There’s Even Bigger Problems in the Reinhart & Rogoff Thinking….

Much of the discussion surrounding the Reinhart and Rogoff debacle has been focused on the spreadsheet error and the obvious cherry picking within the data.  That’s led many to conclude that their model was suddenly flawed and appears to discredit the research in large part.  This seems like a big “aha” moment for most people in the mainstream media even though many of us (primarily MMTers and Monetary Realists) said that the research was flawed many years ago.   It was clear, from many of the data points, that no clear distinction in types of monetary systems was being made.  For instance, in comparing currency issuing nations with currency using nations the research was hugely flawed from its start.

Since the UMass Amherst paper made waves a few weeks ago Reinhart & Rogoff have responded in a number of different articles.  Their latest is an FT piece which I believe exposes more flaws in their framework.  The part that concerns me is this:

“Unfortunately, ultra-Keynesians are too dismissive of the risk of a rise in real interest rates. No one fully understands why rates have fallen so far so fast, and therefore no one can be sure for how long their current low level will be sustained. John Maynard Keynes himself wrote How to Pay for the War in 1940 precisely because he was not blasé about large deficits – even in support of a cause as noble as a war of survival. Debt is a slow-moving variable that cannot – and in general should not – be brought down too quickly. But interest rates can change rapidly.

Economists simply have little idea how long it will be until rates begin to rise. If one accepts that maybe, just maybe, a significant rise in interest rates in the next decade might be a possibility, then plans for an unlimited open-ended surge in debt should give one pause.”

This reminds me of the Tomas Sargent commercial which goes like this:

Man’s Voice: “Tonight our guest, Thomas Sargent, Nobel Laureate in economics and one of the most cited economists in the world.  Professor Sargent, can you tell us where CD rates will be in two years?

Professor Sargent: “No.”

Woman’s voice: “If he can’t, no one can”.

When that commercial comes on TV I usually jump out of my seat like a 10 year old in class who knows the right answer to something (well, more likely, I am too busy reading a boring paper about finance to notice, but me jumping up and down is a better visual so let’s go with that).   But R&R might be right about one thing – maybe economists really do have “little idea how long it will be until rates begin to rise” because they have no understanding of the market dynamics that drive interest rates. I tried to explain this concept last year:

“long rates are ultimately a function of current economic conditions.  The Fed sets short rates based on expectations of future economic conditions and long rates are an extension of short rates.  In fact, if the Fed wanted to pin the 10 year t-bond at 0% it would just do it, but that’s a different matter.   And bond traders front-run the Fed in trying to outguess the future economic conditions.  So, it’s best to think of this whole relationship like a person walking a dog through traffic.  The Fed walks the bond market around and the bond market tries to steer the Fed by guessing where traffic is headed.  But the Fed can always control the rate and the leash if they want.  The dog ultimately knows this and so doesn’t steer too far from its master (though it doesn’t want to be behind its master!).  So it’s all a delicate guessing game because there’s no telling when the traffic might become faster or slower than we expect.”

Now, we know one thing for certain – the Fed is the monopoly supplier of reserves to the banking system.  If it wants to set the short rate at 0% it simply challenges bond traders to bid against its bottomless pit of bank reserves.  Once they’ve bankrupted enough arrogant bond traders the rest of them tend to get in line with the understanding that you don’t fight the Fed when it wants to set a price in the overnight market.  Theoretically, the Fed could do the same thing across the entire curve of government debt.  Yes, if it wanted to name the price of the 30 year t-bond and set it at, say, 0%, it could.

The government has other options as well with regards to interest rates.  For instance, if the Treasury decided they didn’t want to issue anything over a 5 year note they’d simply stop issuing all longer durations and then you’d have the Fed setting short rates and the structure of the curve would almost perfectly reflect Fed policy.  That’s a slightly different matter, but it shows that interest rates are a much smaller problem for a currency issuing central bank than most people presume.

The point is, R&R’s understanding of the monetary system appears to be largely flawed.  Not only does their original paper include apples and oranges comparisons that render it flawed, but their recent comments prove that they don’t really have a full grasp on the importance of having a politically cohesive central bank and Treasury who act as facilitating currency issuers to the monetary system.

You don’t have to be an “ultra Keynesian” to understand how the monetary system works.  You just have to study the actual operational realities.  Many of us have been beating this drum for years now repeatedly stating why Europe’s monetary system was at risk of bond vigilantes and why the USA’s monetary system wasn’t.  Many of us have been right about many of these big picture concepts while flawed modelling has clearly led some very smart people astray.  In my opinion, understanding the monetary system at its core operational and institutional levels is the key to putting the pieces of this puzzle together.  Why we continue to rely on people with obviously failed models is beyond me….

* Read “Understanding the Modern Monetary System” here.  

Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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Comments

    • There might be a calculation error in the spreadsheet, but the real issues are living within your means, paying your debts, and not borrowing just to finance a lifestyle you otherwise aren’t willing to pay for. The bubble will burst in a few years. The sociopaths who profit from central banker exuberance will prosper. Everyone else will look at 2000 and 2007 as good times.

      • DH, what you’ve just said is one of the most insanely idiotic things I have ever heard. At no point in your rambling, incoherent response were you even close to anything that could be considered a rational thought. Everyone in this room is now dumber for having listened to it. I award you no points, and may God have mercy on your soul.

        • Ah… I don’t agree w/ DH either… and I thought he was over the top w/ that “sociopath” bit… but “insanely idiotic?” … that’s a *little* harsh, don’t you think? Ha!

          • Sociopath might be a little harsh, but not complete inaccurate. The thrust of the paper seemed to state too much public debt is a bad thing. Then a math error came along and cherry picking was alleged. Now, unlimited public borrowing is not only good, but encouraged and some sound ready to let the dogs out now! The borrowing isn’t for infrastructure, it’s not to pay for wars, it’s not to pay for a unexpected catastrophe. It’s just to plug budget holes in normal, everyday consumption. Nobody cares about paying back money. Nobody is concerned about unlimited debt. Bonehead theories abound about how it is justified to borrow in perpetuity with no concerns about repayment. In Europe, the Cyprus solution will be more common since the ECB can’t print money with the same abandon as the Fed and BOJ. Anyone who wants to borrow like that with no worries about consequences is a sociopath.

            • 1st off, “sociopath” was “over the top.” “insanely idiotic” was a little harsh. :)

              R&R here have walked back their alarmism a bit from where it was at while briefing the senate:

              http://delong.typepad.com/sdj/2013/05/is-a-higher-borrowing-trajectory-warranted-or-not.html

              … and which seems clearly based the false knee in the curve their errors caused:

              http://m.static.newsvine.com/servista/imagesizer?file=steve-benen47149E19-49A9-7774-72B7-CA8426521B17.jpg&width=380

              Their tune has changed… no more talk of a tipping-point, or that the senators better act right away before it’s too late! Instead they say:

              “To be clear, no one should be arguing to stabilise debt, much less bring it down, until growth is more solidly entrenched”

              But Cullen is right: they’re STILL conflating users and issuers! A user has *different* budgetary constraints than an issuer. Folksy household budget witticisms don’t apply to the latter. Does that mean they have NO constraints… absolutely NOT! Inflation, for ONE!

              You say the borrowing is “not to pay for infrastructure, … wars, or … unexpected catastrophe.”

              Infrastructure: Who’s fault is that? Sure it might be better to SPEND MORE to build bridges rather than ONLY staff soup kitchens… but try explaining that to congress!
              Wars: In case you didn’t notice we’re STILL at war! (and may be entering some new ones soon!)
              Unexpected catastrophe: Well perhaps it wasn’t unexpected, but what do you call 50% unemployment rates amongst 25 yr olds in Spain? What do you call the rise of the neo-Nazis in Greece? Catastrophic unemployment levels don’t count?

              R&R again bring in Keynes worrying about paying for the War… when employment was 100% for the war effort and demand exceeded supply for almost everything. Very different situation! Perhaps inflation may have been on his mind then you suppose?

              “In Europe, the Cyprus solution will be more common since the ECB can’t print money with the same abandon as the Fed and BOJ. Anyone who wants to borrow like that with no worries about consequences is a sociopath.”

              Not worrying about the wrong thing doesn’t make you a sociopath! You seem to be confusing what the central band does with borrowing. The Market Monetarists would take you to the woodshed on that one! Speaking of which, the Fed seems rather complacent about undershooting it’s inflation target yet again… which is provoking a response from the left and right:

              http://uneasymoney.com/2013/05/02/the-vampire-theory-of-inflation/

              http://www.nytimes.com/2013/05/03/opinion/krugman-not-enough-inflation.html?_r=0

              • A good salesman can come up with a million excuses for unlimited borrowing. They all sound great. There will be no consequences, if you ask them. Only bad results if you don’t. Then, if there are still problems, just borrow some more. Sucker. You’re the poor schmuck, or your kids, who will be left holding the bag. The idea people who got you to go along will be rolling in the dough they talked you into agreeing to pay back for them. I have little use for any economic theory that can’t or won’t wallow around at street level in the real world.

          • Besides, my 5th grade reading teacher comes across, to me, as a sales hustler who specializes in financial products. He’s trying to use distraction and insults to discredit me instead of attacking the ideas. Fools and their money are soon parted and this man is trolling for idiots.

            • You have a lively imagination… what he wrote looks like a generic bunch of insults to me… it could have been a cut and pasted comment from almost any blog on any subject. … which gave me an idea! I cut and pasted it… and sure enough, it’s a movie quote!

              http://www.youtube.com/watch?v=5hfYJsQAhl0

              Well I guess your “teacher” got the better of both of us! Here I was chiding him for being too harsh, and you’d already worked out that he must be a “sales hustler who specializes in financial products!” Hahaha!

          • And central banker exuberance is also an issue. All financial market drops are caused by a lack of liquidity. In times of trouble, cash becomes king, then scarce, then assets are sold for whatever they can bring in. Eventually, the fall bottoms, people get brave again, and cash flows more freely.

            Since QE1, the Fed had played the role of cash provider, not those who would have otherwise provided it. To the good, they stopped a liquidity rout and turned it around. To the bad, they became the provider of first resort and still are. Asset prices world wide in every class are grossly distorted now. People with real money are afraid to lend like before because of these price distortions. It’s easier and safer to trade financial assets because the Fed has everyone’s back now. This will not change if central bankers micromanage economies by valuation of financial assets.

            Janet Yellen is rumored to be a front runner for the job next, and she is rumored to make Bernanke look conservative if she gets the job. Eventually, the central banker induced bubble will burst. It will be ugly.

            • Hmmm… as discussed in the links I provided above, the Fed seems feebly unable (and unwilling) to even get inflation high enough to reach their modest 2% target! Perhaps the Fed is correct in their defense… perhaps they can’t do it alone and congress should act too. Or perhaps Ben is worried because he has to make a trip to Texas:

              http://uneasymoney.com/2013/05/02/the-vampire-theory-of-inflation/#comment-17897

              Either case, disinflation seems like an odd choice given our current circumstances.

              • Please explain / justify / support the case for mispricing financial assets of all types worldwide, possibly in purputuity. Thank you.

                • Well, no one can explain that better than the libertarian free-market loving Milton Friedman acolytes, … the Market Monetarists:

                  http://www.themoneyillusion.com/

                  … if, indeed “mispricing financial assets of all types worldwide, possibly in purputuity [perpetuity]” is actually what’s happening. I’m not convinced that it is, or that QE is how you get there if that’s what you WANT to do (as the MMers advocate… although they wouldn’t describe it quite like that… they’d say they were targeting nominal growth so as to bring back good old conservative values… like Say’s Law… to the market.. essentially eliminating the “money illusion” and restoring the economy to full supply side barter efficiency!)

                • DH,

                  Just so we’re clear – are you claiming that my work doesn’t account for mispricing of assets via QE? Or that it doesn’t account for potential problems from too much govt spending? If so, you’re entirely wrong….Hope I am not jumping to conclusions there.

                  CR

                  • Not at all. You come across as quite aware of the reasons for and consequences of radical monetary theory, even if the proponents of said theory are in charge of running economies. I’m not a great theorist unless the theory can be brought to street level. Otherwise, it’s only an intellectual hobby. Thus, my application of fairly lofty ideas that are cleverly hidden by gut level metaphors and other literary devices. You’re a smart kid. Keep up the good work.

                  • I’m also not a blog fanboy. If I can’t add to the discussion, I won’t waste my time.

              • Extra points…justify the substitution of printed money as opposed to savings for this purpose. Explain why you should add you savings to the printed money asset buying binge of the central banks. Please include in your explanation how the value of the assets you paid for out of savings will change when or if central bank binging ends.

                • If you’re asking me to justify what the Fed has been doing with QE, I don’t think I can! I think the jury is still out about it’s effects… one thing is likely though.. if anything it is less of an effect than many people are giving them credit / blame for. You are aware of the basics of it, right? It doesn’t directly or immediately change anybody’s equity position. It’s an asset swap. Safe reserves for safe T-bonds. I have an example of what it does drawn out here on the various players balance sheets:

                  http://brown-blog-5.blogspot.com/2013/03/banking-example-4-quantitative-easing.html

                  The Fed isn’t giving away free money or buying cars, or food, or stock, or gasoline. And as the MMer’s rightly point out, what it’s doing does NOT add to the debt. It’s trading one safe gov asset for another. The fact that it has an unlimited capacity to do this isn’t really coming into play because they aren’t setting the prices of these assets… they’re setting the quantity they buy (but keep in mind Treasury continues to supply new ones). Do they have an influence on these asset prices and others? Great question! But again, I think to overstate what they’re actually doing (good or bad) just obscures what’s really going on. It’s good to be realistic about it!

                • And if you’re asking me to justify the Fed meeting it’s inflation target, I thought this from David Glasner, in response to someone who was prattling on about how the Eurozone periphery is getting what they have coming to them and that “inflation is theft” was on point:

                  “And would you mind explaining why transferring wealth from creditors by price inflation (actually by inflation greater than expected) is theft, but transferring it from debtors by price deflation (actually by inflation less than expected) is not theft?”

                  http://uneasymoney.com/2013/04/26/mrs-merkel-lives-in-a-world-of-her-own/#comment-17494

                • DH – it is clear you’re a first time visitor to PragCap and haven’t the slightest idea what any of us are talking about. You’re coming up with the same objections that other first time visitors come up with – for example, you think somehow Cullen thinks “unlimited borrowing” is OK. He said nothing of the sort, but as many reactionary first time visitors do, you jump to the most extreme conclusions that you possibly can and thus “prove” that Cullen’s years and years of work on this subject is wrong. Unfortunately you’re completely missing the point. You’re so far off the mark that it’s impossible to know how to get you back on track – so all I’ll say is that you need to come here with an open mind, and not jump to conclusions that no one is suggesting. In addition, you need to understand the difference btwn “inside money” and “outside money” because the biggest flaw in your argument is that Fed “printing” is money that makes it into the real economy. That’s a common misunderstanding – most mainstream economists don’t understand this either, and NONE of the media does – so few in the public possibly could. But here you are – conversing with the few. Have an open mind and you’re going to learn a LOT here.

                  • Dude, adding to the discussion is not picking a fight if you don’t sound like a fanboy. It’s called a ‘discussion’. Ask, don’t assume.

                  • If this is only another fanboy zone, I’m prepared to move along. It otherwise looked like a good place to develop ideas with some smart people.

                    • This isn’t a cult zone or whatever. I try to cultivate an environment of learning and open minded thinking. I don’t pretend to know everything, but I know a fair amount and try to pass on knowledge where I feel as though I can. I also deeply value the readers here who I’ve learned a lot from. It’s a two way street. Some people will defend my work because I think they see the value in its accurate descriptive nature as opposed to some sort of ideological “fanboy” zone.

                    • DH,

                      I think MR is worth following. I came here kicking and screaming about stuff CR was saying especially in his MMT dark days due to his turning left at the intersection. However when he saw the road was heading in the wrong direction he turned back and built himself a new road with the help of some very clever friends.
                      There may be more changes in the road ahead but if there is I expect CR will be the first to realize that something just is not fitting and will pick up the shovel again.
                      Complex systems can’t be fully understood because human behavior won’t fit neatly into a math equation.

                    • “This isn’t a cult zone or whatever” … although late one night I couldn’t resist: a “newbie” showed up looking for answers… obviously somewhat leery of a potential cult environment… I invited him in, directed him to grab a purple robe and a glass of Kool-Aid and told him not to worry: and then I proceeded to ramble to him in an insane way about MR and Cullen… similar to the way Dennis Hopper does about Col. Kurtz in “Apocalypse Now!”

                      Unfortunately I don’t think he got the joke… I think I scared him off for good!

                    • Iluvatar, I didn’t mean you!!! I know you’re a long timer!! … I did make a similar post in response to you… but that was just me being a dick. Sorry about that!

  1. Good piece Cullen. So MR argues that CBs can control the rates on the long bonds by setting short rates and setting expectations. R&R seem to argue indirectly that the size of a nations bond market relative to the size of their economy is consequential to rates; size matters if you like.. I understand that you dismiss their argument because of their flawed understanding of the monetary system, but is there any point where the quantity of an independent currency issuers outstanding bonds relative to GDP could challenge the assumption that CBs control rates and will always lead the dog?

    And one more related follow up question.. Is there any limit, in your opinion, on how much the fed or any other central bank can expand its balance sheet and increase base money supply (outside money) without having severe consequences on financial markets or other unintended consequences? Thanks

    • The CB can’t control the economy so higher inflation could always force the CB’s hand. But that’s not default risk like in Europe. I don’t have a link, but Cullen has explained this more thoroughly in other pieces.

      Also, CB’s implement policy by purchasing existing private sector assets. Mostly government issued assets. So the limit is the outstanding amount of those assets though I guess it could also be expanded beyond government assets.

      • LVG, thanks for the reply. So hypothetically, the fed could expand it´s balance sheet to 15+ trillion by replacing reserves for government bonds, MBS, etc if there is no danger of inflation, right? They would not be creating any new assets in this case. My doubts are under an extreme scenario like this, what implications would it have, if any, on systemic financial stability? I guess this is what the Japanese experiment is all about right?

    • The central bank dictates rates based on expected economic conditions. Traders will generally front-run the Fed’s moves by trying to forecast the economy. But if the Fed wants to set a rate it can even in the face of economic conditions that might dictate otherwise. But the Fed will generally combat inflation by raising rates so it tends to be reactive to some degree.

      LVG has this right. The fed, in theory, could buy anything.

      • With such a low velocity of money and bankers appearing to chase exotic trades over working capital loans and other forms of corporate investment, deflation is all that’s on the horizon … especially if inflation is officially measured as inflation sans inflation. The fed will only react to the economy attempting to go to equilibrium, only that equilibrium will be in a place the fed finds academically inappropriate. This will likely lead to QE forever if they have their way. These are educated,but not smart, people.

  2. And just one more question.. Since credit growth as explained by MR is not restrained by bank reserves, the increase of the “outside money supply” has no implications on credit growth, right? So what are the implications of expanding the outside money from a “pre-crisis” level of less than 1 trillion to the theoretically possible 15+ trillion? I appreciate everybody´s patience. I truly can´t get my hands around this point.

    • I don’t say outside money has no influence on inside money. I say it’s designed to facilitate inside money. So, the Fed can help set rates by intervening through the use of outside money. That influences the price of inside money. So it’s better to think of outside money as facilitating and not just useless.

  3. Is the Fed setting short rates based on expectations of future economic conditions, or is it more concerned with artificially juicing investors’ risk appetites at present? If it’s the latter, it seems likely that it will lose control of things at some point down the road…maybe that’s what R&R are alluding to…

  4. Lots of ‘ifs’ there. ‘If the Fed wanted to pin the 10-year T-rate at 0′ and ‘if the Treasury decided they didn’t want to issue anything over a 5 year note …’
    These are things that haven’t been done, to my knowledge. Those are things that would have unknown consequences and change the system. Is this Modern Monetary THEORY or Realism?
    Oh, and do we know where interest rates will be in 10 years? No, we don’t. But we know that if they go back to 5 or 6 percent, the interest payments will take up all of tax receipts, or the Fed will keep rates at 0 (with unknown consequences) or we will be monetizing debt (the true end game and goal of those advocating deficit spending.)

    • You’re really reaching there. There’s a big difference between something like MMT (which requires changes to the actual legal and institutional structure of the money system) and saying that there are policy options currently available. It’s as if I’ve said Congress could cut taxes and you’re suddenly accusing me of deviating outside of MR’s basic insights. That’s just silly because MR doesn’t say anything about policy. It gives us a framework for understanding the world. There are lots of policy options outside of the realm of MR and you seem to keep claiming that these policy options are somehow embedded components of some ideology….As I’ve told you a million times – policy options are outside of the realm of MR’s core understandings.

      • If the Fed has to directly buy bonds in order to keep rates at zero, that would require changes in the structure of the money system.
        We’re being maneuvered into a situation in which monetizing debt will be the only way to keep rates at zero.
        PS: Even if we understand MR, We are perfectly free to understand the Fed CAN do something but to argue that it should not.

        • MR just gives you the framework for understanding. In the current environment we know that paying IOR is enough to keep rates where the Fed desires. I don’t think you’re quite picking up on all the underlying understandings? Or I haven’t explained them all that well to you….

          • “In the current environment we know that paying IOR is enough to keep rates where the Fed desires.”

            The reason being that there’s excess reserves (ER), correct? ER means the overnight rate IS the IOR rate. To maintain this, the Fed just has to make sure there’s ER. It doesn’t have to necessarily keep buying bonds to do that… only when ER gets close to zero does it need to buy, correct?

            Now how does the Fed set the 30 year rate to zero? You say by setting the price… so you mean it literally selects a price it will pay for 30 yr T-bonds (which corresponds to a 0% rate?), and now the market rate becomes that rate, correct? That price would be higher than the current market price I presume.

            Just out of curiosity, what would the yield curve look like if it did that? (Say they keep IOR and ER like it is as well). Would it bow upwards then?… with 10 yr T-bonds having a high rate, and dropping off on either side say?

            So then could the Fed actually completely control the entire yield curve then? Selecting prices for each maturity and then conducting open ended purchases at those prices?

            • Right. So, the excess reserves put downward pressure on the FFR. So the Fed is pushing the FFR up by paying IOR. If we didn’t have the excess reserves the fed would set the FFR as they always do which is primarily via communication and minor maintenance.

            • “So then could the Fed actually completely control the entire yield curve then? Selecting prices for each maturity and then conducting open ended purchases at those prices?”

              The answer (yes) is available via study of the activities of the Fed’s daily Securities Lending OMO, the most “invisible” of all Fed activities.

          • My comment got stuck in the spam filter I think… but my question was: Can the Fed control the entire yield curve? Would it do that by selecting a price it will pay (corresponding to the interest rate it wants) at each maturity and then making open ended purchases of T-bonds at those prices?

                  • Ah, Ok!… but to my point, the Fed could control the interest rate at each maturity by just setting the price it pays for each maturity bond and then conducting open ended purchases of bonds at those maturities in the market?

                    • Right. The Fed can essentially challenge anyone in any market if it wants. Bond traders won’t fight the Fed on a price because they’re the reserve monopolist. No one can compete with the Fed. Although the Fed is driven by economic expectations so the economy could force the Fed’s hand. High inflation is a very dangerous problem to have so central bankers try to get in front of it, so it’s important to keep the whole dance in context. The Fed can control the curve, but it can’t necessarily control the economy and the economy ultimately dictates Fed policy….

        • Agree JE. The Fed is manufacturing their own Hobsen’s choice. Buy down rates in perpetuity because making the UST pay its way will cause federal expenditures to be too high or allow rates to rise and see the economy crumble because bankers are now addicted to trading over lending. Plus, rising US rates will cause European rates to rise in order to maintain a credit quality spread. There will be another euro crisis. There is no good ending.

  5. Cullen

    Since I’ve been following PC blog and read your papers I have a fuller understanding of ‘monetary realism’ – and continue to be surprised at how many really smart, successful people in the financial/economic world who make high conviction misstatements.

    As for my question – if the fed is walking the dog thhrough traffic as you say, what is guiding the fed? The economy, right? So In our ‘new normal’ world do you think we are in a 2 percent growth range +/- with static employment growth — for some time??. And basically more of the same monetary conditions for next several years??

    (What I am implying in my question is, will the Feds efforts (aka inside and outside money) make any true economic impact? Some say very little– all about fiscal stimulus not monetary stimulus.

    Thoughts?

    • I wouldn’t say the Fed is having no impact. But I think it’s doing less than most people think. In my opinion, the big driver of economic growth in recent years has been the budget deficit. We had a big debt bubble, balance sheets collapsed, the govt was able to provide net financial assets to improve balance sheets, the Fed was able to support the banking system and reduce burdens on debtors, and the pvt sector has slowly healed as a result.

      • Well Scott Sumner sure seems to be doing a victory lap of sorts this morning after the April jobs numbers and revisions to previous month’s numbers came out today:

        http://www.themoneyillusion.com/?p=21021

        He’s basically saying “In your face Keynesians! This year is better than last even WITH austerity! You know why? Because of the Fed’s ‘monetary offset’ of course!”

        Well it’s good to know that part of economics has been solved, and we can all move on now. Ha! :)

        • Could it be, precisely as I predicted using S=I+(S-I) that private investment would pick up the slack increasingly as the de-leveraging peeled off? Could it be that fiscal policy has played an increasingly smaller role in the economic recovery as the private sector balance sheet has healed and that the recovery is increasingly organic and not govt driven?

          Of course monetary policy has helped to some degree, but he’s acting as if the Fed just fixed everything and as though there’s no organic private sector growth at all. It’s almost a statist view of the world as if the Fed has generated a command economy and we should all bow at their altar….Ridiculous if you ask me. You didn’t need to understand NGDP targeting to understand the current economic environment.

      • I agree that the effect of QE is less than many (most) think. Although if you read what the Fed has published of the minutes, most of the Fed open market committee holds a similar view. And I agree the US benefitted from the budget deficit compared with the Euro zone which went to austerity much sooner.

  6. “long rates are ultimately a function of current economic conditions. ”

    I am not sure I agree with this statement. The long term cycles in the long-term rates (the current one started in 1982) have been relatively insensitive to the economic cycles through all these decades. There are clearly other elements, like inflation, monetary and fiscal policy, that play a role here.