Thursday, February 4, 2016

Durations and Standards of "Tightness"

In Revisiting the Causes of the Great Recession David Beckworth writes

the Fed was doing a decent job responding to the housing bust up until 2008. After that point it tightened monetary policy and catalyzed the reaction that lead to the Great Recession.

Beckworth describes two phases of the tightening:

First, beginning around April 2008 the Fed began signalling it was planning to raise interest rates ...

1. Forward guidance. Second, Beckworth says that in the latter half of 2008,

the natural interest rate is falling fast and the Fed fails to lower its target interest rate until October 2008. This is a passive tightening of monetary policy

2. The Fed did nothing.

First, in April the Fed still expected inflation; second, the bottom fell out and the Fed did nothing until October. That's Beckworth's story of how the Fed got tight in the second and third quarters of 2008, causing the Great Recession.

Commenting on Beckworth's post, Philip disagrees with Beckworth's tightening timetable:

The monetary tightening that caused both the housing crash and the Great Recession began in 2006 ...

Philip offers a graph in evidence; I'll offer one of my own in support of Philip's view. It shows two years of slow base growth before Beckworth's mid-2008 moment:

Graph #1: Percent Change from Month Ago, Base Money, Jan 2002 thru Aug 2008

Beckworth's post is a re-statement of an op-ed he wrote with Ramesh Ponnuru. David Glasner evaluates the views expressed in that op-ed on his blog, in How not to Win Friends and Influence People. Glasner:

Beckworth and Ponnuru themselves overlook the fact that tightening by the Fed did not begin in the third quarter – or even the second quarter – of 2008. The tightening may have already begun in as early as the middle of 2006. The chart below ...

In 2006? That's what Philip said. Here's Glasner's chart:

Base Money Growth 2004-2008.  Source: David Glasner
Here's how Glasner describes the chart:

From 2004 through the middle of 2006, the biweekly rate of expansion of the monetary base was consistently at an annual rate exceeding 4% with the exception of a six-month interval at the end of 2005 when the rate fell to the 3-4% range. But from the middle of 2006 through September 2008, the bi-weekly rate of expansion was consistently below 3%, and was well below 2% for most of 2008.

I don't read the chart as Glasner does. He sees base growth consistently above 4% for two and a half years (except for six months in 2005). I see base growth varying about a persistent downtrend:

Graph #3: Base Money Growth 2004-2008. Duplicates Glasner's Graph, Adds a Trend Line by Eye
I see persistent tightening.

Oh, and maybe I'm reading things into it, but David Glasner seems to think 4% is a good number, 4% to maybe 6%. He seems to think 4% is not "tight". As opposed to two or three percent. Do you get that from what he says? I do.

On what basis is 4% a good number? Perhaps because it is in the neighborhood of the nominal GDP growth we want? Perhaps. But I reject the thought. We don't only need base money growth commensurate with GDP growth. We also need base money growth commensurate with the growth of financial obligations: If accumulated debt grows three times faster than base money between 1960 and 2007, then base money is tight.

Glasner implies base money was not tight in 2004 and 2005 because its growth rate was a little above 4%. If that is the case, then 6% to 8% growth (or more) would likely be loose, no?  Too loose, maybe.

The next graph is the same as Graph #3: same data, same units, same trend line. Graph #4 only shows more years. It begins in January, 2000.

Graph #4: Base Money Growth 2000-2008. Expands Glasner's Graph. Same Trend Line as Graph #3
The tightening trend I see in David Glasner's graph of base growth 2004-2008, that same trend extends back to 2003, maybe 2002, maybe earlier. Tightening all the while. I recall something Glasner wrote a while back, in Why Fed Inflation-Phobia Mattered:

To promote recovery, the Fed increased the monetary base in 2001 (partly accommodating the increased demand for money characteristic of recessions) by 8.5%. The monetary base subsequently grew by 7% in 2002, 5.2% in 2003, 4.4% in 2004, 3.2% in 2005, 2.6% in 2006, and a mere 1.2% in 2007.

From 2001 to the crisis, base money growth fell. By David Glasner's numbers, base growth was higher in 2001 and 2002 and 2003 than the acceptable 4% level of 2004 and 2005. Was inflation a threat because of it? It was. But inflation remained low, despite rapid base growth.

Then, when base money growth was slow enough that inflation was not a concern, base money growth was no longer fast enough to keep up with the growth of financial obligations. It became crisis-inducing.

There are two separate standards for "tight" money. It is possible for base money growth to be at the same time fast enough to raise inflation concerns and slow enough to undermine the financial system.

There is more to the story of tight money than Glasner tells. There is more to the story than Beckworth tells. As Graph #4 shows, there was persistent decline in base money growth for near a decade before the Great Recession. A decade.

The next graph shows a long view of base money growth, with the years from Graph #4 circled in red:

Graph #5: Percent Change from Year Ago, Base Money (Long Term) and a Repeating Decline

Kevin Erdmann at Glasner's:

I think the very slow monetary base growth in the 2000s is important and widely overlooked... I’m very pleased to see you advance the idea that Fed tightening was a much earlier issue than most people think is plausible.

Go, Kevin!


Jazzbumpa said...

Well - this is interesting.

You know I love trend channels, so I definitely think you're on to something here.

The similarity to the 20's in Graph 5 is striking.

Roll Graph 4 back a few more years, and I think you can make a good claim that tightening has been in effect since July, 1993.

I've included CPI inflation next to monetary base growth. There is no clear and obvious relationship.


The Arthurian said...

Thanks Jazz.

It is amazingly difficult to find people who find this stuff interesting.