Dual Mandate

There is a very good short essay by Dan Altman over at Big Think.

It deals with the dual mandate faced by the Federal Reserve. For those of you who are unfamiliar with the term, the Federal Reserve is obliged by law to consider “maximum employment, stable prices, and moderate long-term interest rates.” The kicker is that first part. Many other central banks around the world are focused on stable prices only. This makes sense if you subscribe to the idea that money is neutral and understand the relationship in the equation of exchange M * V = P * Q  (or P * Y as many prefer).

But the author points out that it complicates monetary policy when fiscal policy is ineffective.  I even wonder if fiscal policy-makers are generally unwilling to face hard choices, hoping that monetary policy can solve the problem alone. If true, the tools in the monetary policy toolbox may not offer the solution that is being sought.  This is not the time to use the old adage, “when all you have is hammer, treat everything like a nail.”

I look forward to your comments.

Wealth and Income Effects of Monetary Policy

Back when I worked for the Federal Reserve Bank of Chicago, there were a couple of issues that had to be dealt with repeatedly. One was the limitations of monetary policy – there were certain macroeconomic goals that were easier than others to address through monetary policy. The other was the fact that monetary policy was a broad tool.  One could not really initiate policy to affect a narrow sector of the economy – too often it had effects on other areas.

This latter is illustrated well in an opinion piece (free content at time of this writing) from today’s edition of The Wall Street Journal . The piece is critical of the Fed’s monetary policy move referred to as QE2.  The charge is that it was meant to have a specific effect on financial markets, but has had unintended consequences in other markets, such as commodities.  While I don’t pretend to know whether this is true or not, the piece does explain how QE2 resulted in wealth effects and income effects.  And it is there that it provides a service for those of us who teach.

In explaining the linkage between an accommodative monetary policy and prices (of both securities and commodities) it can be used to help students understand the wealth effects (confidence arising from rising stock prices) and income effects (falling real income) that accompany the changing value of the dollar.

You might want to take a look. Let me know if you agree.

The Imaginot Line

Foreign Policy has a very engaging article on the recent financial crisis and central banking (HT Arts & Letters Daily). The article compares the faith in central banking prior to the crisis to the faith of the French nation in the Maginot line prior to World War II.

The article notes there are reasons to quibble over the comparison, but it is a good place to start when thinking about how we place our faith in institutions (rules and organizations) and that can impact our choices - for good or for ill. I recommend it.

Money & Central Banks

I don't know how many of you generally listen to National Public Radio's This American Life.  I don't always catch it, but I usually enjoy it when I do.

This weekend they had a really interesting episode on What is Money? It does a good job explaining how money is just a tool and has value only to the extent that we believe in it. The episode began when a number of NPR reporters started to wonder about the money that was "lost" in the recent down market.  It meanders through how Brazil addressed its inflation problem in the 1990s by creating a virtual currency. And it winds up with a discussion on how the Federal Reserve usually creates money and what it did differently during this last crisis (think "lender of last resort").

It will take you an hour to listen to, but it will be worth your time even if you only get some great short anecdotes to use in your classroom.

Let me know what you think.

Some Tools for Teaching Policy Tools

You may already be aware of both of these. But if you're not, it's worth your time to look at them.

The first is a new interactive on The New York Times website. (HT to Econlog.) It's a game on cutting the federal budget. You can cut certain spending categories and or raise certain taxes in effort to bring the Federal Budget back in line. It is rather simplistic and doesn't really show the complexity of the trade-offs, but it’s not bad for the venue. And I think that for a traditional high school economics course, it makes a great introduction.

The second resource is an opinion piece in today's issue of The Wall Street Journal. It's written by Princeton economics professor and former Vice-Chairman of the Federal Reserve Board of Governors, Alan Blinder. Dr. Blinder offers an interesting defense of the Fed and quantitative easing. I would think it would be usable for the monetary policy section in your AP or IB courses.

More on Monetary Policy

A good friend and colleague in Chicago sent me this link to a post on National Public Radio's Planet Money blog. It offers a unique translater for the most recent FOMC statement.  I think you'll find it amusing...and hopefully useful.

Quantitative Easin'

This may not be appropriate for use with your class. You need to decide that.  But it is funny and it explains what is meant by quantitative easing.  (HT to Greg Mankiw)
 

China's Central Bank and Currency

Earlier this week, The Wall Street Journal carried this story about a move by the Chinese central bank that sparked a sell-off in the market. The Chinese central bank had, unexpectedly, raised its short-term lending rate. Many saw this as a portent that the Chinese economy was being slowed and this would not be good for future growth as it would dampen Chinese demand for goods from around the world. This is a solid observation. But I want to raise two other points.

First, as long as the Chinese currency is tied to the U.S. dollar, or more accurately a basket of currencies that includes the U.S. dollar, the Chinese central bank is limited in its policy. Essentially, to maintain parity, it must match the policy of the countries to which it has tied its currency. This implies that as these other countries ease policy to fight recession, the booming Chinese economy is subject to a similar easing. This only invites inflation. Essentially, any nation that ties its currency to another's, must commit to a similar monetary policy. That's good if the business cycles are coincident. But when they diverge, it isn't a good idea.

Second, given the pressure on China to let the currency float, this might be a first step to do so. A higher interest rate will strengthen the currency which will help Chinese consumer buy imports and put a bit of a burden on Chinese exporters. It seems that is what many have been calling for. As a result, I'm surprised by the reaction.

As always, I welcome other insights. I do think this story is a great way to talk about monetary policy and its connection to exchange rates

Deflation and Fisher Equation

Many of us use the Fisher Equation: Real interest rate = Nominal interest rate - Inflation rate. Many more of us don't know that Fisher was thinking about a specific market.

This article in the October issue of Monetary Trends by the Federal Reserve Bank of St. Louis provides some historical context. But more importantly, it puts the equation into current context by providing another view of the complex challenge the Fed faces as it deals with a slow economy coupled with the possibility of renewed inflationary pressure. I strongly recommend it for that section on monetary policy in your macro sections.

And share your thoughts. Is this usable with your classes? Or too "high-end"?

Reserves Don't Necessarily Lead to Loans

One of the analogies we often use when teaching monetary policy is "pushing on a string". The idea behind the analogy is that banks are imperfect transmission mechanism. The Fed can loosen policy in an effort to stimulate the economy, but just because the Fed loosens doesn't mean the economy will respond quickly - other parties (banks and borrowers) have to respond to the conditions and take up the slack.

Here is a good, short piece from the Federal Reserve Bank of St. Louis's Monetary Trends that should help explain that a bit more thoroughly, using the current economy as an example.

Read it through and share your thoughts. Would this help your students better understand the transmission mechanism and how it can limit the effectiveness of policy? Would you use it directly with your students, or just as your own background?  And if you wouldn't use it, what is missing?

What's Policy Supposed to Do?

When we teach monetary policy, we tell students that counter-cyclical policy would be to expand the money supply as a recession or panic hits, and these off as the economy turns the corner to recovery. And while we haven't heard anything official on the end of the most recent recession, many economists think the economy turned the corner in summer 2009.

Marginal Revolution provides an interesting link to the Shadowstats website. The charts show growth data for the monetary base, M1, M2 and what appears to be a proxy M3 measure (M3 is no longer officially recorded), beginning in 2006. (Please note, the charts in the explanatory links from the Federal Reserve Bank of St. Louis cover a longer period than the charts on Shadowstats.) There is a clear uptick as the financial crisis kicks in 2008. (The Fed clearly learned something from 1929.) And growth, while still accommodative, has fallen from the higher levels of 2009. These could be useful in teaching those chapters on monetary policy, if you want to illustrate what accommodative policy during a financial crisis looks like.

Risk and the Limits of Monetary Policy

Two articles in the newspaper caught my attention this morning. And as they are related, they had more significant impact.

The first was from The Washington Post. Ezra Klein discusses some moves the Fed is said to be contemplating as there are signs the recovery may not be as strong as previously thought. The efforts are largely designed to provide banks with an incentive to lend.


This brings me to the second article, which was in The Wall Street Journal. (Subscriber content at this writing, but put “Risk Aversion Keeps Economy in the Slow Lane” in your browser and you may find a free version. This article talks about risk aversion both by borrowers and lenders. For borrowers, the desire to avoid debt when the future appears shaky is understandable. I suspect you tie in Keynes’ “paradox of thrift” when you discuss this. On the lenders side, it may be more complex. Yes, lenders are reluctant to lend, especially to businesses when the outlook is uncertain. But add the pressure being put on lenders by regulators and the government. The lenders are being chastised (in many cases correctly) for taking on excessive risk. This is being translated by many as “lenders shouldn’t take risk.” Unfortunately, credit involves risk.

We can get into the aspects of maturity risk, liquidity risk, and default risk another time. But when lenders are being chastised for lending, and borrowers are being told that things aren’t as rosy as we would have hoped, the appetite for risk is muted. I look forward to your thoughts.

Mankiw on the Crisis

Greg Mankiw has a longer, interesting piece in National Affairs. The article examines the recent recession and the problems inherent in measuring the effect of government policy as a corrective. It provides a couple of great items for you to consider integrating into your discussions of business cycles and aggregate demand.

The analogy of the economy as a sick patient, with unique symptoms is helpful. The inability to determine whether worsening condition means the diagnosis was wrong, or the prescribed treatment was ineffective or insufficient, would be thought-provoking for students, who sometimes approach economics as if it were a cut-and-dried science.

Also of interest were the discussions about fiscal policy, particularly the spending multiplier vs. the tax multiplier. Mankiw provides some specifics about the assumptions of the Obama administration and insights into research that question at least some of those assumptions.

As I said, it’s a longer article but it’s worth a quick read at least, and some deeper thought if you see uses in your classroom.

The Euro and ECB

A couple days ago, The Washington Post had an piece by Ezra Klein on the ramifications of the European debt situation on the future of the European Central Bank (ECB). I found it particularly insightful on two counts.

The first was the institutional barriers that make the ECB so difficult to manage. Specifically, each of the member countries has different views towards inflation and unemployment, which means a single policy (which focuses on inflation), is going to be unpopular in many of the member countries, particularly if they are experiencing differing economic conditions. In that respect, it is not unlike the Federal Reserve, which must formulate policy across a geographically and economically diverse nation. The advantage the Fed has is that the U.S. view on those conditions has had more than two centuries to approach something like consensus. The ECB hasn't had that luxury, even for its oldest members.

The second insight was the ECB's reversion to buying debt. Like the Fed, it is basically restricted from buying debt in the primary market (direct from government). As a result, it resorted to buying debt in the secondary or open market (individuals and institutions that had already purchased government debt).

If you're interested in the functioning of central banks, I strongly recommend you read Klein's piece.

Follow-up to Central Banking

Yesterday, I posted some resources on central banking. Here is one more in the form of a podcast from the VoxEu web site.

It's an interview with Sir Howard Davies, a director of the London School of Economics. And while it focuses on the European Central Bank for the most part, there are a lot of general lessons for consideration. Instead of a beach read, consider it "beach running" material for your mp3 player.

Central Bank Reading

And finally, here are a couple of interesting readings about central banking. The first comes from the Federal Reserve Bank of San Francisco and discusses the Fed's exit strategy for the most recent recession. Specifically, it looks at how the Fed might withdraw from the monetary easing and other actions that were put in place as the economy was slowing. It's a quick read and may prove valuable as the situation progresses. You can always refer to it when discussing the process with your students.

The second is from a speech from one of the senior members of the Bank of England (HT to Marginal Revolution). It deals with central bank independence and what characteristics are most important for a properly functioning central bank. It's a bit longer, but it is still interesting reading.

Some Fed Articles on Inflation

Here are three interesting and readable short pieces from the Federal Reserve System. They all deal, in one way or another, with inflation, and they all provide good background for teachers and students alike.

The first is from the Federal Reserve Bank of Cleveland's Economic Trends and is by far the timeliest. By that I mean it really is of the moment and probably needs to be used or read in the near term to have the most value.

The remaining two are courtesy of the Federal Reserve Bank of St. Louis. This one is from their Economic Synopses publication and deals with a practical definition of monetizing the debt. You know, it’s the answer you have to give when students ask "why doesn't the government just print more money and pay off the debt?" In this case, the definition depends upon intent. And the article provides some good historical context.

The next article is a brief essay from the recent issue of Monetary Trends. It asks "Why Do People Dislike Inflation?" And it provides a good answer. If your students sometimes speak like inflation might be a good thing (wages rise, debts are easier to pay off, etc.), this could be helpful.

I look forward to your thoughts on these articles.

Something on the Great Depression

For those of you interested in The Great Depression, you might want to check out this site for a very interesting podcast. (HT to Econlog.) It is a libertarian site, but the podcast should prove interesting.

I've read Scott Sumner before. (In fact, if you read his blog, The Money Illusion, you have too.) In my opinion, he is always interesting.  I may not always agree with him, but he is interesting.

Fed Speak Summary

If you're a professional Fed watcher, you already have or know about this graphic from The Wall Street Journal. (HT to The Big Picture.) But if you're an interested amateur, or if you're a student involved in something called the Fed Challenge, you may not be aware of it. Consequently, enjoy.

Very Intriguing Article on Macro Policy

When discussing economic policy (monetary and fiscal) with students, the "easy" part is explaining how each tool is supposed to act. The harder part is discussing the impact of the policy mix. Here is an article is an article from Voxeu that,while not solving the problem, provides some lessons learned about policy mix as a result of the current downturn. Admittedly, it does not say "Do this." But I think it does provide some context for discussion on the limits of each kind of policy. Do you agree?