      The Fed exiting(let alone selling) is one of many inputs on net. It is a strong input though. There are Austrians that expect another rise in bond prices before they finally revert back to norms, for the reason just noted.

      in summary we can make the input by the Fed simple

      RIght now it is a +2, 0 if not buying, -2 if unwinding.

      If net prices of bonds do rise again during 0, then the obvious conclusion is that THEY WOULD HAVE RISEN MORE with the Fed in the market still. In current economic conditions it is obvious that bonds should be much much lower.

      I see a possibility of another rise in bond prices. I will add to my short position if they do so. Remember, they are still buying. Investors are anticipating the 0 condition.

  9. RPLong says:

    With Sumner, it’s always heads I win, tails you lose. I remember telling him that food prices were inflating, and he openly denied it. Then, a year later, he blogged about the rise in food prices as if everyone knew about it. I called him out on this, and my comment mysteriously never appeared on his blog. So I put it on my own blog with all the relevant citations. Never reason from a price change. Never reason from a change in interest rates. Never reason from a change in the rate of change of NGDP. The only thing you are allowed to reason from is what Scott Sumner tells you about NGDP.

    I’ve written a million things about how NGDP targeting is circular reasoning, but it becomes like gospel. You get used to the language, and it starts feeling like a self-contained system. After that, there’s no reasoning with you any longer. It’s strange how certain ideas can captivate highly intelligent people. We just have to remember that we are the same species that invented frenology.

  10. JSR08 says:

    That is some weapons-grade denial, right there. I wonder, when the inevitable correction to all of this money-printing and inflating comes, if intelligent people like Sumner will be able to see past their biases and recognize and acknowledge their mistakes. I know Krugman never will, as he is too much of a blind partisan and non-economist, but it is nice to think guys like Sumner actually want the truth but have just arrived at incorrect, but logical-seeming, conclusions.

  11. Tony says:

    Wow Sumner is pathetic.
    “The fact that Krugman, Cowen, Kling, myself and many others were surprised by the surge in rates over the past few weeks actually speaks well of our understanding of macro. It shows that we’ve been paying attention, that rates don’t usually behave this way. As for those who “got it right,” you have some “splaining to do” about the surging yields in Japan in response to more ”

    CORRELATION DOES NOT IMPLY CAUSATION!!!!
    You can’t go through life in the mindset of “B happened after A, so B was caused by A”. What happened the last time bond yields were at 2%? they reverted quickly to more normal levels. The Fed is an additional (of many) inputs affecting the bond market. Sumner is focusing on one input. This shows his utter lack of common sense.

    -With so many bonds in existence, the price should be very low (S&D right?).
    -A low growth period with low net inflation acts beneficial to bond prices.
    -Central banks buying most/many of them raises prices.
    -Central banks unwinding their balance sheets will cause bonds to go further down.
    -Retail investors will sell if they expect prices to go lower. And they did have to rise at some point.

    THEY HAVEN’T “reverted quickly to more normal levels.” Any chart makes this obvious. Then consider the enormous size of debt today versus the last 50 years.

  12. Innocent says:

    Okay I admit my own ignorance here.

    Basically the Fed ha injected liquidity into the banking sector. They have done this through the purchase of about $1 Trillion in mortgage backed securities. Which are the self same securities that caused the fiscal crisis, but that is not really relevant here. By doing this it has allowed Banks to invest money, not in investors, but in stocks ( creating inflation in the Stock Market )

    At the same time it was doing this it was buying 10 Year Treasuries forcing down the interest yield on that as well. These two actions combined together seem to have caused an increase in price in stocks, and lowered the long term interest rate on housing to ‘artificially’ low levels. Now the truth is that they are a market player so this is I suppose not ‘artificial’ but rather a direct result of the Fed purchasing assets in this way.

    Now to Krugmans statement ‘Austrians are wrong for blaming “artificially” low interest rates on Bernanke’s “aggressive” policies’ – What was the stated Goal of the Fed in making these policy decisions? Was it not his stated goal to LOWER interest rates? If you have a hot tub filled with normal people and then a 600 pound man gets in what will happen to the water level? Will it not ‘rise’ to a higher level? IS this ‘artificial’ or simply the result of a huge man getting into small pool of water? If his stated goal is to raise the level of the water will this not be accomplished. If Krugman’s contention is the word artificial rather than ‘on purpose’ then I agree with him. But then we are simply dealing with semantics.

    What has happened is the Fat man has said, I am going to be getting out of the water soon. People realize what the result of that will be, investors are NOT stupid.

    Anyway. A better question will be how LONG will the long term interest rates rise, my guess like a wave it will go up and then settle back down as people tend to over react.

    A better question is if the Fed stopped QE3 today what would the result be?

  13. Earle I. Padilla says:

    The bond market was on another rollercoaster ride on heavy volume, a day after remarks by Federal Reserve Chairman Ben Bernanke about the U.S. central bank’s bond purchase program prompted a massive selloff in Treasuries.

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