tag:blogger.com,1999:blog-8702840202604739302.post1920103544087413435..comments2024-03-27T11:12:49.188-07:00Comments on MacroMania: Excess reserves and inflation risk: A modelDavid Andolfattohttp://www.blogger.com/profile/12138572028306561024noreply@blogger.comBlogger20125tag:blogger.com,1999:blog-8702840202604739302.post-29436586271181972012014-07-18T14:32:34.139-07:002014-07-18T14:32:34.139-07:00David, yesterday Scott Sumner had a look at Jason&...David, yesterday Scott Sumner had a look at Jason's model, and had this question:<br /><br />"Jason, Does the model forecast P better than alternative approaches, like TIPS spreads?"<br /><br />This prompted Jason to investigate, and he produced these three posts in response:<br /><br />http://informationtransfereconomics.blogspot.com/2014/07/better-than-tips.html<br /><br />http://informationtransfereconomics.blogspot.com/2014/07/inflation-prediction-errors.html<br /><br />http://informationtransfereconomics.blogspot.com/2014/07/us-inflation-predictions.html<br /><br />Sumner's response:<br /><br />"Interesting. I hope people with more time and skill that I have will investigate your model."<br /><br />Do you think this model has some promise?Tom Brownhttps://www.blogger.com/profile/17654184190478330946noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-12644576223914865742014-07-03T12:46:52.518-07:002014-07-03T12:46:52.518-07:00Hi David,
My admittedly snarky challenge was issu...Hi David,<br /><br />My admittedly snarky challenge was issued because I wanted to see how well I was doing relative to "real" models and it doesn't seem like many are available out there. It is certainly possible to get one variable right and all the rest terribly wrong ... but I'd even be interested in seeing that :)<br /><br />Additionally, predictions are hard (the economy is a stochastic system), so I'm more interested in models that describe the existing time series with a (hopefully) small number of variables. That kind of defines what I mean by model ... a theoretical equation (or differential/difference equation) with a few parameters that encompasses the behavior of data.<br /><br />This works (see Figure 5):<br /><br />http://www.newyorkfed.org/research/staff_reports/sr618.pdfJason Smithhttps://www.blogger.com/profile/12680061127040420047noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-28990289537315586222014-07-03T12:36:07.999-07:002014-07-03T12:36:07.999-07:00David, thanks for your reply. I passed that along....David, thanks for your reply. I passed that along. The <a href="http://informationtransfereconomics.blogspot.com/2014/06/hard-core-information-transfer-economics.html" rel="nofollow">"hard core" of his theory</a> is comprised of just two items, one of which includes a simple definition of price (p). That differential equation (in the link) has both an endogenous solution and an exogenous one. The endogenous price level (P) model follows from that, and looks basically something like this:<br /><br />log P ~ (1/kappa - 1)*log M<br /><br />with kappa = log M / log NGDP. <br /><br />So perhaps the answer to your second question is that the simple core of his theory is concerned with price, and thus perhaps it's one of the most natural things for him to model. Regarding fitting some things well and others less well, I know the model does produce other outputs such as interest rates. And also, although this doesn't address your concern directly, but if we just look at a couple of things: P and NGDP vs M say, granted these are a limited number of items to model, but the same model seems to match data from a number of economies (different countries) pretty well, <a href="http://2.bp.blogspot.com/-x6nXN9mzjs8/U7IJBo7QDxI/AAAAAAAAFOc/Ev3zJBcip9A/s1600/p+vs+m+and+n+vs+m.png" rel="nofollow">for example this plot.</a> The cluster of blue model curves on the right there are intended to give a feel for the theoretical variance/distribution.<br />Tom Brownhttps://www.blogger.com/profile/17654184190478330946noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-25525221330360923212014-07-02T21:06:13.797-07:002014-07-02T21:06:13.797-07:00Hi Tom,
First, I'm not even sure how this fe...Hi Tom, <br /><br />First, I'm not even sure how this fellow defines a "model." <br />Second, even if I did have a model that made conditional predictions for the path of the price-level, why would I only want to focus on the price-level and not on the joint-behavior of ALL the model's variables? It is possible to fit well along one dimension, while missing on others. David Andolfattohttps://www.blogger.com/profile/12138572028306561024noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-32457072548069610512014-07-02T13:43:10.902-07:002014-07-02T13:43:10.902-07:00Excuse me, vs year, not M!Excuse me, vs year, not M!Tom Brownhttps://www.blogger.com/profile/17654184190478330946noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-14508409942060890952014-07-02T13:41:51.445-07:002014-07-02T13:41:51.445-07:00David, O/T: Where's the best place to find a c...David, O/T: Where's the best place to find a curve derived from a macroeconomic theoretical model of the price level (P) vs M (using any measures of M and P) with, for comparison, empirical data plotted on the same chart? Here's an example of what I mean for <a href="http://4.bp.blogspot.com/-LnhMz8TjIjo/U7NFZRdL48I/AAAAAAAAFPM/w8tJKBSOciw/s1600/oh+canada+gdp+and+mb.png" rel="nofollow">Canada</a> and for <a href="http://2.bp.blogspot.com/-Lv9tcB4X70o/U7NHd-R16CI/AAAAAAAAFPY/6eK0ETmI2jE/s1600/japan+price+level+update+6-13-2014.png" rel="nofollow">Japan</a>. Those both use the same model, by the way, and the author of the model also created a related pair of curves for the interest rates in those two countries (and others). He's <a href="http://informationtransfereconomics.blogspot.com/2014/07/a-challenge-to-macroeconomists.html" rel="nofollow">trying to compare his model results with professional examples</a> but he can't find any professional examples (he says when he does a Google image search for "price level model" he only finds his own plots!). Where should he be looking?<br /><br />Thanks!Tom Brownhttps://www.blogger.com/profile/17654184190478330946noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-47296863709095456682014-06-28T14:38:20.699-07:002014-06-28T14:38:20.699-07:00The Nicks (Rowe and Edmonds) will set you straight...The Nicks (Rowe and Edmonds) will set you straight every time! :DTom Brownhttps://www.blogger.com/profile/17654184190478330946noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-14507835898839409882014-06-28T11:08:36.232-07:002014-06-28T11:08:36.232-07:00I think having the Fed in the equation confuses th...I think having the Fed in the equation confuses the matter (no offense!). <br /><br />Let's say the fiscal authority decides to fund itself short duration and its asset is long duration (future tax revenues). If interest rates rise, the resulting duration loss produces a tax liability. The fiscal authority may decide to prevent interest rates from rising by coercing banks into buying its liabilities at below-market rates. This leads to inflation. The only way to stop inflation is to issue liabilities at market rates. This, eventually, requires tax revenue to cover the government's duration losses (higher deficits). Thus, the bigger the fiscal authority's duration bet, the bigger the taxpayer's contingent tax liability. This only makes sense. Seigniorage revenues are really irrelevant to this whole dynamic. <br /><br />This paper on a fiscal theory of inflation is relevant, although it doesn't mention the duration-loss dynamic that I focus on. My view is that the "spark" for the inflation dynamic is duration aversion on the part of the public in the presence of a large government duration bet.<br /><br />http://www.dallasfed.org/assets/documents/research/eclett/2014/el1406.pdf<br />Diegohttps://www.blogger.com/profile/18084671738464414141noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-1133808839373058632014-06-28T09:50:45.281-07:002014-06-28T09:50:45.281-07:00I'm not entirely sure I understand this, Diego...I'm not entirely sure I understand this, Diego.<br /><br />Booking a deferred asset essentially permits the Fed to finance the carrying cost of government debt (whether in the form of interest-bearing reserve accounts or US treasuries makes no difference economically) by printing money. In principle, this does not mean higher taxes or Treasury issuance, although it could mean higher inflation. Am I wrong?David Andolfattohttps://www.blogger.com/profile/12138572028306561024noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-50040431636411220752014-06-28T07:41:47.246-07:002014-06-28T07:41:47.246-07:00(A) IN GENERAL- Balances maintained at a Federal R...(A) IN GENERAL- Balances maintained at a Federal Reserve bank by or on behalf of a depository institution may receive earnings to be paid by the Federal Reserve bank at least once each calendar quarter, at a rate or rates not to exceed the general level of short-term interest rates.<br /><br />That's all Congress had to say on the matter. <br /><br />Some economists argue deferring the loss means "never having to say you're sorry" because future profits will cover it. This is simply wrong. The CBO already includes projected Fed profits in its baseline budget projection, which, in turn, is the basis for revenue decisions. Thus, if the Fed's remittance comes up short of baseline, it must be funded by either tax increases or higher Treasury issuance. This is why the Fed's balance sheet creates a contingent tax liability anyway one slices the accounting. Diegohttps://www.blogger.com/profile/18084671738464414141noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-67796632368987364882014-06-27T09:54:35.556-07:002014-06-27T09:54:35.556-07:00David thanks for the update after Nick E's com...David thanks for the update after Nick E's comment.Tom Brownhttps://www.blogger.com/profile/17654184190478330946noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-47308247040053090552014-06-27T09:42:21.105-07:002014-06-27T09:42:21.105-07:00Correct. I think you can get more details here:
ht...Correct. I think you can get more details here:<br />http://www.federalreserve.gov/pubs/feds/2013/201301/201301pap.pdfDavid Andolfattohttps://www.blogger.com/profile/12138572028306561024noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-13786714628091287952014-06-27T02:30:04.588-07:002014-06-27T02:30:04.588-07:00I think I just realized what you meant by "de...I think I just realized what you meant by "deferred asset", it's claim on it's own future profits that would otherwise be remitted to the treasury but instead are kept to retire the asset.<br /><br />So, if IOR can't be funded out of current asset income it is funded with a claim on future asset income. Correct?Adam Phttps://www.blogger.com/profile/16316584837610367439noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-46312668332796934332014-06-27T00:45:38.559-07:002014-06-27T00:45:38.559-07:00"then the Fed will (effectively) have to prin..."then the Fed will (effectively) have to print money (it would book a deferred asset) to finance interest on money. The effect of such a policy would be inflationary."<br /><br />Presumaly the Fed doesn't need treasury permission to simply reduce the amount of profit it remits, thus the first few increases could be funded out of the interest earned from the asset holdings and thus wouldn't involve the creation of new government debt,so wouldn't be inflationary.<br /><br />Only if the rate of IOR goes above the average running yield of the asset portfolio does the fed need to ask the treasury for money.<br /><br />That does however bring up an interesting question that you may know the answer to. Usually the Fed can only create resereves to buy assets or lend against collateral, they can't just create them and give them out.<br /><br />So, when they were given permission to pay interest on reserves was this done with a treasury promise to fund the interest if the Fed couldn't do so out of earnings or was it a case of the Fed being able to create reserves and just give them away without receiving anything in return?Adam Phttps://www.blogger.com/profile/16316584837610367439noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-38347945649157170892014-06-26T09:38:36.246-07:002014-06-26T09:38:36.246-07:00Yes, Nick, I think you may be correct. Let me chec...Yes, Nick, I think you may be correct. Let me check over my calculations. Thank you!David Andolfattohttps://www.blogger.com/profile/12138572028306561024noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-61159518423025061282014-06-26T00:15:57.294-07:002014-06-26T00:15:57.294-07:00I'm having some trouble following this, in par...I'm having some trouble following this, in particular how you are changing M and R independently. In your case 1 for example, when you keep D fixed but change the money/bond ratio, doesn't a change in the price level violate your first constraint (y = m/p + b/p)? I would expect that R would have to change here to accommodate the change in money.Nick Edmondshttps://www.blogger.com/profile/15342983814699700396noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-73260735555568542092014-06-25T11:51:29.360-07:002014-06-25T11:51:29.360-07:00"Monetization" is a concept complicated ..."Monetization" is a concept complicated by the IOR, as are all other monetary concepts (money, monetary base, etc). The government issues liabilities to fund deficits. It can issue them at market rates (Treasuries) or coerce acceptance at below market rates (interest-paying reserves). If the it does the latter, velocity rises and inflation ensues. The only thing it takes to spark inflation is the fear of losses from future coercion. The risk of loss is magnified when the taxpayer also holds a great deal of duration risk. The worst-case scenario is one in which taxpayers suffer both real wealth losses AND duration losses as a behind-the-curve Fed raises nominal rates only to see inflation rise further. Diegohttps://www.blogger.com/profile/18084671738464414141noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-59699507699523165032014-06-25T10:15:20.689-07:002014-06-25T10:15:20.689-07:00What does either have to do with "money"...<i>What does either have to do with "money"? </i><br /><br />The question is whether the larger deficit is to be monetized or not. So clearly, monetary and fiscal policy are intertwined here. David Andolfattohttps://www.blogger.com/profile/12138572028306561024noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-83467634942115842942014-06-25T10:15:12.621-07:002014-06-25T10:15:12.621-07:00This is the common case for hyperinflation. The ...This is the common case for hyperinflation. The more people are not rolling over their bonds, the more money the central bank makes to buy bonds. But the more new money there is, the less people want hold bonds. So you get a death spiral. The central bank can not stop buying bonds because the government can not operate without the help of the central bank. Government does not have the money to pay off bonds coming due except by selling new bonds, but the only buyer is the central bank. So really they end up printing and spending money. So once the spark is lit, this blows up your currency.<br /><br />http://howfiatdies.blogspot.com/2013/09/hyperinflation-explained-in-many.html<br /><br />It happens again and again and yet most economists don't appreciate the danger of having huge amounts of debt. The excess reserves can be converted to cash and will in a hyperinflationary scenario. So they will end up adding to the hyperinflation just as the debt does.Vincent Catehttps://www.blogger.com/profile/06502618776820144289noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-88088158192295844392014-06-25T09:59:54.475-07:002014-06-25T09:59:54.475-07:00The reason I prefer a fiscal approach is your seco...The reason I prefer a fiscal approach is your second to last paragraph. The IOR is the same as Treasury issuing short term interest paying bills. A Fed capital loss is the same as a larger Treasury deficit. What does either have to do with "money"? <br /><br />I think what you are really saying is that the fiscal authority may finance capital losses by issuing short term bills at below-market yields (i.e. zero or negative real). When debt to gdp is large, a broad swath of agents has an incentive to avoid holding those bills and purchase goods instead. Pull-forward buying of goods causes inflation. Lending comes into play because, once inflation gets going, speculators have an incentive to finance an increase in goods inventories. It is all about pull-forward.<br /><br />In terms of your model, an exogenous increase in "R" occurs when agents fear that the fiscal authority will persistently finance capital-loss deficits at below-market rates. This sets the whole thing in motion. All that is needed for the feedback loop to work is 1) fear and 2) duration risk accumulated by the fiscal authority. <br /><br />Diegohttps://www.blogger.com/profile/18084671738464414141noreply@blogger.com