tag:blogger.com,1999:blog-8702840202604739302.post8479245640266048267..comments2024-03-12T22:00:25.991-07:00Comments on MacroMania: Is QE lowering the rate of inflation? David Andolfattohttp://www.blogger.com/profile/12138572028306561024noreply@blogger.comBlogger51125tag:blogger.com,1999:blog-8702840202604739302.post-6923287190615398562013-12-10T07:33:29.834-08:002013-12-10T07:33:29.834-08:00Collateral does not facilitate "lending"...Collateral does not facilitate "lending" or "credit". The vast majority of collateralized obligations are rated AAA/AA. <br /><br />I don't think we understand this collateral issue well. At its core, converting long term safe (credit risk free) collateral to s.t. assets is a duration bet. Someone along the chain is going to make or lose money depending on the volatility of interest rates. Therefore, one could imagine that the use of "collateral" is related to rate volatility expectations. Enter Fed forward rate guidance, which has held down rate volatility for much of the past decade. This guidance coincided with the explosion in shadow bank assets.<br /><br />"Safe assets" are not safe from a duration risk standpoint. I think this bears keeping in mind. <br /><br />Diegohttps://www.blogger.com/profile/18084671738464414141noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-49503022900289572512013-12-07T12:25:55.311-08:002013-12-07T12:25:55.311-08:00Well, unsecured lending occurs in reality even awa...Well, unsecured lending occurs in reality even away from the ZLB. It is straightforward to accommodate the coexistence of unsecured credit and exchange media by introducing some limited amount of record keeping. In some models, a subset of agents or trades are assumed to be "monitored" (i.e., recorded). Then the failure of not repaying debt is punishable by ostracism, for example. I'm not sure whether incorporating unsecured lending in the model will overturn Steve's results. Of course, it is important that credit markets do not work perfectly. David Andolfattohttps://www.blogger.com/profile/12138572028306561024noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-32685636769861617792013-12-07T09:57:17.461-08:002013-12-07T09:57:17.461-08:00"You realize that there is no unsecured lendi..."You realize that there is no unsecured lending/borrowing in Steve's model, right? (The limited commitment friction prevents this). Might this be the source of the confusion? (If not, let us continue to sort things out.)"<br /><br />Woo-hoo. We have gotten there. This is exactly what I was trying to say in my original response to JP, with one twist. You are explaining why the model simply excludes unsecured lending, while I was reading JP's question as asking how we should think about such a model when in the actual liquidity trap we do in fact have unsecured lending, such as in the interbank market, at/near the zero bound. dlrhttps://www.blogger.com/profile/04670525946774419874noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-37915080911270979762013-12-07T09:23:01.987-08:002013-12-07T09:23:01.987-08:00"I know R is not the nominal interest rate pa..."I know R is not the nominal interest rate paid on money, but I am saying that R must equal the nominal interest rate to borrow and lend money if the the illiquid capital asset is risk free per your assumption."<br /><br />You realize that there is no unsecured lending/borrowing in Steve's model, right? (The limited commitment friction prevents this). Might this be the source of the confusion? (If not, let us continue to sort things out.)<br /><br />Also, I'm getting a little confused with the terminology you are introducing, like "nominal rental rate." Can't we just stick with the generic no-abritrage-condition R(i)*L(i) = (1/B)*P for assets i = 1,2,...,N and go from there? David Andolfattohttps://www.blogger.com/profile/12138572028306561024noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-81838614892419889462013-12-07T05:02:21.844-08:002013-12-07T05:02:21.844-08:00Yes, that's a good way of putting things.Yes, that's a good way of putting things.JP Koninghttps://www.blogger.com/profile/02559687323828006535noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-31953627414172502432013-12-06T20:15:12.293-08:002013-12-06T20:15:12.293-08:00"Well, in the model I described, R is not the..."Well, in the model I described, R is not the nominal interest rate on money. R is the nominal interest rate earned by an illiquid (non-monetary) asset (the nominal rate of return R compensates the holder of the asset for its illiquidity). <br /><br />There is more than one interest rate in this economy. Are we getting closer?"<br /><br />Maybe? I know R is not the nominal interest rate paid on money, but I am saying that R must equal the nominal interest rate to borrow and lend money if the the illiquid capital asset is risk free per your assumption. The liquidity yield is earned by the borrower of money, so the nominal rental rate of money is the nominal rate paid on money plus the liquidity yield, which = R-1 = inflation plus the discount rate in your story. JP isn't asking how the nominal rate paid on money/bonds can be zero, he is asking how the rental rate of the money/bond asset can be zero, if L and P are both > 1. Do you agree that the nominal rental rate (borrowing rate) of money in your model should be positive as long as L and P are > 1?dlrhttps://www.blogger.com/profile/04670525946774419874noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-34921519066588968152013-12-06T20:06:44.840-08:002013-12-06T20:06:44.840-08:00I can think clearer using actual examples of inter...I can think clearer using actual examples of interest rates. Say that new bonds are being issued with a yield of 0. There is a liquidity premium on bonds and central bank deposits. <br /><br />Given this setup, the overnight fed funds rate will be greater than 0 since anyone who lends central bank deposits requires a return to compensate them for foregone liquidity services. Any sort of bank-issued government insured term deposit will also yield more than 0, since anyone who swaps central bank deposits or cash for a relatively illiquid term deposit requires a return to compensate for foregone liquidity. The repo rate, however, will be 0. Repo is a swap of central bank deposits for bonds. Since both provide the same liquidity services on the margin, neither party to the repo transaction require an interest yield to compensate for forgone liquidity services. <br /><br />So at the zero-lower bound that you & Steve are describing, there will be some market rates that are at 0 and some that are greater than 0. I think the traditional zero-lower bound has all interest rates at 0, or at least the fed funds rate at 0.JP Koninghttps://www.blogger.com/profile/02559687323828006535noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-10123992699281765442013-12-06T18:46:17.238-08:002013-12-06T18:46:17.238-08:00"The nominal rental rate in your model (as I ..."The nominal rental rate in your model (as I believe JP means it) is not the nominal interest paid on money, it is R."<br /><br />Well, in the model I described, R is not the nominal interest rate on money. R is the nominal interest rate earned by an illiquid (non-monetary) asset (the nominal rate of return R compensates the holder of the asset for its illiquidity). <br /><br />There is more than one interest rate in this economy. Are we getting closer? David Andolfattohttps://www.blogger.com/profile/12138572028306561024noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-62382732085486327492013-12-06T16:57:36.426-08:002013-12-06T16:57:36.426-08:00Maybe this comes down to a difference in defining ...Maybe this comes down to a difference in defining the "nominal rental rate?"<br /><br />Unless I'm really missing what you're getting at, I think everything you're saying is very standard but not a reason why the ZLB (as JP's question above means to define it) could co-exist with a liquidity premium and inflation. Say as a random case in your example, if the liquidity yield on money is 3%, inflation is 2% and the discount rate is 1%: I agree that money can pay zero nominal interest, generate a -2% real return, and a 1% total return including the 3% convenience yield. But the rental cost of money, the nominal interest rate, is definitely not zero. The rental cost of money is 3%. And as long as the liquidity premium and inflation are both positive, then the nominal rental rate (the nominal rate paid to borrow money) must be positive. The nominal rental rate in your model (as I believe JP means it) is not the nominal interest paid on money, it is R. And R (R-1 actually) cannot be zero if both L and P are > 1. I read his question as "how can the liquidity premium on the money/bond asset and inflation both exist in a world where the nominal interest rate is zero?" <br /><br /><br /><br /><br /><br /><br /> dlrhttps://www.blogger.com/profile/04670525946774419874noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-83924557721034805922013-12-06T11:11:27.027-08:002013-12-06T11:11:27.027-08:00You don't have to fish, Patrick.
[1] http://n...You don't have to fish, Patrick.<br /><br />[1] http://newmonetarism.blogspot.com/2013/12/the-intuition-is-in-financial-markets.html<br /><br />[2] http://newmonetarism.blogspot.com/2013/12/intuition-part-ii.htmlDavid Andolfattohttps://www.blogger.com/profile/12138572028306561024noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-32521024469623899122013-12-05T22:47:27.905-08:002013-12-05T22:47:27.905-08:00that's a good one too!that's a good one too!Patrickhttps://www.blogger.com/profile/06658507365116962150noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-20923893806122422602013-12-05T22:45:36.756-08:002013-12-05T22:45:36.756-08:00@ David, I'll be frank I wasn't able to re...@ David, I'll be frank I wasn't able to read much of Williamson's blog, I found the tone far too unpleasant. But fair point, you're right, I "should" fish his blog for stories, it's just that I probably won't.<br /><br />@ Rajiv, thanks for the links, I will follow them up too.Patrickhttps://www.blogger.com/profile/06658507365116962150noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-20473597262834393652013-12-05T22:09:03.665-08:002013-12-05T22:09:03.665-08:00dlr, let me try again (please bear with me):
Cons...dlr, let me try again (please bear with me):<br /><br />Consider two risk free assets, labeled "capital" and "money." Capital is illiquid. Money is liquid. Capital earns nominal (gross) interest R. Money earns nominal (gross) interest 1. If both assets are to be willingly held in individual wealth portfolios, then the following no arbitrage condition must hold: R = L, where L is the liquidity premium on money.<br /><br />If we denote the (gross) rate of inflation by P, then the same no arbitrage condition implies: R/P = L/P. <br /><br />Because capital is illiquid, it will earn the real rate of interest (G/B), so R/P = G/B (see equations above in my post). <br /><br />Let's assume zero growth for now, so that G=1. Of course, B<1. <br /><br />So we have R/P = 1/B, for the illiquid asset.<br /><br />Of course, we also have L/P = 1/B for money, the liquid asset.<br /><br />Therefore, the real rate of return on money is 1/P = 1/(BL), where L>1. <br /><br />So here, we have the real rate of return on money is less than the real rate of return on capital. Both assets are risk free here. The difference in rates of return is attributable to due to the liquidity premium. <br /><br />Notice that it is possible for the following to hold: R/P = 1/B = L/P with P>1 (positive inflation). All that is required for positive inflation is a high enough liquidity premium L. This is despite the fact that money earns zero nominal interest.<br /><br />Hope this makes sense to you. But if not, let me know.David Andolfattohttps://www.blogger.com/profile/12138572028306561024noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-85115123864658676272013-12-05T14:10:43.573-08:002013-12-05T14:10:43.573-08:00I'm not sure that's right; i.e. It doesn&#...I'm not sure that's right; i.e. It doesn't seem like it's the real vs. the nominal rental rate that explains why a 0% rate is consistent with a positive convenience yield on bonds/money. Unless deflation is expected, a risk free asset which pays no interest with a positive liquidity yield should have a positive nominal rental rate -- and the model does not seem to require expected deflation to hit the zlb, right? But the financial frictions and safe asset shortage at the core of the model might explain it. The only way you can rent out money/bonds is to exchange it for a riskier IOU (by definition, after all if you collateralized your loan with Treasuries then the convenience yield to the borrower is eliminated). So there are plenty of willing borrowers at 0% when expected inflation => 0, but lenders would prefer to exploit the convenience yield themselves (even if the marginal benefit to the particular lender is below the hypothetical market convenience yield) than take the risky 1% it is worth to borrowers in convenience yield. <br /><br />But what could explain the fact that there is any lending at 0% then? Maybe the only lending that takes place is infra-marginal lending among holders and borrowers satiated or near satiated in safe assets. dlrhttps://www.blogger.com/profile/04670525946774419874noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-29428199051172504252013-12-05T11:18:32.535-08:002013-12-05T11:18:32.535-08:00That's correct, but do not confuse a "rea...That's correct, but do not confuse a "real" rental rate with a "nominal" rental rate. The nominal rental rate could be zero, but this does not mean that the real rental rate has to be. <br /><br />In terms of the math, from equation [1] L = (G/B)*P. You seem to want to say that if R=1, then L=1. But I just don't see why that has to be the case. David Andolfattohttps://www.blogger.com/profile/12138572028306561024noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-90979640474678089202013-12-05T10:45:00.021-08:002013-12-05T10:45:00.021-08:00"Clearly, if R = 1, then money can have no li..."Clearly, if R = 1, then money can have no liquidity premium relative to bonds, if both money and bonds are the same thing."<br /><br />I agree.<br /><br />"But money and bonds as an asset class can still be in "short supply," even if the nominal interest rate is zero."<br /><br />But if money is in short supply, then people will put a positive marginal value on the liquidity services it throws off. In which case, they require a positive rental rate in order to compensate them for forgoing those services overnight. Which means the overnight rate, or nominal interest rate, can't be zero. So when money is in short supply, nominal rates must be greater than zero. What am I not getting?JP Koninghttps://www.blogger.com/profile/02559687323828006535noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-10564197774146372152013-12-05T09:24:14.304-08:002013-12-05T09:24:14.304-08:00JP, maybe the confusion lies in the term "pre...JP, maybe the confusion lies in the term "premium" -- premium relative to what?<br /><br />Clearly, if R = 1, then money can have no liquidity premium relative to bonds, if both money and bonds are the same thing.<br /><br />But money and bonds as an asset class can still be in "short supply," even if the nominal interest rate is zero. When this is the case, then the purchasing power of these assets will exceed their "fundamental" or "socially desirable" values. <br /><br />Does this help?David Andolfattohttps://www.blogger.com/profile/12138572028306561024noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-79913923161549456972013-12-05T07:07:27.910-08:002013-12-05T07:07:27.910-08:00Hi David, can you shed some more light on this phr...Hi David, can you shed some more light on this phrase?<br /><br />"One scenario that emerges in Steve's model is R =1 and K = L > 1. In this case, the economy is at the ZLB, but government liabilities (cash and bonds -- they are perfect substitutes in this case) exhibit a liquidity premium. "<br /><br />If cash exhibits a liquidity premium that means it is providing investors with valuable liquidity services on the margin. Investors will only rent out this cash at some positive rate so that they can be compensated for foregone liquidity services. But the existence of a positive rate means we are not at the zero-lower bound. This is why the above phrase confuses me, since it seems to indicate we can simultaneously be at the ZLB and money can exhibit a liquidity premium -- but the existence of these two together is impossible. When money exhibits a liquidity premium, we are by definition off of the ZLB.JP Koninghttps://www.blogger.com/profile/02559687323828006535noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-21552392631756765622013-12-05T06:08:03.412-08:002013-12-05T06:08:03.412-08:00David, I agree that we need to be eclectic, and th...David, I agree that we need to be eclectic, and the learning literature is difficult and highly specialized. We can't have disequilibrium analysis in every equilibrium model. But when one gets comparative statics results in an equilibrium model that defy common sense and economic intuition, I think it's important to check for robustness. <br /><br />My most recent post on this issue is here:<br /><br /><a href="http://rajivsethi.blogspot.com/2012/04/on-equilibrium-disequilibrium-and.html" rel="nofollow">On Equilibrium, Disequilibrium, and Rational Expectations</a><br /><br />And two earlier posts are:<br /><br /><a href="http://rajivsethi.blogspot.com/2011/02/belief-heterogeneity.html" rel="nofollow">Belief Heterogeneity</a><br /><a href="http://rajivsethi.blogspot.com/2009/11/on-rational-expectations-and.html" rel="nofollow">On Rational Expectations and Equilibrium Paths</a><br /><br />By the way I also endorse your point about building bridges, and wish that Krugman would be less aggressive in making his points. But I also find the tone on Williamson's blog to be insufferably smug and condescending. Nick Rowe is a model of civility in comparison... seems to be a really good natured guy. Would like to meet him some day. Rajivhttps://www.blogger.com/profile/13667685126282705505noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-31525430596206577432013-12-05T01:45:24.713-08:002013-12-05T01:45:24.713-08:00Actually come to think of it, this is just like ol...Actually come to think of it, this is just like old Tobin's Portfolio Balance model of money demand, with liquidity instead of risk. There too there is a substitution and income effect and depending on how it goes, money demand can be positively or negatively related to the interest rate. Of course everyone believes the inverse relationship but that's for empirical reasons.YouNotSneaky!https://www.blogger.com/profile/06378267534638281151noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-33080171873014275012013-12-04T18:59:29.995-08:002013-12-04T18:59:29.995-08:00Rajiv, thank you (btw, I was looking for something...Rajiv, thank you (btw, I was looking for something you may have posted on your blog concerning this topic, but evidently you did not?)<br /><br />I appreciate the point you are making. In my view, this is all a very difficult business. At some point, we need to impose a solution concept. Having imposed that solution concept, there will always be another layer of hand-waving or story-telling about how "we got there." So, my personal preference is to remain eclectic on the matter. Let people construct theories they way they think is useful, then let them try to interpret the data, make predictions, and persuade us that the interpretation is useful. <br /><br />@Patrick, go take a look at Williamson's blog if you are interested in story telling. I am a bit surprised with Krugman on this front. He frequently cites James Tobin's general equilibrium theory of money as a way to organize thinking about inflation and financial markets. Steve is working in that tradition. I wish that Krugman was more interested in building bridges, rather than canals. David Andolfattohttps://www.blogger.com/profile/12138572028306561024noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-7562152397740868732013-12-03T22:54:40.592-08:002013-12-03T22:54:40.592-08:00Cute modeling, but about as appropriate as a bikin...Cute modeling, but about as appropriate as a bikini and lipstick on an 8-year old. No international cointegration, no drivers of inflation except the mob (oh excuse me, I meant the interest rate). The Fischer relation (not Stan) deserves better; but, if you're unwilling to raise wages, investment, and social spending, by all means raise interest, it is, after all a cost.Ronald Calitrihttps://www.blogger.com/profile/07206853993777529429noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-74082655082491832512013-12-03T14:26:47.347-08:002013-12-03T14:26:47.347-08:00Excellent job Rajiv. I think it's fair to say ...Excellent job Rajiv. I think it's fair to say that game theory has shown that you can't really have rationality in the sense of RE AND disequilibrium dynamics in the sense of out-of-equilibrium path beliefs (or something) because you get caught in an infinity of infinities, hence level-k reasoning with k finite and quite small.Patrickhttps://www.blogger.com/profile/06658507365116962150noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-14443229312749363892013-12-03T10:57:55.374-08:002013-12-03T10:57:55.374-08:00YouNotSneaky: sorry. Yes. I was working off a simp...YouNotSneaky: sorry. Yes. I was working off a simpler version.Nick Rowehttps://www.blogger.com/profile/04982579343160429422noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-55869751671397714662013-12-03T08:01:24.976-08:002013-12-03T08:01:24.976-08:00We are replacing illiquid assets with liquid asset...We are replacing illiquid assets with liquid assets which means we can expect inflation. More liquidity, more inflation... In this sense QE is inflationary... But i agree with interest rate increase because interest cost will go up, prices will go -up. Our purpose to generate inflation will be solved. We want a policy which can make people spend more; it is a demand problem, even if it is under compulsion under price-rise. If inflation is high people will have to spend more. But if prices go down due to disinflation, probably deflation, people will spend willingly because now they have more money, they do not need wages/income to increase, when prices fall real wages increase. We do not need persistent deflation but a short-period of lower prices to remove excess supply and then back to the normal. The problem with QE is that we need to pursue it for a very long-time if we have to bring unemployment to its natural rate because we need to remove excess supply and we will have to wait till people’s income increase, which is constant in the short-run. Higher real wages are easy to achieve than a nominal appreciation during a recession hang-over. <br /><br />Our other problem is liquidity-trap a situation which has made people accumulate reserve and post-pone spending because they are expecting a deflation and interest rate are at zero. To improve savings in banks we need to improve return on savings. We will not need QE to improve banks balance-sheet it will get repaired itself. More reserves for lending. <br /><br />I think deflation is also a rational expectation because when prices are elevated after a period of increase people expect it to come down during recession. We should not go opposite of the popular-expectation…<br />Shaleen Nath Tripathihttps://www.blogger.com/profile/01325685244509823838noreply@blogger.com