global financial crash yay!

[vimothy]

Just read about that on Bloomberg actually. Weird. And incoherent. Does the guy even know what "saving" means? I note that he's Asia chairman of some iBank though. Hey ho.

Re the end of "fractional reserve banking", Sumner will presumably do back flips. Either that or just ignore it and pretend that it doesn't mean anything. I don't understand how he clings to his belief about reserves determining the money supply. It's really bizzare.

Hey, one thing that bothers me: what the hell is that NGDP futures thing that Sumner is always going on about? I suspect that it's gibberish but I've never been able to make enough sense of it to tell for sure.

 

[vimothy]

Krugman & others discuss Chinese exchange rate policy at the EPI: http://epi.dreamhosters.com/media/100312/qt/20100312_3_panel2discussion.mov

 

[rumble]

Well, it's difficult to explain something that fundamentally doesn't make any sense, but here goes:

Sumner thinks that the US should not target inflation, or try to separate inflation from real growth. He thinks that they should just target NGDP which is the combination of inflation and real growth. The idea is stupid to begin with: if you had 6% real growth and 0% inflation (with a NGDP target of 3%), why would you want to tighten and kill the growth? It makes no sense

Secondly, he doesn't seem to understand the difference between the target of monetary policy and the instrument. He thinks that if the government creates a futures market for NGDP and then controls it that actual NGDP will end up being whatever they want it to be. He's so stupid that he doesn't even realize that you cannot have the instrument and target be the same thing. They have to be separate variables or else you have no real feedback to guide your policy. It would be like the BoE announcing that they are going to execute monetary policy by making a market in inflation futures. Sumner thinks that if they bought and sold inflation futures @1% then actual inflation would simply end up being 1%. That's what happens to people whose brains are rotted out by Rational Expectations. They start believing that expectations are everything, that all prophecies are self-fulfilling.

It's pretty insane on the face of it. In his world where expectations are everything, if the government were to put out a futures contract on future NGDP and buy up enough of them to have the futures indicate a 20% rise in NGDP, then people will just believe it and then NGDP will rise 20% that year.

A little while back when he first started his blog Adam P and JKH challenged him on this stuff. IIRC, when it came down to it he sort of backtracked into admitting that the target would be NGDP but that the actual instrument would be the supply of reserves, which he naively assumes simply translates into more money and higher prices.

The other problem with his NGDP theory is that it is supposed to be market determined (the Fed is supposed to be responding to the free market) except the problem is that he has the NGDP futures pegged by the Fed, so there is no incentive at all for anyone in the private market to trade them. There would be no private liquidity, they would never change price and they would give you no useful information. But hey, someone who actually believes in the EMH could never understand that, or else they wouldn't believe in the EMH either.

 

[rumble]

The other main thing is that futures change spot prices by forcing arbitrage between the futures market and the spot market. If you drive up the price of corn futures, you will drive up the price of physical corn because arbitrageurs will start buying it off the spot market and selling it forward. The thing that Sumner can't seem to get through his head is that the NGDP futures would have to be CASH SETTLED. There's a big difference between physical delivery futures and cash settled futures. There's no such thing as a spot market for physical NGDP, so there's absolutely no arbitrage mechanism that would cause actual NGDP to follow the NGDP futures

 

[vimothy]

I get the NGDP thing. I don't think that's the worst of his ideas. Worst is the inability to distinguish between Fed policy tools (OMO), operating targets (ON rates), short term targets (short term rates), and long term goals (low inflation, stable growth). Which you quite correctly point out. Most of the commentators have become infected with the same disease: the Fed should just stabilise NGDP. I asked a few of them how, and their answer was basically that it should do this by stabilising NGDP. I asked Scott and his answer was the same. More prodding and he suggested the NGDP futures market. Even though it doesn't exist.

Or make sense. At least to me. Heroic effort though, rumble. Cheers.

 

[vimothy]

Sumner thinks that if they bought and sold inflation futures @1% then actual inflation would simply end up being 1%.

This is what I don't get--but how? What is the mechanism that translates a trade for futures into inflation?

EDIT: This? Just a simple matter of people looking at the futures prices and then NGDP rising by magic by the correct amount?

It's pretty insane on the face of it. In his world where expectations are everything, if the government were to put out a futures contract on future NGDP and buy up enough of them to have the futures indicate a 20% rise in NGDP, then people will just believe it and then NGDP will rise 20% that year.

 

[rumble]

well a combination of Rational Expectations gone awry and the problem I bring up in my second comment there. It could work if there were a market for spot inflation like there is for pork bellies - but obviously there isn't.

 

[rumble]

the difficult thing about explaining Sumner is that he gets just about everything wrong. You could only believe what he believes based on a complex interlocking system of wrong ideas. There's no single wrong idea that is the source of his mistaken view. It's the sum of a multitude of boneheaded mistakes, mind-boggling ignorance and dogged 1970s chicago free market fundamentalism.

 

[vimothy]

Am I just being dense--how can you have a nominal GDP derivative? Precisely what is delivered at the settlement date?

 

[vimothy]

The other main thing is that futures change spot prices by forcing arbitrage between the futures market and the spot market. If you drive up the price of corn futures, you will drive up the price of physical corn because arbitrageurs will start buying it off the spot market and selling it forward.

So Sumner is saying that the Fed can raise (bid up) the price of the NGDP futures contract, which will then cause the *price* of GDP to rise...?

 

[rumble]

It would have to be cash settled based on some agreed standard figure, like government CPI on the settlement date.

Say we enter into a $100 futures contract on the price level. I go long and you go short. If the price level rises by 2% you would owe me $2 at settlement, but it sinks by 2% I would owe you $2. You can't deliver anything, so you always just settle the difference.

If we are talking about the /ES on the other hand (S&P futures), even though they are cash settled based on the S&P index, if you buy enough of them you will actually move the underlying market, because arbitrageurs will buy the SPY (S&P ETF) or the underlying stocks that make up the index.

Sumner seems to believe that people will go out and buy perfectly balanced chunks of GDP.. or something.

 

[vimothy]

Okay, that makes sense. I'm not sure how we go from there to --> control of the money supply --> control of nominal GDP. The Fed would have to long on its target level (never short), so that it would add reserves when NGDP is under target and remove reserves when NGDP is above target. Through the magic of the MV = PQ equation this then translates into an adjustment of the money supply which results in NGDP (PQ) always staying exactly where we want it. QED.

 

[vimothy]

Quick question: in your example, did money change hands before the settlement date ($100 for the face value of the contract)?

 

[rumble]

heres the thing though, Sumner has the Fed buying and selling the NGDP futures at a fixed price, but he also wants to use it as an indicator of them they need to increase the money supply (on a generous reading of his position). But how can you tell that you need to raise or lower actual NGDP when the futures contract you are using as an indicator never moves?

Sumner attempts to solve this by saying that the CB would respond to the imbalance on the order book - ie if more people want to buy the futures at the fixed price than want to sell, that means that NGDP is going to overshoot. the problem is that he assumes that people would even have a reason to buy this contract. Why would you buy an NGDP contract that never changes price? What the hell would be the difference between that and just holding the cash?? there is no difference, and there would be no liquidity in such a market, and therefore no indicator for the Fed to use.

 

[rumble]

no, I don't think so anyway. It's a futures contract, so I think the only thing that would initially happen is that the collateral from both sides would be posted with the exchange. If anyone's position gets really bad they would just have to post more collateral or be forced to sell/cover their position

 

[vimothy]

It's just that in this post http://www.themoneyillusion.com/?p=1210 Sumner seems to be saying that the Fed will be buying and selling futures and offsetting all transactions with bond sales or purchases (at five times face value of the futures contract). I guess this is some kind of genetic memory of reality (defending FF target rate by draining or injecting reserves as needed), but it makes no sense to me in the context of the NGDP futures proposal, because whatever the hell happens to NGDP, there is no way that it will move more than 5 times the par value of the contract, so it won't ever move enough to make up for the bond sale/purchase OMO.

Perhaps the most important element of the proposal, however, is that the Fed will make ordinary open market operations in parallel to the trades of these futures contracts, and these open market operations will impact base money.

Trades in the futures contract will be at the initiative of “the market,” specifically, futures speculators. Because the “market” initiates the trades, it has sometimes been called “index futures convertibility.”

If a speculator chooses to buy a contract at the price of $15.90, the Fed will create and sell the contract for $15.90. At the same time the Fed sells the future, it will simultaneously make an open market sale. Presumably, it would sell treasury bills. Sumner proposes that it sell five times the dollar value of the contract, so $79.50 worth of T-bills would be sold per futures contract the Fed sells.. (In my view, $15.90 is a very low value for a future contract. Perhaps one hundred millionth of NGDP, or $159,000 would create a future contract more typical.)

If a speculator chooses to sell a contract at the price of $15.90, the Fed would create and buy the contract for $15.90. At the same time the Fed buys the contract, it also makes an open market purchase, presumably buying Treasury bills worth $79.50. (Sumner also lists other sorts of securities the Fed might buy.)

 

[rumble]

yeah I'm not sure. It's difficult to disentangle what he means. for one thing that whole bit is by Bill Woolsley, who at least isn't quite as stupid as Sumner

Here's the thing: supposing that this system works, why would anyone buy one of those contracts when the Fed would be working to guarantee that you don't get any payout?

 

[vimothy]

In the comments he also seems to be saying that the Fed would go long or short the contracts, and that private traders would also take both sides of the contract if desired. I don't understand how this would work (since no monetary base is added or removed if the Fed isn't involved, and it is removed if NGDP is below trend and the Fed is short--which should be deflationary according to Sumner), but maybe this is just price discovery and the Fed then uses this to inform its actual operations...?

It's probably not worth trying to figure it out.

EDIT: Actually, this may be it:

“The way it works is as follows. If investors think NGDP growth will be less than 5% (like right now) they would buy NGDP futures contracts. Each time they bought one, the Fed would do a parallel OMP (probably involving T-bills) to actually change the base.”

So basically, this isn't any different to the current regime, it just involves some kind of fucking intrade market in futures to get a forecast of NGDP!! Jesus.

 

[vimothy]

Hahaha! God above. So the NGDP futures market is just a forecasting device. I thought it was some kind of policy tool that Sumner imagined would automatically adjust to keep NDGP growth at target.

 

[rumble]

yeah I think that's basically it

although the way that Sumner sets it up, I don't think it would even work as a forecasting device