What Did This Week Teach Us?

Scott Sumner is trying to figure out the answer to that question in an interesting thread on his blog.  I just posted this comment.

Scott, Sorry I have not been following this thread and am just jumping in from out of left field, so pardon me if this has already been mentioned, but as you pointed out to me in an email, one also needs to take into account the uncertainty or riskiness of estimates of expected inflation. I think that it is quite plausible that the FOMC statement confused everybody and increased the perceived risk of TIPS, causing the BE TIPS spread to rise even though the mean expected inflation rate may not have risen or even fallen. It’s a jungle out there.

To elaborate slightly:  Last week when things started to fall apart, I flagged falling inflation expectations as a likely factor tending to push down stock prices.  For several days changes in stock prices and in inflation expectations (as reflected in the TIPS spread) were fairly closely correlated.  This week, however, the S&P 500 seemed to be decoupled from the TIPS spread.  I asked Scott in an email what his thoughts were about that, and he reminded me that the Cleveland Fed has a model in which the TIPS spread is decomposed into inflation expectations plus a risk factor.  (Sorry, I am rushed now so I can’t provide a link.)  My tentative hypothesis is that the FOMC confused everybody this week causing up and down movements in the stock market and an increase in the TIPS spread which reflected not an increase in expected inflation but increased risk in attempting to predict expected inflation.  Once again, a great job by the FOMC.


21 Responses to “What Did This Week Teach Us?”

  1. 1 Benjamin Cole August 12, 2011 at 2:30 pm

    I wonder if we can make too much of very short-term market reactions. In fact, many causal correlations are hard to seg out from chatter, in every science.

    This delving into minutia also does not frame a solid argument for anyone, and may even give ammo to the stolid, “do nothing ever ” crowd.


  2. 2 David Pearson August 12, 2011 at 6:52 pm

    Standing back and looking at the past few months, what stands out is how inflation expectations have held up in the face of a crash in nominal yields. Unlike last year, the 5yr TIPS spread remains close to 2%, and the 10yr at 2.2%.

    What accounts for the difference in TIPS spread behavior between August of 2010 and August of 2011? Why are markets willing to take down NGDP expectations while leaving inflation expectations at normal levels?

    One interpretation is that the market is learning, slowly, that the Fed controls the price level but has less influence on real growth.


  3. 3 Benjamin Cole August 12, 2011 at 8:44 pm

    The Fed will have less influence on real growth when you won’t stoop down to pick up a Ben Franklin. If I counterfeited $1000 tomorrow, and hired a fellow to build some furniture, our nation would be richer for it, having some additional furniture, and then the $100 would continue to make the rounds.

    The Fed will stop being influential when everybody is working full out. Then you get inflation only.


  4. 4 Morgan Warstler August 12, 2011 at 8:45 pm

    Standing back and looking at the last 12 years what is MOST obvious is that public employees should never have received overall pay increases past inflation.

    This is obvious for two REASONS:

    1. what else are they going to do?
    2. They haven’t gotten better – they haven’t done the same job with less people.

    So we can’t do QE morally until either David or the guys who sit on either side of him are fired.

    Right david?


  5. 5 Morgan Warstler August 12, 2011 at 8:47 pm

    Benji I’m glad to have you agree with me.


  6. 6 Luis H Arroyo August 13, 2011 at 1:46 am

    II think as Benjamin, reactions in so short term are dificult to rationalise.
    Is not much more meaningful the fall of TIP rate into negative territory? I don´t think that that means an increase in expected inflation.
    Simply, the volatility is very high, as we can see in the movement from the monetary funds to stocks and its reversal

    “One of the most volatile weeks in market history sparked a bigger flight to safety than the collapse of Lehman Brothers as global investors parked a record $50bn in money market funds this week, yanking money out of bonds and shares.”



  7. 7 Morgan Warstler (@morganwarstler) August 13, 2011 at 6:53 am

    Benji, but this is WRONG.

    “The Fed will stop being influential when everybody is working full out.”

    As I have asked of David and he will not respond honestly about…

    We could easily cut public employee compensation by 25% across the board and pay 16M unemployed $25K per year. Suddenly NO unemployed.

    Why would the Fed PRINT MONEY to create more employment, when we could just stop paying public employees as much?

    Especially after there has been a huge run up in public employees?


    Exactly, NONE of you have a reason. The Fed’s job is to see those increases rolled back BEFORE it deploys any Monetary help.


  8. 8 Benjamin Cole August 13, 2011 at 12:00 pm

    Morgan-I am all for cutting federal outlays to 16 percent of GDP, by trimming Social Security, Medicare, and whacking federal employees.

    Why not voucherize the VA… That would get 275,000 employees off the federal payroll overnight. A probably result in better and cheaper care for vets. No GOP’er ever calls for vouchers for vets. Why not?

    They are deeply corrupt.


  9. 9 Morgan Warstler (@morganwarstler) August 13, 2011 at 3:05 pm

    Benji, I actually LOVE the VA, and I’ve encourage the progressives to adopt the play to replace Obamacare.

    We call it Soup Kitchen Care – we a lot $4K per man per year set against inflation. ANYONE can join it, so it serves as the public option, It is global budget locked requiring a super majority to increase spending per man.

    In it you are a #, you get no choice on treatment, its mostly run by student doctors, there’s never any in patent drugs, patients queue.

    It automatically receives whatever the lowest price is that a company offers to any other customer in the US.

    And we all admit that: Soup Kitchen Care is just OK, anyone who can afford it, likely wants the good stuff.

    VA care is $5500 a man, and scores very high in satisfaction surveys.

    The real cuts just need to be productivity gains based. Let the greed of the great workers drive out the bad ones. Problem solved.


  10. 10 Benjamin Cole August 13, 2011 at 5:13 pm

    I prefer free markets and giving vets a voucher for $5500 and letting them choose where they get their care, and wiping out the 275,000 federal workers.

    I wonder if your $5,500 figure includes all the pensions we are going to have to pay to VA workers.


  11. 11 Morgan Warstler (@morganwarstler) August 13, 2011 at 7:00 pm

    I don’t know the answer to that one. But I have no problem making them pay for their own health plan and 401K.

    But the $5500 is correct, it’s a big savings especially as there are many disabled and drug addicted in VA system.

    And while I like free markets, it is not realistic. Soup Kitchen Care is realistic. Note: my plans real goal is to have a realistic place to move Medicare patients after a certain age…. when the crisis hits.

    iI truly believe when the crisis hits, we’ll solve the entire health care problem by just ending “expensive ” treatments for anyone over 85, 86, 87, 88 (as we live longer), unless they can pay for the fancy stuff themselves.

    I think that is the most fair way to deal with it.


  12. 12 David Glasner August 13, 2011 at 8:29 pm

    Benjamin, I agree that we shouldn’t put too much faith in anyone’s rationalization of why the stock market did what it did. But as long as people are playing the game, and as long as we don’t take these stories too seriously, I don’t think that there is anything wrong in offering a possible rationalization of what the market did that reflects the larger narrative that one believes is the best explanation for why the economy is doing whatever it is doing.

    David I partially agree with what you say, but I think that there may be circumstances in which the price level does have an effect on the level of real GDP, e.g., a higher price level now would increase real GDP, and the market “knows” it.

    Benjamin II, You are overstating it somewhat, but that is the gist of my reply to David.

    Morgan, So you think that I am as wasteful as two of my coworkers? That was a very cruel thing to say. But putting aside my hurt feelings, I still don’t see the logical connection between whatever level of waste is associated with the federal workforce and the state of the economy. Do you think that the wastefulness of the federal workforce increased over the past decade? If not, what is the connection between federal workers and the worsening condition of the economy?

    Luis, I agree that there was a huge increase in perceived uncertainty over the past two weeks.

    Morgan, If you were an absolute dictator, you could easily do a lot of things. In the actual world that we inhabit, it would not be at all easy to do what you suggest. Whether it will be easy for President Perry to do what you hope he does, we shall have to see. But that won’t happen for at least another 17 months. By the way, have you ever had a direct personal reaction with a member of the FOMC?


  13. 13 Morgan Warstler (@morganwarstler) August 13, 2011 at 10:19 pm

    “Do you think that the wastefulness of the federal workforce increased over the past decade?”


    I know it hasn’t made 2-5% productivity gains YoY since they stopped measuring it in 1996 (to save money!).

    I think in the real world, the only reason anyone should have gotten a pay raise in your office since 1996, is when one of three of you became redundant… just like in the real world.

    You think I need to be a dictator for this stuff to happen?

    David, the stuff I’m explaining is a fait accompli – the long knives are coming out, and I have a better sense of who’s going to side with who.

    And public employees (not just Federal – State and Local as well) are simply the EASIEST and MOST DESERVING of the cleaver.

    The Internet, this thingy you type into, hasn’t come close to remaking government into a low staff operation… and the tech guys, and the investor class are gong to get a hold of it and privatize the bejesus out of it.

    Once again, you did not answer my question. What is it that keeps you from thinking through:

    1. no increase in AD – gvt. spending stays the same.
    2. no unemployment – 16M making $25K a year
    3. more government services – I suggest free massage, baby sitter, laundry for private sector income tax payers.
    4. happy Tea Party

    VS. public employee wants to print money (DeKrugman says it takes $200B a month) and not deliver the productivity gains that the tax payers deliver like clock-work.

    And since I answer questions… no, I’ve never kept friends with FOMC board members. I assume they are not as smart as my friends and associates I’m most impressed with – but they don’t drive buses either.

    Please try and really answer. I’m point to the HOLE in the boat, you are pretending you are so focused on bailing water, you can’t take the time fix the hole.


  14. 14 Benjamin Cole August 14, 2011 at 12:40 pm


    As you may have noticed, I try to frame arguments in a robust easy-to-understand language. Hence my little story about Ben Franklins on the sidewalk or counterfeiting currency. (BTW, I encourage all first-rate counterfeiters to move to the USA and start printing as much cash as you can, as long as it is undetectable. Also, there is something like $800 billion in US currency trading outside out border. We should beg the drug lords to bring that money home.

    I am not a Phd economist, and so I feel I have little to offer above that of Scott Sumner, Nunes, Beckworth and yourself. You guys are nailing it, intellectually, in my layman’s opinion.

    What I can offer is language and framing of arguments that might win in the public arena. Try to refer to the Bank of Japan as feeble and dawdling. Call Bernanke “Mr. Bernanke-san.” Refer to Chicken Inflation Littles and their hysterical reaction small rate of inflation. Dismiss the “gold fetishists.” Reserve contempt for those who worship currency.

    The tub-thumpers for a “stable” currency have had generations to perfect their language, and they have great language. People like you want to “debase’ the currency, bring inflationary ruin and deprive poor people of food. You are reckless, and confuse expanding the money supply with bona fide economic growth etc etc.


  15. 15 David Pearson August 14, 2011 at 6:47 pm


    Exactly my point — If the market “knows” inflation increases RGDP, then all the more chance it will happen. However, the market is beginning to signal that it doubts it.

    The Fed has to be worried that markets are taking down expectations of growth without meaningfully lowering those of inflation. What if they promise yet more inflation and TIPS spreads widen while real yields stay low? This would be a sign that actors do not believe monetary policy will be effective in producing growth. Something to watch out for…


  16. 16 João Marcus Marinho Nunes August 14, 2011 at 8:27 pm

    Not to be missed:
    And the semi official “birth of QM”. Hot of the FT:
    To make the case for new stimulus, the Fed needs better arguments. The past few weeks have settled, to my satisfaction at least, a long-running debate on this very topic. Rather than targeting inflation, central banks should keep nominal incomes growing on a pre-announced path: say 5 per cent a year. Nominal gross domestic product is the sum of inflation and growth in real output – and is the variable that monetary stimulus directly drives.
    And there´s much, much more:


  17. 17 David Glasner August 15, 2011 at 9:56 pm

    Morgan, Thanks for responding to my questions. I think that cutting federal pay by 25% is obviously not something that could pass the current Congress. To my knowledge, it wasn’t part of the Republican budget. Perhaps you are confident that after the next election, a new Congress and a new President will do so, but I haven’t heard any Presidential candidate propose doing that. But I concede that you may have a better feel for where public opinion is headed on this than I do. But I would be really surprised if that were the case.

    It is not correct that the only people who get raises in a market economy are those whose productivity rises. Some workers do not become more productive, say, musicians and actors, but their pay increases over time nevertheless because the demand for their services is inelastic enough so that the prices of their services can increase enough to make it worthwhile for them to continue in their current occupations rather than switch to other occupations in which productivity is increasing.

    How is this for an answer? For any given fiscal policy, however contractionary, monetary policy can ensure that AD will be sufficient to generate enough spending to achieve full employment. So for whatever fiscal policy you come up with, I can come up with a monetary policy that will generate full employment. Does that satisfy you?

    Benjamin, Your contributions are greatly appreciated and all of us are indebted to you being so passionately involved in trying to fix our broken monetary policy.

    David, I think that you may be correct. However, it is also possible that as real yields drop because of increasing pessimism, the level of inflation required to overcome those pessimistic expectations is increasing. So unless we get inflation expectations up to at least 3 percent, we will not get a recovery.

    Marcus, Yes a very important contribution.


  18. 18 Morgan Warstler (@morganwarstler) August 16, 2011 at 12:39 pm

    David, this is perfect:

    “How is this for an answer? For any given fiscal policy, however contractionary, monetary policy can ensure that AD will be sufficient to generate enough spending to achieve full employment. So for whatever fiscal policy you come up with, I can come up with a monetary policy that will generate full employment. Does that satisfy you?”

    This is WHY you and Sumner have some legs.

    If you made that the subject of your blogs, you’d have a winner.

    The compelling point is that SINCE there is magic fairy dust, we can now chew through fiscal spending goring public employees left right and center WITHOUT heed to DeKrugman’s warning that this will hurt growth.

    That is WHY we only use magic fairy dust WHEN we are killing off fiscal spending, so that people learn the cutting government is good.

    Yes i know Baumol… you should REALIZE that Matty has finally come over to my side and now (after two years) admits that technology allows LARGER CLASSROOMS – it is hard to argue with Khan Academy.

    You tards need to learn to listen to the guys who do this stuff for a living.

    Also note: the rise of Avatars and game engines to replace actors, the rise of voice synthesizers to sound like a given actor.

    Lawyers are being replaced by computer.

    Productivity gains my friend. You need to stop arguing and start delivering them.


    Wisconsin public employees just took an effective 15% pay cut and the voter came out in TWO special elections – today another – to make SURE those cuts STICK.

    See Chris Christie.

    What’s sad here is that you got so hung up on 25%, that you STILL as an economist skip over the interesting bit:

    Full employment with NO increase in AD.

    And we can do it simply by taking EXACTLY the gains the public employees made since 2000 in annual income and giving it to the unemployed.


  19. 19 David Glasner August 16, 2011 at 9:06 pm

    Morgan, Sounds like I made your day, but you shouldn’t have been surprised. Any good monetary economist will tell you that fiscal and monetary stimuli are fungible. And in principle, monetary policy as a general proposition trumps fiscal policy because the printing presses (yikes, I hope your friend Perry doesn’t read my blog) can be run non-stop. Having said all that, I am still very dubious about your assumption that federal employees will be treated as you would like them to be. And not just because of the implications for AD. But time will tell. BTW, who is Matty?


  20. 20 Morgan Warstler (@morganwarstler) August 18, 2011 at 2:41 pm

    Matt Ygelsias.

    C’mon David say it out loud why do you think we won’t force Federal Public employees to deliver productivity gains comparable to the private sector?


  21. 21 David Glasner August 18, 2011 at 7:42 pm

    Same reason we have an ethanol mandate. What’s Perry’s position on ethanol. Has he made any speeches in Iowa about ethanol. Just our of curiosity, do you think that the ethanol MANDATE is unconstitutional? Why aren’t 26 attorneys general suing in federal court to have the ethanol MANDATE declared unconstitutional? Whew, sorry, don’t know what came over me just now.


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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


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