Here’s Tyler Cowen:
One of the current macro puzzles is that we keep on receiving good labor market reports during a time of monetary and credit tightening. Which is the missing “dark matter” variable that helps to explain this?
I see no “current macro puzzle” because I see no monetary tightening. NGDP growth over the past couple of years has been very rapid, and thus the strong labor market is no surprise. Perhaps Tyler would say that the strong NGDP growth is surprising. If so, why? Is he assuming that rising interest rates reflect monetary tightening? (It doesn’t.) Does he judge monetary policy by the growth rate of M2? (He shouldn’t.) What’s his metric? What causes Tyler to conclude that monetary tightening has been significant?
I am aware that the extremely rapid NGDP growth has been gradually slowing—but it’s still quite rapid. If you wish to call that “tightening,” that’s fine. But the strong labor market is no surprise given the high NGDP growth rate. I don’t see any mystery here. David Beckworth produced this graph:
Again, what macro puzzle? If Tyler insists on finding some mysterious “dark matter,” how about the following:
The unobservable natural rate of interest has risen faster than the policy rate, producing easy money. The cause of the rise in the natural rate is the monetary and fiscal stimulus of 2020-21, which generated very fast NGDP growth. Higher NGDP growth leads to a higher natural rate of interest in 2022.
If you insist on focusing on M2, then the dark matter is movements in velocity.
READER COMMENTS
roundtree
May 7 2023 at 1:17pm
The only thing missing from this post is the usual Sumner reminder: Don’t reason from a price change. As always, insightful and applicable. Many thanks!
Spencer
May 7 2023 at 1:58pm
Money demand, M2/GDP, is still high:
https://fred.stlouisfed.org/graph/?g=eTtE
The deceleration in M2 is entirely due to dis-savings (drop in savings deposits relative to means-of-payment money). At some point, this decrease in money demand, temporary rise in Vt, will end.
In Alfred Marshall’s “Cash Balances Approach” (the demand for money), K = “the length of the period over whose transactions purchasing power in the form of money is held”. K is related to Vt; it is the reciprocal.
Andrew_FL
May 7 2023 at 5:02pm
Steelmanning a bit:Dropping from 15.4% NGDP growth in Q1 1973 to 4.1% NGDP growth in Q4 of Q1 of 1974 was apparently sufficient to trigger a recession which caused unemployment to go from 4.6% in October 1973 to 9% in May 1975. Since Q4 2021 we’ve dropped from an NGDP growth rate of 14.3% to 5.1% in Q1 2023, so a comparably rapid slowdown in a comparable timeframe, but no negative movement of employment whatsoever.
BC
May 7 2023 at 6:54pm
Under the Natural Rate Hypothesis, even with no monetary tightening, eventually unemployment has to go back to its natural rate, albeit at a higher inflation rate, because the long run aggregate supply and Philips curves are vertical, right? How long is “eventually”?
Kenneth Duda
May 7 2023 at 8:20pm
When market participants’ inflation expectations match the new inflation rate. We get excess employment when employees are surprised by unexpected higher inflation, meaning their wages ended up being worth less than the employee expected. Once the higher inflation rate is baked into expectations, employment comes down to its natural rate.
Scott Sumner
May 8 2023 at 12:08am
It’s hard to say, but it generally takes at least a few years. As Ken Duda said, it’s about expectations. So it’s not just a question of inflation/NGDP growth leveling off, it also depends on whether the public expects inflation to return to 2%.
bill
May 8 2023 at 8:56am
Is it possible that the increases to date have been closing the gap with the natural rate, but only gradually? That we’re still below it, but not as much as we were a year ago?
Scott Sumner
May 8 2023 at 12:10pm
It’s quite possible that the gap has completely closed.
Thomas Hutcheson
May 8 2023 at 9:35am
No tightening? FF rate has gone from less than inflation expectations to greater? Inflation is falling. Is that just a coincidence? As for Tyler’s non-sequitur question about employment, if done skillfully enough, reducing inflation back down to target need not produce unemployment. Sure the Fed’s models of how the economy responds to changes in its monetary instruments may not be good enough to actually guide us to a non-recessionary on-target inflation, [Tips seem to think we are headed to inflation shortfall, which can hardly happen w/o a recession] but that is what the Fed should be shooting for and why rule out that it will be able to comply with its mandate?
Spencer
May 8 2023 at 9:35am
The increase in large time deposits demonstrates an increase in velocity.
Large Time Deposits, All Commercial Banks (LTDACBM027NBOG) | FRED | St. Louis Fed (stlouisfed.org)
As Dr. Philip George says: “The velocity of money is a function of interest rates”
As Dr. Philip George says. “When interest rates go up, flows into savings and time deposits increase”.
As Dr. Philip George puts it: “Changes in velocity have nothing to do with the speed at which money moves from hand to hand but are entirely the result of movements between demand deposits and other kinds of deposits”.
Michael Sandifer
May 8 2023 at 10:13am
Implied in your continued claims that monetary policy is still too loose is that the Treasury market is wrong. We know that there are at least sometimes liquidity problems in the Treasury markets, particularly during times of acute stress. Do you have a view why now, however, the inflation breakevens are wrong?
Scott Sumner
May 8 2023 at 12:09pm
“Implied in your continued claims that monetary policy is still too loose”
Where did I say that? I said it’s been too loose—which is true.
Michael Sandifer
May 8 2023 at 1:59pm
Okay, so you don’t think monetary policy is too loose at the moment?
Scott Sumner
May 9 2023 at 2:29pm
To be clear, I don’t agree with current monetary policy, but mostly because it’s so poorly communicated that it’s hard to tell if it’s too loose. What are they trying to do? What’s the target? Is FAIT still in effect? Is it still asymmetrical?
But as for whether it is obviously too loose right now, I’d say no. It’s not obvious to me that NGDP growth going forward will be too high or too low. But again, that doesn’t mean I support the current policy. I don’t. It’s too uncertain.
Michael Sandifer
May 10 2023 at 2:55am
Yes, I obviously don’t agree with this monetary policy either. While policy may have been too loose for a while in 2022, and I’m not even completely convinced it was, it seems that the present circumstances support the idea that the current high inflation is due to some combination of supply-side factors, continued expression of pent up demand, and lagged components of the inflation indexes.
Also, there is some empirical support for the notion that sustained RGDP growth is higher than most assumed. If you buy that the economy isn’t overheated right now, the robost job growth and low inflation breakevens, the latter despite NGDP being above its long-run trend growth path, seem to indicate that real growth could remain higher than the 1%-to-2% most economists seemed to expect. Economists have obviously often famously been wrong with such predictions, particularly coming out of periods of multiple and/or extremely large negative supply shocks.
Though I wouldn’t characterize the dollar index as necessarily being a reliable indicator of the stance of monetary policy in and of itself, it is still interesting that during our period of supposed loose money, the dollar was strengthening. It began weakening during as the tightening began. That could reflect more about other currenices than the dollar, but it should at least be interesting.
Spencer
May 8 2023 at 10:35am
Dr. Milton Friedman: In the short-run, which may be as much as five or ten years, monetary changes affect primarily output. Over decades, on the other hand, the rate of monetary growth affects primarily prices.
As economist David Beckworth posted on “Macro and Other Market Musings”:“What makes this really interesting is that these wide swings in economic activity are not matched by similarly-sized swings in the price level. Most of the seasonal boom is in real activity. Put differently, there is an exogenous demand shock every fourth quarter where prices remain relatively sticky so real activity surges. This is a microcosm of demand-side theories of the business cycle”
Alan Greenspan eliminated the transaction’s concept of money velocity. Greenspan was responsible for discontinuing the G.6 Debit and Deposit Turnover Release in Sept. 1996. Then, it was the longest running Fed time series.
“The 2019 Federal Reserve Payments Study”
https://www.federalreserve.gov/paymentsystems/2019-December-The-Federal-Reserve-Payments-Study.htm
The March 24, 2020 removal of 6 withdrawals per month should accelerate money velocity.
Link: “REG D TRANSACTION LIMITATIONS FOR SAVINGS AND MMDA ACCOUNTS”
https://www.finsolinc.com/uploads/5/6/9/3/56932361/regulation_d_transaction_limitations_for_savings_and_mmda_accounts.pdf
We do know that to ignore the aggregate effect of money flows on prices is to ignore the sine qua non of the inflation process. And to dismiss the concept of (Vt) by saying it is meaningless because people can only spend their income once, Vi, is to ignore the fact that (Vt) is a function of three factors: (1) the number of transactions, (2) the prices of goods & services, & (3) the volume of (M).
Inflation analysis cannot be limited to the volume of wages & salaries spent. To do so is to overlook the principal “engine” of inflation, viz., the volume of credit (new money) created by the Reserve & the commercial banks and the expenditure rate (velocity) of these funds. Also overlooked is the effect of the expenditure of the savings of the non-bank public on prices. The (MVt) figure encompasses the total effect of all these money flows.
Spencer
May 8 2023 at 10:39am
re: “that the Treasury market is wrong”
The Treasury market has always ignored Vt. The “time bomb” of the 1st qtr. of 1981 is prima facie evidence.
Bobster
May 8 2023 at 1:16pm
The only puzzle is what the Fed is trying to do.
They want to get to 2% inflation, but over what timeframe? And are they still doing AIT?
Scott Sumner
May 9 2023 at 2:30pm
Yes, I agree. See my reply to Michael.
Spencer
May 8 2023 at 6:38pm
The correct course of action isn’t being followed. Powell has yet to tighten. Powell, just like Volcker, is letting the economy burn itself out.
The Keynesian economists have achieved their objective, that there is no difference between money and liquid assets.
The problem is that Reg. Q ceilings were removed by the DIDMCA (“allocation of funds across sectors”).
And the NBFIs are not in competition with the DFIs.
Disintermediation of the regional banks is made in Washington.
“No member bank shall, directly or indirectly by any device whatsoever, pay any interest on any deposit which is payable on demand … The Federal Reserve Board shall from time-to-time limit by regulation the rate of interest which may be paid by member banks on time deposits, and may prescribe different rates for such payment on time and savings deposits having different maturities or subject to different conditions respecting withdrawal or repayment or subject to different conditions by reason of different locations.” – Section 11(b) of the Banking Act of 1933
Spencer
May 9 2023 at 8:28am
Powell is letting the economy burn itself out, just like Volcker did. He’s attempting a “soft landing”.
N-gDp is still too high.
https://fred.stlouisfed.org/series/A191RP1Q027SBEA
Reserve Bank credit shows inconsequential tightening.
https://fred.stlouisfed.org/series/RSBKCRNS
The FED’s preferred inflation index shows minor deceleration.
https://fred.stlouisfed.org/series/PCEPILFE
The FED’s “holding pattern” will impact R-gDp more so than inflation.
Spencer
May 10 2023 at 9:45am
Core CPI was up 5.2%. The FED’s too loose.
Spencer
May 10 2023 at 1:41pm
The FED should discontinue publishing income velocity. Vi can move in the opposite direction as Vt, the transactions’ velocity of money (Irving Fisher’s truistic metric, not Friedman’s). A bank originating a loan, which it distributes to a nonbank, e.g., a GSE, increases Vt, but does not affect Vi.
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