I will kill the afternoon with my dentist.
"April 8, 2013, 8:25 am 44 Comments
The Intellectual Contradictions of Sado-Monetarism
Still convalescing from This Week; but it helped focus my thoughts a bit more on the jihad against low interest rates.
What I realized is that Stockman, and many others, represent the latest incarnation of sado-monetarism, the urge to raise rates even in a deeply depressed economy. It’s a long lineage, going back at least to Schumpeter’s warning that easy money would leave “part of the work of depressions undone” and Hayek’s inveighing against the “creation of artificial demand”. Nothing must be done to alleviate the pain!
I have to admit that the resurgence of sado-monetarism has come as a surprise. In the early stages, some readers may recall, there were many people — e.g. my colleague David Brooks — arguing that we should use monetary rather than fiscal policy to respond to the crisis. The hard task of persuasion therefore seemed to be one of explaining the zero lower bound and why it matters, the great difficulty of getting monetary traction and hence the need for fiscal action.
But now that the deficit scolds have killed fiscal policy, monetary policy is also under attack, and with even more vehemence. Yet there’s something very odd about that attack.
The modern sado-monetarist view is, after all, very much centered on the presumption that markets, left to their own devices, will get it right, and that it’s only the distortions introduced by money-printing central banks that cause bubbles and crises — which is why the Fed must stop its easing right away.
But here’s the problem: for loose monetary policy to have the dire effects the sadomonetarists claim, markets must massively get it wrong, and hugely overreact to low interest rates.
Suppose, to take the obvious example, that your claim is that loose policy by the Fed caused the housing bubble, and hence all our current woe. Well, it’s true that borrowing costs were relatively low during the bubble years. Here are mortgage rates:
So mortgage rates fell by about 20 percent from late-90s levels. If
housing prices were the simple inverse of bond prices, this could
explain something like a 25 percent rise. Realistically, you can adjust
this either up or down; focusing on real rates would push the number up,
realizing that there are other costs to buying a house would push it
down. But one thing seems clear: on no rational calculation can the
fairly modest interest rate decline shown above justify this:
Now, you could try to explain the doubling or more of housing prices
in key markets by arguing that low interest rates were what set in
motion a process of irrational exuberance, in which lenders and
borrowers both got carried away; I would agree with Ben Bernanke
that most of the evidence suggests otherwise, but your mileage may
vary. The point, however, is that even if you want to make the Fed the
villain here, you can only do that by assuming that markets are highly
irrational and unstable. If they can overreact so drastically to loose
money, why should you believe that they get it right in response to
other shocks?
So sadomonetarism is intellectually inconsistent. It wants to blame central banks for all the instability in the economy, it preaches a doctrine of non-intervention, but it can only make the case by insisting that financial markets are irrational and unstable to begin with, in which case it’s hard to see why laissez-faire makes sense under any conditions.
And no, I don’t think the sadomonetarists have thought this through. Their position isn’t intellectual, it’s visceral: easy money=sin, and must not be condoned. And while everyone is entitled to his own viscera, this is no way to make economic policy."
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What I realized is that Stockman, and many others, represent the latest incarnation of sado-monetarism, the urge to raise rates even in a deeply depressed economy. It’s a long lineage, going back at least to Schumpeter’s warning that easy money would leave “part of the work of depressions undone” and Hayek’s inveighing against the “creation of artificial demand”. Nothing must be done to alleviate the pain!
I have to admit that the resurgence of sado-monetarism has come as a surprise. In the early stages, some readers may recall, there were many people — e.g. my colleague David Brooks — arguing that we should use monetary rather than fiscal policy to respond to the crisis. The hard task of persuasion therefore seemed to be one of explaining the zero lower bound and why it matters, the great difficulty of getting monetary traction and hence the need for fiscal action.
But now that the deficit scolds have killed fiscal policy, monetary policy is also under attack, and with even more vehemence. Yet there’s something very odd about that attack.
The modern sado-monetarist view is, after all, very much centered on the presumption that markets, left to their own devices, will get it right, and that it’s only the distortions introduced by money-printing central banks that cause bubbles and crises — which is why the Fed must stop its easing right away.
But here’s the problem: for loose monetary policy to have the dire effects the sadomonetarists claim, markets must massively get it wrong, and hugely overreact to low interest rates.
Suppose, to take the obvious example, that your claim is that loose policy by the Fed caused the housing bubble, and hence all our current woe. Well, it’s true that borrowing costs were relatively low during the bubble years. Here are mortgage rates:
So sadomonetarism is intellectually inconsistent. It wants to blame central banks for all the instability in the economy, it preaches a doctrine of non-intervention, but it can only make the case by insisting that financial markets are irrational and unstable to begin with, in which case it’s hard to see why laissez-faire makes sense under any conditions.
And no, I don’t think the sadomonetarists have thought this through. Their position isn’t intellectual, it’s visceral: easy money=sin, and must not be condoned. And while everyone is entitled to his own viscera, this is no way to make economic policy."
France Has Its Own Currency Again
Joe Weisenthal
draws our attention to a development that may surprise many people:
French borrowing costs are plunging. (Don’t tell George Osborne — he
thinks that low British rates are a unique personal achievement). Here’s
the chart for French 10-years:
But wait– wasn’t France supposed to be the next Italy, if not the next Greece?
Well, Joe has what I agree is the right explanation: markets have concluded that the ECB will not, cannot, let France run out of money; without France there is no euro left. So for France the ECB is unambiguously willing to play a proper lender of last resort function, providing liquidity.
And this means that in financial terms France has joined the club of advanced countries that have their own currencies and therefore can’t run out of money — a club all of whose members have very low borrowing costs, more or less independent of their debts and deficits.
Welcome to the club, France. Now, why are you doing all this austerity?"
Well, Joe has what I agree is the right explanation: markets have concluded that the ECB will not, cannot, let France run out of money; without France there is no euro left. So for France the ECB is unambiguously willing to play a proper lender of last resort function, providing liquidity.
And this means that in financial terms France has joined the club of advanced countries that have their own currencies and therefore can’t run out of money — a club all of whose members have very low borrowing costs, more or less independent of their debts and deficits.
Welcome to the club, France. Now, why are you doing all this austerity?"
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The ECB, OMT, and Moral Hazard
Back in 2011 and again in the summer of
2012, a number of economists pleaded with the European Central Bank to
intervene in sovereign bond markets, buying troubled nations’ debt to
stop the “doom loop” of plunging bond prices and financial distress that
was pushing the euro to the brink. The objection from austerians was
always that this would create moral hazard: it would let countries off
the hook, and lead them to slack off on their belt-tightening.
In the end, however, the prospect of imminent collapse concentrated the mind. First through the LTRO lending program, then with the promise to do “whatever it takes”, including Outright Monetary Transactions, the ECB did intervene or at least promise to intervene.
And sure enough, there turns out to be a problem of moral hazard — but not the kind everyone warned about. Instead, the people who ended up being left (temporarily) off the hook were the austerians themselves, who took the narrowing of spreads — which was the result of the ECB’s new activism — and took it as proof that austerity was working.
Via Mark Thoma, Francesco Saraceno marvels at the European Commission’s response to the Portuguese political crisis; the Commission praises the government’s determination to impose austerity no matter what the courts say, because austerity is producing “growing investor confidence in Portugal”. Say what? Well, pretty obviously they’re referring to the narrowing of interest rate spreads.
The point is that this narrowing of spreads has nothing to do with austerity. As Paul De Grauwe points out, the amount by which a country’s interest rate spread against Germany has narrowed is fully explained by how big its spread was at the peak of the crisis — there is essentially no indication that policies mattered at all:
(OK, if you squint really hard you can maybe find that Ireland has
done a bit better than one might have expected, but the point stands).
Yet the Commission has chosen to claim credit for this narrowing of spreads — it is, after all, the only good news they have to show for three years of austerity — and claim that it would go away if there was any relaxation of the pain.
So as I said, there is some clear moral hazard here; the ECB’s intervention has let some people off the hook, and encouraged them to continue with bad policies. But the people in question aren’t spendthrift governments, they’re pain-inflicting troika members, who have been given license to keep on inflicting pain."
In the end, however, the prospect of imminent collapse concentrated the mind. First through the LTRO lending program, then with the promise to do “whatever it takes”, including Outright Monetary Transactions, the ECB did intervene or at least promise to intervene.
And sure enough, there turns out to be a problem of moral hazard — but not the kind everyone warned about. Instead, the people who ended up being left (temporarily) off the hook were the austerians themselves, who took the narrowing of spreads — which was the result of the ECB’s new activism — and took it as proof that austerity was working.
Via Mark Thoma, Francesco Saraceno marvels at the European Commission’s response to the Portuguese political crisis; the Commission praises the government’s determination to impose austerity no matter what the courts say, because austerity is producing “growing investor confidence in Portugal”. Say what? Well, pretty obviously they’re referring to the narrowing of interest rate spreads.
The point is that this narrowing of spreads has nothing to do with austerity. As Paul De Grauwe points out, the amount by which a country’s interest rate spread against Germany has narrowed is fully explained by how big its spread was at the peak of the crisis — there is essentially no indication that policies mattered at all:
Yet the Commission has chosen to claim credit for this narrowing of spreads — it is, after all, the only good news they have to show for three years of austerity — and claim that it would go away if there was any relaxation of the pain.
So as I said, there is some clear moral hazard here; the ECB’s intervention has let some people off the hook, and encouraged them to continue with bad policies. But the people in question aren’t spendthrift governments, they’re pain-inflicting troika members, who have been given license to keep on inflicting pain."
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