Diane Coyle — Rescuing macroeconomics?

Short review of Roger Farmer's Prosperity for All: How To Prevent Financial Crises. 

Useful for those interested in DSGE.

The Enlightened Economist
Rescuing macroeconomics?
Diane Coyle | freelance economist and a former advisor to the UK Treasury. She is a member of the UK Competition Commission and is acting Chairman of the BBC Trust, the governing body of the British Broadcasting Corporation

Steve Randy Waldman — Some thoughts on QE

I really dislike QE because I have theories about how it actually does work. I think the main channel through which QE has effects is via asset prices. To the degree that QE is taken as a signal of central banks “ease”, it communicates information about the course of future interest rates (especially when paired with “forward guidance”). Prolonging expectations of near-zero short rates reduces the discount rate and increases the value of longer duration assets. This “discount rate” effect is augmented by a portfolio balance effect, where private sector agents reluctant (perhaps by institutional mandate) to hold much cash bid up the prices of the assets they prefer to hold (often equities and riskier debt). Finally, there is a momentum effect. To the degree that QE succeeds at supporting and increasing asset prices, it creates a history that gets incorporated into future behavior. Hyperrationally, modern-portfolio-theory estimates of optimal asset-class weights come to reflect the good experience. Humanly, momentum assets quickly become conventional to hold, andmanagers who fail to bow to that lose prestige, clients, even careers. So QE is good for asset prices, particularly financial assets and houses, and rising asset prices can be stimulative of the economy via “wealth effects”. As assetholders get richer on paper, they spend more money, contributing to aggregate demand. As debtors become less underwater, they become less thrifty and prone to deleveraging. Financial asset prices are also the inverse of long-term interest rates, so high asset prices can contribute to demand by reducing “hurdle rates” for borrowing and investing. Lower long term interest rates also reduce interest costs to existing borrowers (who refinance) or people who would have borrowed anyway, enabling them spend on other things rather than make payments to people who mostly save their marginal dollar. Whether the channel is wealth effects, cheaper funds for new investment or consumption, or cost relief to existing debtors, QE only works if it makes asset prices rise, and it is only conducted while it makes those prices rise in real and not just nominal terms.

I think that the asset prices the Fed was targeting was residential housing. A price correction that wiped out the gains from the bubble would have left many bank insolvent and greatly exacerbated the crisis. So the purpose of QE was to prevent liquidation. This had the collateral effect of driving the price of risky assets such as equities higher than they would have been otherwise, adding to the wealth effect. However, I think that supporting housing price was the real aim of the program rather than a broader wealth effect, which the Fed did not mind since it would likely add to spending as a counter to deleveraging.

Interfluidity
Some thoughts on QE
Steve Randy Waldman

Lee Adler — Here’s Why “QE Isn’t Money Printing and Does Not Cause Inflation” Are Not Only Big Fat Lies, But Red Herrings

Adler points out that QE results in asset price appreciation that likely would not have occurred otherwise and it constitutes "inflation" that is not measured by standard measures such as price indexing and wage increases.

The Fed has admitted that an aim of QE was to raise asset prices to increase the wealth effect and thereby stimulate the economy through increased spending based on it. The Fed also admitted that this was "asset inflation, in that it resulted in asset prices higher than they would have been otherwise. In other words, blowing more bubbles.

This criticism is a loose use of "inflation," which is technically defined in economics as a continuous rise in the general price level, and it fails to understand the implications of monetary policy and fiscal policy. But the fact is that the Fed wanted to create inflationary expectations to boost asset prices and it succeeded apparently because a lot of people fell for it.

The Wall Street Examiner
Here’s Why “QE Isn’t Money Printing and Does Not Cause Inflation” Are Not Only Big Fat Lies, But Red Herrings
Lee Adler

Yves Smith — The BIS Loses Its Mind, Advocates Kicking Citizens and the Bond Markets Even Harder

Lots of good stuff, including Fed policy and its consequences.

Naked Capitalism

The BIS Loses Its Mind, Advocates Kicking Citizens and the Bond Markets Even Harder
Yves Smith

Bill McBride — Housing bubble: The "Wealth" is Gone, but the Debt Remains

As Norris noted, the bubble wealth is gone, but the debt remains (still high on a historical basis). This was especially hard on younger households since they bought during the housing bubble.

Calculated Risk
Housing bubble: The "Wealth" is Gone, but the Debt Remains
Bill McBride

Philip Pilkington — Stock market wags economy, or not?

If the above analysis is correct then the US economy is even more reliant on the gains made in the stock market than people think. The wealth effect relies on the perception of rising wealth which then leads well-off people with positions in the stock market to spend more money.

So maybe the Fed was right about QE and the wealth effect, i.e., driving risky assets higher than they would be otherwise by reducing the volume of safe assets — Treasuries and agencies — by paying more than they are perceived to be worth. It seems that some of the gains in equities may have spilled into increased consumption by the wealthy.

FT Alphaville
Stock market wags economy, or not?
Philip Pilkington

The Financial Times has announced that FT Alphaville is free with registration, so I am linking to Alphaville but not the Times proper, which remains behind a paywall.

Jeff Cox — The Market Is Not the Economy: What the Fed Misses

"We've made rich people richer," Dallas Fed President Richard Fisher told CNBC in a Monday interview.... 

"This is great for the (Warren) Buffetts and for others who can take advantage of this multiple of great money and cheap money that's been available," he added. "The question is, what have we done for the working men and women of America?"....

As for the "wealth effect" the Fed had hoped to achieve by boosting the stock market with $85 billion of money creation every month, it indeed, as Fisher suggested, has been skewed to upper income levels....

A skeptic on the current Fed approach, Fisher said the tide won't turn until government fiscal policy complements Fed monetary policy.

CNBC NetNet
The Market Is Not the Economy: What the Fed Misses
Jeff Cox | Senior Writer

Ashwin Parameshwaran — House Prices, The Wealth Effect And Crony Capitalism

As I illustrated in a previous post, “a significant proportion of the balance sheet of wealthy Americans is made up of real assets – real estate, stock and business holdings”. Therefore “what wealthy Americans, businesses and banks share is a common interest in supporting asset prices (real and nominal), a lack of interest in seeking full employment unless it is a prerequisite for supporting asset prices, and an aversion to any policies that can trigger wage inflation”. The fact that our dominant macroeconomic policy doctrine depends upon the ‘wealth effect’ simply reflects the fact that our economy is driven by wealthy special interests. 

The real question again is why there isn’t more mass opposition to such a blatantly regressive policy regime. In previous posts(1, 2), I have argued that crony capitalism achieves broad-based support by piggybacking upon broad-based programs aimed at the middle class. But they also achieve this support due to the absence of a safety net that breeds middle-class insecurity. This carrot-and-stick approach ensures middle-class support for the same stabilising policies that transfer wealth to the one percent.

Got that? Read the rest to see how it is done.

Macroeconomic Resilience — towards a more resilient macroeconomy
House Prices, The Wealth Effect And Crony Capitalism
Ashwin Parameshwaran

Konczal — Administration switching positions toward balance sheet recession?

The White House also looks to be on team balance sheet....

When Noam Scheiber wrote about how the administration viewed the economy in late 2010, he explicitly contrasted its wonks’ opinions with that of the balance sheet recession theorist Richard Koo. So is this a revolution within the administration? Is this why it is now pushing for writedowns and refinancing, after having left housing on the side for the past three years? Let’s hope so, since I consider being three years late to the party better than never showing up.

Read it at Rortybomb
Is the Administration Joining Team Balance-Sheet Recession?

by Mike Konczal

Still no sectoral balances mentioned. I guess they haven't discovered MMT yet, or Wynne Godley, either.