Who owns the Fed?
http://www.federalreserve.gov/faqs/about_14986.htm
Can the Fed finance the U.S. government debt?
http://research.stlouisfed.org/publications/es/10/ES1014.pdf
Look at the first footnote: "The Fed is forbidden by law to purchase government securities directly from
the government. The government first sells securities to the private sector and
the Fed then purchases securities from the private sector, specifically, government
securities dealers."
Sunday, October 28, 2012
A Zombie of Fiscal Hawks
It is from my personal conversation with someone else.
That Person: The U.S. government has never run surplus since it went off the Gold Standard.
Me: It did sometimes. It barely did and the most recent one is in the Clinton era.
That Person: That is because he included Social Security Funds. Without it he did not actually run surplus. He balanced the budget but did not run surplus. So he did not decreased the debt.
Oh gosh. This kind of zombie comes to me whenever I talk with fiscal 'hawks'.
First, the fact: it is very simple. Even without Social Security funds, the Clinton Administration would still run surplus. The 2000's surplus including Social Security surpluses was 236 billion dollars. Social Security surplus was the biggest contributor to the surplus, but without it the U.S. federal government would still run 86 billion dollar surplus. Including Social Security budget balance is, in my opinion, much better because social securities benefits ought to be paid by the government if it runs out of fund. If it runs deficit, the government must take the deficit like it takes surplus.
Second, these people do not understand what really matters when it comes to public debt. What matters is net public debt to GDP ratio, not total amount of public debt or gross public debt to GDP ratio. Why does public debt matter in the first place? If public debt is considered too large, it will drive up interest rates, so both private sector and public sector will be worse off eventually. Both will suffer from too high borrowing costs. Then, we must learn how financial institutions make decisions to lend money to a government. It is basically the same as lending to the private borrowers. They assess the government's assets in terms of value and safety and revenue collection, in other words, income. That shows the government's borrowing (more precisely paying-back) ability. However, here, the government is always in a better position than private sector. Due to its size and authority, usually, financial institutions do not require the government to provide collateral. It is enough for the government to issue bonds as security to promise it will pay back its loans. Therefore, what really matters is not total debt amount. What matters is debt to GDP ratio. If GDP is growing, then debt to GDP ratio can fall even though the total debt amount is increasing, as long as GDP grows faster than debt. Growing GDP means growing tax revenue in the given tax rates. Financial institutions know that, and so has kept lending money to the U.S. federal government even though it has huge amount of debt in total. Then another question can arise: why net debt to GDP ratio? The U.S. states and sub government agencies have debts to the federal government. The federal government may just erase those debts if it finds those states or agencies never pay back. Therefore, the actual burden to the public is only net debt. It also means the federal government ran surplus but gross debt can increase if sub-national government or sub-agencies ran greater deficit. However, net debt may still decrease and indeed did during Clinton's last three years. This is what happened then.
Or, if you still remain zombified...
That Person: The U.S. government has never run surplus since it went off the Gold Standard.
Me: It did sometimes. It barely did and the most recent one is in the Clinton era.
That Person: That is because he included Social Security Funds. Without it he did not actually run surplus. He balanced the budget but did not run surplus. So he did not decreased the debt.
Oh gosh. This kind of zombie comes to me whenever I talk with fiscal 'hawks'.
First, the fact: it is very simple. Even without Social Security funds, the Clinton Administration would still run surplus. The 2000's surplus including Social Security surpluses was 236 billion dollars. Social Security surplus was the biggest contributor to the surplus, but without it the U.S. federal government would still run 86 billion dollar surplus. Including Social Security budget balance is, in my opinion, much better because social securities benefits ought to be paid by the government if it runs out of fund. If it runs deficit, the government must take the deficit like it takes surplus.
Second, these people do not understand what really matters when it comes to public debt. What matters is net public debt to GDP ratio, not total amount of public debt or gross public debt to GDP ratio. Why does public debt matter in the first place? If public debt is considered too large, it will drive up interest rates, so both private sector and public sector will be worse off eventually. Both will suffer from too high borrowing costs. Then, we must learn how financial institutions make decisions to lend money to a government. It is basically the same as lending to the private borrowers. They assess the government's assets in terms of value and safety and revenue collection, in other words, income. That shows the government's borrowing (more precisely paying-back) ability. However, here, the government is always in a better position than private sector. Due to its size and authority, usually, financial institutions do not require the government to provide collateral. It is enough for the government to issue bonds as security to promise it will pay back its loans. Therefore, what really matters is not total debt amount. What matters is debt to GDP ratio. If GDP is growing, then debt to GDP ratio can fall even though the total debt amount is increasing, as long as GDP grows faster than debt. Growing GDP means growing tax revenue in the given tax rates. Financial institutions know that, and so has kept lending money to the U.S. federal government even though it has huge amount of debt in total. Then another question can arise: why net debt to GDP ratio? The U.S. states and sub government agencies have debts to the federal government. The federal government may just erase those debts if it finds those states or agencies never pay back. Therefore, the actual burden to the public is only net debt. It also means the federal government ran surplus but gross debt can increase if sub-national government or sub-agencies ran greater deficit. However, net debt may still decrease and indeed did during Clinton's last three years. This is what happened then.
Or, if you still remain zombified...
Saturday, October 27, 2012
The velocity of money and money demand at the zero lower bound
I have been confused with the relationship between the money demand and the velocity of money.
The quantity theory of money implies that the greater the money demand is the slower the velocity of money will be at the given money market equilibrium, assuming other conditions remain the same. In other words, the more money the people demand, the longer at their hands the money will stay.
However, somewhat the situation in the U.S. economy does not seem to fit this theory. Even though the velocity of money is very low, the interest rate is also quite low and most of the expanded Fed monetary base stays within the Fed vaults, indicating the demand for money is low. It appears the quantity theory of money is being violated.
I realized that the problem of my first intuition lies within something basic in economics that most undergraduate students are struggling with : the difference between movement along the curve and shift of the curve. I suspect the following description shows what is happening.
1) The Fed has increased monetary base and set its interest rate target at zero, and so M1 and M2 have increased accordingly.
2) Since the quantity of money in the market has increased and the interest rate has fallen to zero, the quantity of money demanded by people has increased as much as that along the money demand curve. As a result, the velocity of money has fallen.
3) However, this increased quantity of money is not large enough to restore full employment given the assumption that the money demand itself has fallen, i.e., the money demand curve has shifted downward drastically. The nominal interest rate at zero is not low enough.
4) Therefore, the current velocity of money is not slow enough to keep the newly printed money at people's hands so that they will be able to consume and invest. The newly printed money has disappeared too quickly to the Federal Reserve vaults to stimulate the economy.
If my speculation is right, then we really don't have to expect hyperinflation will occur sooner or later. The money supply is still too tight and the money demand is too low.
The quantity theory of money implies that the greater the money demand is the slower the velocity of money will be at the given money market equilibrium, assuming other conditions remain the same. In other words, the more money the people demand, the longer at their hands the money will stay.
However, somewhat the situation in the U.S. economy does not seem to fit this theory. Even though the velocity of money is very low, the interest rate is also quite low and most of the expanded Fed monetary base stays within the Fed vaults, indicating the demand for money is low. It appears the quantity theory of money is being violated.
I realized that the problem of my first intuition lies within something basic in economics that most undergraduate students are struggling with : the difference between movement along the curve and shift of the curve. I suspect the following description shows what is happening.
1) The Fed has increased monetary base and set its interest rate target at zero, and so M1 and M2 have increased accordingly.
2) Since the quantity of money in the market has increased and the interest rate has fallen to zero, the quantity of money demanded by people has increased as much as that along the money demand curve. As a result, the velocity of money has fallen.
3) However, this increased quantity of money is not large enough to restore full employment given the assumption that the money demand itself has fallen, i.e., the money demand curve has shifted downward drastically. The nominal interest rate at zero is not low enough.
4) Therefore, the current velocity of money is not slow enough to keep the newly printed money at people's hands so that they will be able to consume and invest. The newly printed money has disappeared too quickly to the Federal Reserve vaults to stimulate the economy.
If my speculation is right, then we really don't have to expect hyperinflation will occur sooner or later. The money supply is still too tight and the money demand is too low.
A Federal Reserve Conspiracy
A conspiracy theory I heard recently from someone else: the Fed is privately owned and it is scamming out the American public; the U.S. economy is on the verge of hyperinflation due to the rounds of QEs and what the Fed is doing is huge theft of wealth from the public. Unfortunately, that 'theory' is believed by many although most portion of the Fed expansion in monetary base is still sleeping in the Fed vaults and the velocity of money has slowed. However, you may still suspect that M2 has indeed increased and the U.S. economy is about to face hyperinflation.
I think that kind of widespread belief, even among very intellectual people, that monetary base expansion like QE directly causes hyperinflation is partly, (not mainly), due to how we are taught in macro class. Our Econ professors show a simplified MD/MS diagram, which assumes money supply appears fixed by the central bank. That diagram also appears that the central bank has some magical power to fix the interest rate. Of course, no central bank has that kind of power. It can increase MONETARY BASE, not directly M1 or M2, which are actual money supply indicators; it SETS the TARGET for some interest rates, not fixing interest rates. I think it is a very important notion that is often ignored in our macroeconomics class. If the Bank of Canada or the U.S. Fed really could control the money supply and fix overnight rate, then monetary policy would be much more of mechanical process and our economy would not have any problem from the business cycle.
Of course, My econ profs indeed taught me that expansionary monetary policy itself does not directly lead to inflation and why. I really appreciate that.
Since the quantity theory of money shows MV=PY or P=(MV)/Y, an increase in M will lead to a growth of price level only if V does not fall or Y does not grow. However, the truth is Y has slowly grown anyway and V has fallen. Accordingly, inflation pressure has been offset.
Of course, My econ profs indeed taught me that expansionary monetary policy itself does not directly lead to inflation and why. I really appreciate that.
Friday, October 26, 2012
"Inflation is always and everywhere monetary phenomenon." MiltonFriedman
A lot of people who believe we are on the verge of hyperinflation probably misunderstand what Friedman meant. They simply believe an increase in monetary base will raise the price level. However, if our demand for money is so low that the newly-created money is not used, then inflation never arrives.
Let's look at the very simple quantity theory of money equations:
MV=PY
P=(MV)/Y
This equation means price level will rise as money supply increases only if the velocity does not fall in the given income level. Usually, all these variables change simultaneously, so this theory is a little problematic to apply to our real life. However, since the last few years the U.S. real GDP has grown very slowly, it is a very good chance to conduct a natural experiment.
The Federal Reserve has since Q4 of 2007 increased its monetary base by three times. As a result M2 has risen by about 38%. If velocity of money had not changed, assuming Y constant, the price level should have risen by 38%. However, we haven't seen that and will probably never.
The velocity of money has slowed by about 22% during the same period. Plus, the U.S. Real GDP has risen even though it is not such a good performance. Therefore, huge inflation has not arrived here and it doesn't seem to happen sooner or later.
Let's look at the very simple quantity theory of money equations:
MV=PY
P=(MV)/Y
This equation means price level will rise as money supply increases only if the velocity does not fall in the given income level. Usually, all these variables change simultaneously, so this theory is a little problematic to apply to our real life. However, since the last few years the U.S. real GDP has grown very slowly, it is a very good chance to conduct a natural experiment.
The Federal Reserve has since Q4 of 2007 increased its monetary base by three times. As a result M2 has risen by about 38%. If velocity of money had not changed, assuming Y constant, the price level should have risen by 38%. However, we haven't seen that and will probably never.
The velocity of money has slowed by about 22% during the same period. Plus, the U.S. Real GDP has risen even though it is not such a good performance. Therefore, huge inflation has not arrived here and it doesn't seem to happen sooner or later.
Saturday, October 20, 2012
Core Inflation: Why Are Food and Energy Prices Excluded?
While helping out one of my colleagues at university doing homework, I got into graphing stuff. Thanks to that, I'm now a little bit behind my reading for another class, but it's all fine. Hope so. Here are graphs for inflation rate, core inflation rate, food inflation rate, and energy inflation rate.
As you can see, changes in food prices and energy prices are much more volatile than general inflation rate.
Food and energy price volatility is caused mainly by very unstable supply of those markets. Their prices are very easily affected by changes in climate or military tension in the Middle East.
Every year I see news that the price of cabbage skyrockets all of sudden because of sudden coldness or snowfall, and Korean restaurants are considering to stop serving kimchi. The truth is about a month later I see another news that farmers plow up their yards because of a drastic fall in price of cabbage mainly in response to retailers' import of Chinese cabbages to fill the supply shortage. By the way, the bottom line is these volatile prices play a role as outliers. They change so much that an inflation rate that includes those price changes may skew the result and not reflect changes in other prices.
On the other hand, a lot of other prices are set by firms that produce those products. In other words, firms, more or less, have market power. For example, the Apple Inc. just sets its products prices; it does not even let its retailers change prices in response to every day change in demand; when it sets its prices, probably the production costs matter more than any other factors and they are usually pre-determined. In the short run, therefore, their prices are sticky. Therefore, by taking off too volatile food and energy prices, you can see a broader tendency in price changes.
Food and energy price volatility is caused mainly by very unstable supply of those markets. Their prices are very easily affected by changes in climate or military tension in the Middle East.
Every year I see news that the price of cabbage skyrockets all of sudden because of sudden coldness or snowfall, and Korean restaurants are considering to stop serving kimchi. The truth is about a month later I see another news that farmers plow up their yards because of a drastic fall in price of cabbage mainly in response to retailers' import of Chinese cabbages to fill the supply shortage. By the way, the bottom line is these volatile prices play a role as outliers. They change so much that an inflation rate that includes those price changes may skew the result and not reflect changes in other prices.
On the other hand, a lot of other prices are set by firms that produce those products. In other words, firms, more or less, have market power. For example, the Apple Inc. just sets its products prices; it does not even let its retailers change prices in response to every day change in demand; when it sets its prices, probably the production costs matter more than any other factors and they are usually pre-determined. In the short run, therefore, their prices are sticky. Therefore, by taking off too volatile food and energy prices, you can see a broader tendency in price changes.
Friday, October 12, 2012
The Vice-Presidential Debate
Actually this is not on the vice-presidential debate last night. I haven't watched it. However, I have seen some news articles on it. Therefore, "on media responses to the debate" might be the proper term. It seems to have been very intensive and exciting unlike the presidential debate. However, this is not really for the debate but for the sampled data analysis.
Some say Biden won (CBS, 50 to 31) but some other say Ryan won (CNN, 48-44). Still we'll have to wait until Monday the debate result is taken into account and opinion polls adjusts accordingly. However, other media than CBS and CNN are saying Biden won because the CBS poll shows much greater margin in favour of Biden than the CNN poll. I was not sure this was a proper way to analyze the data in the first place. However, there may be some other better reasons why we can believe so.
CNN conducted survey on 381 registered voters who watched the debate (http://politicalticker.blogs.cnn.com/2012/10/11/cnn-poll-on-debate-winner-ryan-48-biden-44/comment-page-183/); CBS collected data from 431 uncommitted voters. According to CBS, an uncommitted voter is defined a person "who [doesn't] yet know who [he or she] will vote for, or who [has] chosen a candidate but may still change their minds."(http://m.cbsnews.com/fullstory.rbml?catid=57531059&feed_id=null&videofeed=null) Obviously, there is some gap between the CNN poll and the CBS one. The former seems to be more random than the latter. The latter's sample seems to represents only swing voters's opinion. Therefore, we may conclude the CBS survey is biased, and CNN's survey is better. However, is it?
Since this election campaign is a neck-to-neck race, the margin between the two is very narrow. Neither Romney nor Obama is the sure one. They are fighting within the error range. Therefore, the lead in the CBS's sample is a bigger deal than in the CNN's one. Of course, I will have to say I will wait till Monday a better conclusion can be made.
Some say Biden won (CBS, 50 to 31) but some other say Ryan won (CNN, 48-44). Still we'll have to wait until Monday the debate result is taken into account and opinion polls adjusts accordingly. However, other media than CBS and CNN are saying Biden won because the CBS poll shows much greater margin in favour of Biden than the CNN poll. I was not sure this was a proper way to analyze the data in the first place. However, there may be some other better reasons why we can believe so.
CNN conducted survey on 381 registered voters who watched the debate (http://politicalticker.blogs.cnn.com/2012/10/11/cnn-poll-on-debate-winner-ryan-48-biden-44/comment-page-183/); CBS collected data from 431 uncommitted voters. According to CBS, an uncommitted voter is defined a person "who [doesn't] yet know who [he or she] will vote for, or who [has] chosen a candidate but may still change their minds."(http://m.cbsnews.com/fullstory.rbml?catid=57531059&feed_id=null&videofeed=null) Obviously, there is some gap between the CNN poll and the CBS one. The former seems to be more random than the latter. The latter's sample seems to represents only swing voters's opinion. Therefore, we may conclude the CBS survey is biased, and CNN's survey is better. However, is it?
Since this election campaign is a neck-to-neck race, the margin between the two is very narrow. Neither Romney nor Obama is the sure one. They are fighting within the error range. Therefore, the lead in the CBS's sample is a bigger deal than in the CNN's one. Of course, I will have to say I will wait till Monday a better conclusion can be made.
Thursday, October 11, 2012
Election forecast jitters
It seems obsession and irrational reaction to believe that Romney's recent lead means some significant changes. This morning Obama is narrowing the gap. Both are converging towards Romney's "47%". And the trend from the past shows Romney's surge didn't last long. I think it may be true again at this time.
Wednesday, October 10, 2012
Is it because of the debate?
Romney is on rise obviously. However, I started half-doubting if it is really due to the debate on October 3rd. Of course, a lot of people say Obama lost and Romney won. However, is his lead really due to that debate? Let's look at the following graph offered from RealClearPolitics.com
Romney started rising well before the debate. He hit the bottom around September 27.His rate started rising on September 30. Before the debate, Obama's popularity was also on rise but Romney's slope was much steeper. After the debate, Obama's rate started falling very drastically while Romney has kept on the rising track.
My conclusion: Obama's support is falling due to the debate: it seems so. What about Romney? I think it is just a reactive bounce due to his weak performance in September. Since he was very weak in September, the Republicans felt threatened and started gathering around Romney.
According to Romney, there are 47% who vote for him whatever he does; there are also other 47% who vote for Obama whatever he does. I think he is right. Currently neither strongly gains in the rest 6%. If only Romney surge is very stable until November, I may believe Romney is leading because of the October 3rd debate.
Friday, October 5, 2012
Liquidity Trap and Foreign Exchange Rates: A Speculation
I might be wrong, but I want to share this idea. I'm not even sure I'm original at this.
Let's imagine an open economy in a liquidity trap. In the short run, price level is sticky but not one hundred percent. Perfect capital mobility and flexible exchange rates are assumed too. Nominal interest rate is zero, but the demand for money is much shorter than the money supply at zero nominal rate. It needs to fall further, but the central banks somewhat do not let it happen. The central bank has made a pledge to price stability and it is very responsible.
To stimulate the economy, however, the central bank implements very aggressive expansionary monetary policy. Initially, the return on foreign assets is expected to rise because much more domestic currency in the FX market is expected. Due to the lack of money demand and zero lower bound, actually, the quantity of money in the market does not grow: the market is worried about the central bank's future contraction and do not use the newly printed money. As a result, the expectation of higher exchange rate does not come true. Rather, the interest rate is not low enough at zero, so the domestic currency remains over-valued. As a result, return on foreign deposit is expected to fall and it will really come true because the interest rate does not change and there is net capital inflow; the economy runs the current account deficit.
Now, the government implements a massive expansionary fiscal policy. As a result, the domestic price level and output is expected to rise and the demand for money starts rising. The central bank still secures the increased monetary stock to stay there; in other words, it makes a pledge to be responsibly irresponsible at inflation over its target. The quantity of money in the market will grow, the zero nominal interest rate eventually becomes low enough, as a result, the domestic currency is eventually expected to depreciate and it indeed does. Then people start depositing in foreign accounts. As a result, there is a rising net capital outflow, so the net export will rise. There is not only no crowding out effect but also gains in the current account from expansionary fiscal policy.
Let's imagine an open economy in a liquidity trap. In the short run, price level is sticky but not one hundred percent. Perfect capital mobility and flexible exchange rates are assumed too. Nominal interest rate is zero, but the demand for money is much shorter than the money supply at zero nominal rate. It needs to fall further, but the central banks somewhat do not let it happen. The central bank has made a pledge to price stability and it is very responsible.
To stimulate the economy, however, the central bank implements very aggressive expansionary monetary policy. Initially, the return on foreign assets is expected to rise because much more domestic currency in the FX market is expected. Due to the lack of money demand and zero lower bound, actually, the quantity of money in the market does not grow: the market is worried about the central bank's future contraction and do not use the newly printed money. As a result, the expectation of higher exchange rate does not come true. Rather, the interest rate is not low enough at zero, so the domestic currency remains over-valued. As a result, return on foreign deposit is expected to fall and it will really come true because the interest rate does not change and there is net capital inflow; the economy runs the current account deficit.
Now, the government implements a massive expansionary fiscal policy. As a result, the domestic price level and output is expected to rise and the demand for money starts rising. The central bank still secures the increased monetary stock to stay there; in other words, it makes a pledge to be responsibly irresponsible at inflation over its target. The quantity of money in the market will grow, the zero nominal interest rate eventually becomes low enough, as a result, the domestic currency is eventually expected to depreciate and it indeed does. Then people start depositing in foreign accounts. As a result, there is a rising net capital outflow, so the net export will rise. There is not only no crowding out effect but also gains in the current account from expansionary fiscal policy.
A news article on North Korean sweatshop in China
I just read a news article from South Korea. Unfortunately it is written in Korean, so I cannot post it in entirety. However, I translated some interesting parts:
"There are about 20,000 North Korean workers and 400 in Liaoning and Jillin, China respectively... North Korea is eager to send its workers there...It doesn't matter whether a business is one in which South Koreans invest as long as that fact does not appear on official documents...
"The (Chinese) employers can use North Korean workers in half wages they are supposed to pay Chinese workers for equivalent jobs...
"Since 2010 when the Battleship Cheonan sank, the South Korean government banned South Korean businesses from...newly investing in North Korea...and contacting with North Koreans...It is 'impossible' for South Korean firms (operating within China) to hire North Korean workers...
"In one factory, the Chinese employer pays 1,500 yuans, but those North Korean female workers receive only 150 yuans after the North Korean and Chinese authorities take taxes and some 'common expenses'. The next morning after the first pay day, their North Korean managers already took those expenses from the female workers. In their hometown, the local authority takes some money from their families too one the authority notices their daughters have been sent to China for work. However, the remaining money in their hands are still very large amount in their sense, so job application is very competitive."
"There are about 20,000 North Korean workers and 400 in Liaoning and Jillin, China respectively... North Korea is eager to send its workers there...It doesn't matter whether a business is one in which South Koreans invest as long as that fact does not appear on official documents...
"The (Chinese) employers can use North Korean workers in half wages they are supposed to pay Chinese workers for equivalent jobs...
"Since 2010 when the Battleship Cheonan sank, the South Korean government banned South Korean businesses from...newly investing in North Korea...and contacting with North Koreans...It is 'impossible' for South Korean firms (operating within China) to hire North Korean workers...
"In one factory, the Chinese employer pays 1,500 yuans, but those North Korean female workers receive only 150 yuans after the North Korean and Chinese authorities take taxes and some 'common expenses'. The next morning after the first pay day, their North Korean managers already took those expenses from the female workers. In their hometown, the local authority takes some money from their families too one the authority notices their daughters have been sent to China for work. However, the remaining money in their hands are still very large amount in their sense, so job application is very competitive."
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