What happens when near zero interest rates meet the corona virus?
Many economists think fiscal policy is a slow and clumsy macroeconomic tool. That's why mainstream macroeconomics has favored monetary policy, which is de-politicized relative to fiscal policy. Thanks largely to Milton Freedman, monetary policy has been a key feature of neoliberal macroeconomic thinking since the early 1980s.
And, since the early 1980s, when interest rates were around 15%, both long-term and short-term interest rates have been going down and down and down. Now both the 10 year Treasury Bond and the 3 month TBill have yields of less than one percent.
So, how can central banks stimulate the economy in response to an external shock, such as the corona virus, when nominal interest rates are approaching zero percent? This is a serious problem, and it's why central bankers are now calling for fiscal stimulus. It's also why Milton Friedman is probably rolling over in his grave.
There are temporary fiscal measures that the congress and the White House can argue about, but my thought is to put the technocrats at the Fed in charge of a limited form of fiscal policy. This is something I'm calling Robinhood Fiscal Policy - or, if you prefer, Robinhood Economics.
Essentially, Robinhood Economics calls for giving the Fed the power to tax the very rich and to distribute the proceeds to the not-so-rich. This stimulates the economy because the rich already spend what they want on consumer goods, while the poor will quickly spend any new money that comes their way.
Long term decline in the 10 year Treasury Bond yield.
Recent decline in the 3 month Treasury Bill yield.
Long term decline in the 3 month Treasury Bill yield. Notice how the Fed typically drops short term interest rates by around 5 percent when a recession is on the horizon. Of course, when nominal short term interest rates are around one percent, the Fed cannot drop these rates more than one percent. That would result in negative nominal interest rates. How would this be logically possible?
The Yield Curve (10yr Treasury Bond yield less the 3mo TBill yield) as a predictor of recessions. The gray bars are recessions. Note that banks hate it when the yield curve inverts, which is when the line drops below zero in this chart.
---------------------------------
Beshears, Fred
The Cyclically Adjusted Price-to-Earnings Ratio (CAPE)
by Fred M Beshears
https://innovationmemes.blogspot.com/2017/07/the-cyclically-adjusted-price-to.html
---
The Five Sector Circular Flow Model of an Economy
by Fred M Beshears
https://innovationmemes.blogspot.com/2017/10/the-five-sector-circular-flow-model-of.html
---
Let's Put the Fed in Charge of Robinhood Fiscal Policy
by Fred M Beshears
https://innovationmemes.blogspot.com/2020/02/lets-put-fed-in-charge-of-robinhood.html
---
The Macroeconomics of the US Stock Market
by Fred M Beshears
https://innovationmemes.blogspot.com/2019/10/the-macroeconomics-of-us-stock-market.html
See this article for more on the Wilshire 5000 / GDP Ratio.
---
Robin Hood Macroeconomics
by Fred M Beshears
https://innovationmemes.blogspot.com/2017/09/robin-hood-macroeconomics.html
---------------------------------
Federal Reserve Bank of St. Louis (FRED)
10-Year Treasury Constant Maturity Minus 3-Month Treasury Constant Maturity
https://fred.stlouisfed.org/series/T10Y3M
10-Year Treasury Constant Maturity Rate
https://fred.stlouisfed.org/series/DGS10
3-Month Treasury Bill: Secondary Market Rate
https://fred.stlouisfed.org/graph/?id=DTB3,
Wilshire 5000 Total Market Full Cap Index/Gross Domestic Product
https://fred.stlouisfed.org/graph/?g=qLC
---------------------------------
Harding, Robin
Coronavirus: why central bankers say it is time for fiscal stimulus
Many policymakers are calling for more government spending in response to economic disruption
by Robin Harding in Tokyo, Brendan Greeley in Washington and Martin Arnold in Frankfurt
3/6/2020
https://www.ft.com/content/606f1c8c-5f96-11ea-8033-fa40a0d65a98
"""
The US Federal Reserve, which Ms Yellen used to chair, had already been forced to cut its target interest rate to a range of 1.5-1.75 per cent during 2019 because of concerns about global growth. Mr Draghi’s European Central Bank and the Bank of Japan still had negative interest rates, despite a decade of aggressive monetary stimulus. If any kind of shock were to hit the economy, there was little room to respond.
“All four of us said ‘fiscal policy’, not having any clue coronavirus was coming,” says Mr Posen, a former BoE policymaker who is now head of the Peterson Institute in Washington, describing the panel at the American Economic Association’s annual meeting.
Just weeks later, that shock arrived. First coronavirus ripped through Wuhan, prompting perhaps the largest quarantine in history and all but shutting down China’s economy. Then the number of cases began to rise around the world, slowly but inexorably, prompting the OECD to warn this week of a global downturn.
"""
-------------------------------------
Rogoff, Kenneth
Fantasy Fiscal Policy
by Kenneth Rogoff
Feb 3, 2020
https://www.project-syndicate.org/commentary/resisting-risky-fiscal-policy-by-kenneth-rogoff-2020-02
"""
Many leading central bankers now argue that, instead of just playing its traditional role of deciding the allocation of government spending, investment, taxes, and transfers, fiscal policy must substitute for monetary policy in economic fine-tuning and fighting recession. That would be a big mistake.
"""
----------------------------------
Skidelsky, Robert
The Monetarist Fantasy Is Over
by Robert Skidelsky
Feb 17, 2020
UK Prime Minister Boris Johnson, determined to overcome Treasury resistance to his vast spending ambitions, has ousted Chancellor of the Exchequer Sajid Javid. But Johnson’s latest coup also is indicative of a global shift from monetary to fiscal policy.
https://www.project-syndicate.org/commentary/boris-johnson-global-shift-from-monetary-to-fiscal-policy-by-robert-skidelsky-2020-02
"""
Kenneth Rogoff of Harvard recently argued that fiscal stabilization policy “is far too politicized to substitute consistently for modern independent technocratic central banks.” But instead of considering how this defect might be overcome, Rogoff sees no alternative to continuing with the prevailing monetary-policy regime – despite the overwhelming evidence that central banks are unable to play their assigned role. At least fiscal policy might in principle be up to the task of economic stabilization; there is no chance that central banks will be.
"""
And, since the early 1980s, when interest rates were around 15%, both long-term and short-term interest rates have been going down and down and down. Now both the 10 year Treasury Bond and the 3 month TBill have yields of less than one percent.
What happens when zero interest rates meet the corona virus? We may soon find out.
So, how can central banks stimulate the economy in response to an external shock, such as the corona virus, when nominal interest rates are approaching zero percent? This is a serious problem, and it's why central bankers are now calling for fiscal stimulus. It's also why Milton Friedman is probably rolling over in his grave.
There are temporary fiscal measures that the congress and the White House can argue about, but my thought is to put the technocrats at the Fed in charge of a limited form of fiscal policy. This is something I'm calling Robinhood Fiscal Policy - or, if you prefer, Robinhood Economics.
Essentially, Robinhood Economics calls for giving the Fed the power to tax the very rich and to distribute the proceeds to the not-so-rich. This stimulates the economy because the rich already spend what they want on consumer goods, while the poor will quickly spend any new money that comes their way.
Charts showing the downward path of interest rates and their effects
Recent decline in the 10 year Treasury Bond yield.
Long term decline in the 10 year Treasury Bond yield.
Recent decline in the 3 month Treasury Bill yield.
Long term decline in the 3 month Treasury Bill yield. Notice how the Fed typically drops short term interest rates by around 5 percent when a recession is on the horizon. Of course, when nominal short term interest rates are around one percent, the Fed cannot drop these rates more than one percent. That would result in negative nominal interest rates. How would this be logically possible?
The Yield Curve (10yr Treasury Bond yield less the 3mo TBill yield) as a predictor of recessions. The gray bars are recessions. Note that banks hate it when the yield curve inverts, which is when the line drops below zero in this chart.
The Wilshire 5000 Stock Index divided by Gross Domestic Product. This is Warren Buffet's favorite measure of a bubble in the stock market. The Federal Reserve apparently likes it, too. Once again, the gray bars are recessions. Stock market crashes typically happen before recessions.
The Cyclically Adjusted Price-to-Earnings (CAPE) Ratio. This is Robert Shiller's favorite measure of a bubble in the stock market.
The growth in the SP500 Stock Market Index (SPX) over the last ten years. Note how other indexes (i.e. EEM and EFA) have failed to keep up. Therefore, these stock markets are not as inflated as the SP500. The symbol EEM is for an exchange traded fund that tracks emerging markets. The symbol EFA is for an exchange traded fund that tracks stock markets in developed countries other than the US.
References
---------------------------------
Beshears, Fred
The Cyclically Adjusted Price-to-Earnings Ratio (CAPE)
by Fred M Beshears
https://innovationmemes.blogspot.com/2017/07/the-cyclically-adjusted-price-to.html
---
The Five Sector Circular Flow Model of an Economy
by Fred M Beshears
https://innovationmemes.blogspot.com/2017/10/the-five-sector-circular-flow-model-of.html
---
Let's Put the Fed in Charge of Robinhood Fiscal Policy
by Fred M Beshears
https://innovationmemes.blogspot.com/2020/02/lets-put-fed-in-charge-of-robinhood.html
---
The Macroeconomics of the US Stock Market
by Fred M Beshears
https://innovationmemes.blogspot.com/2019/10/the-macroeconomics-of-us-stock-market.html
See this article for more on the Wilshire 5000 / GDP Ratio.
---
Robin Hood Macroeconomics
by Fred M Beshears
https://innovationmemes.blogspot.com/2017/09/robin-hood-macroeconomics.html
---------------------------------
Federal Reserve Bank of St. Louis (FRED)
10-Year Treasury Constant Maturity Minus 3-Month Treasury Constant Maturity
https://fred.stlouisfed.org/series/T10Y3M
10-Year Treasury Constant Maturity Rate
https://fred.stlouisfed.org/series/DGS10
3-Month Treasury Bill: Secondary Market Rate
https://fred.stlouisfed.org/graph/?id=DTB3,
Wilshire 5000 Total Market Full Cap Index/Gross Domestic Product
https://fred.stlouisfed.org/graph/?g=qLC
---------------------------------
Harding, Robin
Coronavirus: why central bankers say it is time for fiscal stimulus
Many policymakers are calling for more government spending in response to economic disruption
by Robin Harding in Tokyo, Brendan Greeley in Washington and Martin Arnold in Frankfurt
3/6/2020
https://www.ft.com/content/606f1c8c-5f96-11ea-8033-fa40a0d65a98
"""
The US Federal Reserve, which Ms Yellen used to chair, had already been forced to cut its target interest rate to a range of 1.5-1.75 per cent during 2019 because of concerns about global growth. Mr Draghi’s European Central Bank and the Bank of Japan still had negative interest rates, despite a decade of aggressive monetary stimulus. If any kind of shock were to hit the economy, there was little room to respond.
“All four of us said ‘fiscal policy’, not having any clue coronavirus was coming,” says Mr Posen, a former BoE policymaker who is now head of the Peterson Institute in Washington, describing the panel at the American Economic Association’s annual meeting.
Just weeks later, that shock arrived. First coronavirus ripped through Wuhan, prompting perhaps the largest quarantine in history and all but shutting down China’s economy. Then the number of cases began to rise around the world, slowly but inexorably, prompting the OECD to warn this week of a global downturn.
"""
-------------------------------------
Rogoff, Kenneth
Fantasy Fiscal Policy
by Kenneth Rogoff
Feb 3, 2020
https://www.project-syndicate.org/commentary/resisting-risky-fiscal-policy-by-kenneth-rogoff-2020-02
"""
Many leading central bankers now argue that, instead of just playing its traditional role of deciding the allocation of government spending, investment, taxes, and transfers, fiscal policy must substitute for monetary policy in economic fine-tuning and fighting recession. That would be a big mistake.
"""
----------------------------------
Skidelsky, Robert
The Monetarist Fantasy Is Over
by Robert Skidelsky
Feb 17, 2020
UK Prime Minister Boris Johnson, determined to overcome Treasury resistance to his vast spending ambitions, has ousted Chancellor of the Exchequer Sajid Javid. But Johnson’s latest coup also is indicative of a global shift from monetary to fiscal policy.
https://www.project-syndicate.org/commentary/boris-johnson-global-shift-from-monetary-to-fiscal-policy-by-robert-skidelsky-2020-02
"""
Kenneth Rogoff of Harvard recently argued that fiscal stabilization policy “is far too politicized to substitute consistently for modern independent technocratic central banks.” But instead of considering how this defect might be overcome, Rogoff sees no alternative to continuing with the prevailing monetary-policy regime – despite the overwhelming evidence that central banks are unable to play their assigned role. At least fiscal policy might in principle be up to the task of economic stabilization; there is no chance that central banks will be.
"""
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