resilience, not stability

Archive for June, 2013

Asymmetric Nature of Greenspan/Bernanke Put Monetary Policy

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Via Mark Thoma I came across a post by Antonio Fatas who complains:

I find it surprising that those who argued that QE had very little effect in the economy are now ready to blame the central bank for all the damage they will do to the economy when they undo those measures. So they seem to have a model of the effectiveness of central banks that is very asymmetric – I would like to see that model.

One possible model that contains such an asymmetric response is the model of addiction. Let me provide an analogy that I have explored in detail in an earlier post – the history of psychotropic medication in the United States and its usage to combat an ever-increasing laundry list of mental “disorders”. You keep taking the pills and you hang on, you barely function albeit in a somewhat dysfunctional manner. If you increase the dosage the benefits are negligible. But if you stop taking the pills and do nothing else to break the fall then you risk a catastrophic collapse. That is the asymmetric response of addiction.

Unlike the critics that Fatas refers to, I’m not opposed to the withdrawal of monetary stimulus but the stimulus itself. In particular I am opposed to the nature of the stimulus which focuses all its efforts on propping up asset prices. However, unlike most Fed critics who tend to be conventional “austerians”, I’m a strong critic of asset-price based monetary policy and an equally strong advocate for combined monetary-fiscal stimulus in the form of direct cash transfers to households. I support helicopter drops not just because it is fairer and more “neutral” in its impact on income distribution than quantitative easing. I support helicopter drops because it is the parachute that prevents the hard landing if we stop quantitative easing. I support helicopter drops because it is the most free-market of all macro-stabilisation policies. Rather than bailing out banks and firms and propping up asset prices, helicopter drops simply mitigate the consequences of macroeconomic volatility upon the people. I support helicopter drops because it helps us build a resilient economic system as opposed to chasing the utopian aim of perfect macroeconomic stability.

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Written by Ashwin Parameswaran

June 27th, 2013 at 2:52 pm

An Update

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Over the next few months, I will post a lot more frequently on this blog. But most of my posts will not be long essays but shorter off-the-cuff notes and responses to blog posts elsewhere.

The primary reason for this change is that I’m writing a longer, book-length piece on the ‘invisible foot’. Hence its unlikely that I will find the time and energy to write too many other long-form essays on economics. But my reading and writing sessions generate quite a few byproducts which will find their way here.

Thanks for reading.

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Written by Ashwin Parameswaran

June 27th, 2013 at 1:40 pm

Posted in Uncategorized

Government Debt is Money in an Elastic Monetary System

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Many people think that quantitative easing monetises the government’s deficit spending. As I have argued in a much longer post, the question itself is meaningless. Government debt is already monetised when it comes into existence. Government debt is money. Ask any bank or insurer how they view their holdings of treasury-bills and they will tell you that they view them as money. More importantly, they can use their bondholdings as money. Market counterparties accept treasury-bills as collateral and if bondholders ever need “real” money, they can repo their t-bills for real money.

This “moneyness” of government bonds is not a new phenomenon. In the United Kingdom, it has been true since at least the 18th century when the East India Company repoed its bonds with the Bank of England for money. But the money supply is not “elastic” in this manner in all economies. Take a look at the ongoing Chinese liquidity crunch. In China over the last week it is not clear that T-bills can be repoed for money. But in most western economies, this has been the case throughout the central banking era. By limiting the elasticity of the money supply, the Chinese central bank effectively gives up control of the interbank interest rate (hence the spikes in the overnight interbank lending rate). In a financialised economy such as the United States, this would be a catastrophe. In China, it is unclear what impact this would have on the real economy. India suffered such liquidity crises with habitual regularity throughout the 90s with barely any impact on the real economy.

Inflation does not arise from the central bank’s purchase of the stock of existing government bonds. Inflation arises if the government takes advantage of the central bank’s bond purchases to increase its present and future spending. The central bank in Zimbabwe bought its government’s new debt issuance at a fixed price irrespective of the market demand or inflation. But the inflation arose because the government used this commitment from the central bank to embark upon an uncontrolled spending spree. Whatever your views on our current deficit situation, we are not in the same boat today.

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Written by Ashwin Parameswaran

June 25th, 2013 at 11:27 am

Posted in Monetary Policy