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Why do you believe that the difference between the developments in the US and Europe is explained by different central bank behavior, when there is also a huge

Why do you believe that the difference between the developments in the US and Europe is explained by different central bank behavior, when there is also a huge difference in effective fiscal policy behavior that is consistent with the difference in outcome? You're right though that central banks really target inflation. Inflation -> Interest rate -> Market transactions. If you look broader then the US you will see that the idea of the liquidity trap has essentially been demolished, multible countries easly expanded on zero rates. Switzerland did it for example. The talk about a liquidity trap doesn't actually say that growth is impossible at an interest rate of zero. What it does say is that if you're at an interest rate of zero without growth, the usual monetary theory policy prescription of "just decrease the interest rate" doesn't work. I wouldn't say that that's discredited just yet, even though some central banks have started to implement mildly negative interest rates. The proof of the pudding would be if a country implemented significantly negative interest rates, but that would force commercial banks to charge negative interest rates on regular bank accounts, and nobody wants to go there (for good reason IMO - messing with institutions like that is not something you do lightly). I would also say that the interest rate is not the only transition mechanism, and not the one monetarists focus on. Can you explain that? So far, whenever I've talked to people about this issue, they usually don't come up with any alternative transmission mechanisms at all (i.e. it's all hand-waving and fuzziness/buzzwords), or ones that actually misunderstand what's going on (e.g. confusing open market operations, which are asset neutral, with "helicopter drops" that are basically fiscal policy in disguise).

nickik 10y ago
Since this is a old thread now, I will not spend to much time. > Why do you believe that the difference between the developments in the US and Europe is explained by different central bank behavior, when there is also a huge difference in effective fiscal policy behavior that is consistent with the difference in outcome? Because the US had both expansion and contraction in fiscal policy, and growth was not infected. New Keynesian predicted the 'fiscal cliff' in 2013 and monetarist said it would not have any effect. You can also look at some of the smaller similar economies in Europe that are inside and outside of the Euro. Generally the fiscal policy is not that different, but the countries outside of the Euro generally do better if they had expansionary monetary policy. > Can you explain that? http://www.themoneyillusion.com/?p=23314 http://www.themoneyillusion.com/?p=23314
- nhaehnle 10y ago
  I think we're getting into a region of subtlety where we'd have to actually look at data. I have no idea which countries you're referring to specifically, for example. On the "hot-potato effect", I found this part of the linked article quite funny: > Notice that so far these changes can be fully explained using the basic principles of microeconomics. There is no need to resort to “transmission mechanisms” such as interest rates. Just S&D. Well, how does the author think that the "transmission mechanism" of interest rates is supposed to work? By the basic principles of microeconomics, supply and demand! The price of money is the interest rate. And yes, so far as banks trade financial assets with each other in exchange for reserves, there can be an effect on asset prices. But asset prices are basically an inverse of the interest rate; in particular, when you look at the bond market, long term bond prices are an inverse of long-term interest rates. Indeed, when you look at quantitative easing, it did have the effect of pushing the long-term interest rate even further down, which is equivalent to pushing asset prices up. So yes, the transmission mechanism is the interest rate. The article pretends to disagree with that, but it really doesn't. Instead, it just explains it in more detail, but without being aware of the connection. Of course, there's nothing wrong with explaining things in more detail. There are two points where I believe the article is wrong. The first is a minor point, namely where it says there can be a (direct) effect on output. Since reserves aren't used for transactions in the real economy, that's not possible. The second is quite a bit more important. The article starts its analogy with a scenario where new gold deposits are discovered, i.e. the increase in gold is a purely exogenous event. Base money increases are never purely exogenous events. Of course it might start with a central bank policy decision (although more often than not it starts with a commercial bank decision!), but even in that case, the central bank can only increase the level of base money if it finds a willing commercial bank as a counterparty to a trade. So the "hot-potato effect" is necessarily weaker than in the case of newly found gold deposits. The analogy with gold is not ideal and could be misleading your intuition.

nickik 10y ago

Since this is a old thread now, I will not spend to much time. > Why do you believe that the difference between the developments in the US and Europe is explained by different central bank behavior, when there is also a huge difference in effective fiscal policy behavior that is consistent with the difference in outcome? Because the US had both expansion and contraction in fiscal policy, and growth was not infected. New Keynesian predicted the 'fiscal cliff' in 2013 and monetarist said it would not have any effect. You can also look at some of the smaller similar economies in Europe that are inside and outside of the Euro. Generally the fiscal policy is not that different, but the countries outside of the Euro generally do better if they had expansionary monetary policy. > Can you explain that? http://www.themoneyillusion.com/?p=23314 http://www.themoneyillusion.com/?p=23314

nhaehnle 10y ago
I think we're getting into a region of subtlety where we'd have to actually look at data. I have no idea which countries you're referring to specifically, for example. On the "hot-potato effect", I found this part of the linked article quite funny: > Notice that so far these changes can be fully explained using the basic principles of microeconomics. There is no need to resort to “transmission mechanisms” such as interest rates. Just S&D. Well, how does the author think that the "transmission mechanism" of interest rates is supposed to work? By the basic principles of microeconomics, supply and demand! The price of money is the interest rate. And yes, so far as banks trade financial assets with each other in exchange for reserves, there can be an effect on asset prices. But asset prices are basically an inverse of the interest rate; in particular, when you look at the bond market, long term bond prices are an inverse of long-term interest rates. Indeed, when you look at quantitative easing, it did have the effect of pushing the long-term interest rate even further down, which is equivalent to pushing asset prices up. So yes, the transmission mechanism is the interest rate. The article pretends to disagree with that, but it really doesn't. Instead, it just explains it in more detail, but without being aware of the connection. Of course, there's nothing wrong with explaining things in more detail. There are two points where I believe the article is wrong. The first is a minor point, namely where it says there can be a (direct) effect on output. Since reserves aren't used for transactions in the real economy, that's not possible. The second is quite a bit more important. The article starts its analogy with a scenario where new gold deposits are discovered, i.e. the increase in gold is a purely exogenous event. Base money increases are never purely exogenous events. Of course it might start with a central bank policy decision (although more often than not it starts with a commercial bank decision!), but even in that case, the central bank can only increase the level of base money if it finds a willing commercial bank as a counterparty to a trade. So the "hot-potato effect" is necessarily weaker than in the case of newly found gold deposits. The analogy with gold is not ideal and could be misleading your intuition.