Blog Post

Blogs review: Takeaways from Jackson Hole

Although Jackson Hole was relatively calmer this year in the absence of market moving speeches, it featured a number of provocative research papers. Robert Hall suggested that the tradition of regarding high unemployment as a disequilibrium may rest on a misunderstanding.

By: Date: August 25, 2014 Topic: Global economy and trade

What’s at stake: Although Jackson Hole was relatively calmer this year in the absence of market moving speeches, it featured a number of provocative research papers. Robert Hall suggested that the tradition of regarding high unemployment as a disequilibrium may rest on a misunderstanding. Arvind Krishnamurthy argued that the portfolio balance channel of QE works largely through narrow channels contrary to what the Fed thinks. And Helene Rey argued that the global financial cycle transforms the monetary policy trilemma into a “dilemma”. In this review, I focus on the first two contributions.

Financial crises, higher discount factor and higher equilibrium unemployment

Robert Hall writes that the tradition of regarding high unemployment as a disequilibrium that gradually rectifies itself by price-wage adjustment may rest on a misunderstanding of the mechanism of high unemployment.

Robin Harding writes that the meat of Hall’s paper is about why inflation did not fall much after the crisis despite high levels of unemployment. This has been a surprise during the last few years: unemployment has not driven down wages in a way that led to deflation. The standard explanation is that yes, all that slack in the economy should have led to falling prices, but workers will not let wages fall and inflation is anchored to central bank targets.

Robin Harding writes that what Hall proposes is that the financial crisis did not just affect demand in the economy but also directly affected supply. Thus high unemployment was not a disequilibrium, where the economy’s supply capacity was much greater than demand, but actually an equilibrium because supply temporarily took a hit as well. This rests on a model where hiring a worker is like an investment decision: it depends on all the revenue that a worker will produce in the future, relative to their wages, discounted back to the present day.

Robert Hall considers a source of fluctuations in the job value that has been implicit in the Diamond-Mortensen-Pissarides model from the outset, but has escaped attention. The job value is the present discounted value of the future difference between a worker’s productivity and the worker’s pay. Even if that difference is unaffected by a negative shock, if an increase in discount rates accompanies the shock, the job value will decline and unemployment will rise accordingly.

Source: Robert Hall

Robert Hall writes that the evidence that the job value moves along with the stock market has two implications for output in the post-crisis economy and in other contractions. First, events that trigger a rise in financial discounts, such as a financial crisis, will lower job values substantially, causing a corresponding increase in unemployment and decline in output. In other words, there is a direct linkage from financial disturbances to unemployment, not just a response operating through a decline in the demand for output. A financial crisis has a direct adverse effect on output supply through the discount channel. Second, other forces connected to a financial crisis, such as a decline in real-estate prices, cause declines in output demand. The zero lower bound may block a decline in the discount rate that would have had a favorable effect on the job value and thus cut unemployment and increased product supply.

Paul Krugman writes that Bob Hall’s paper for Jackson Hole is, characteristically for Hall, a mix of very sensible stuff and strange-looking stuff that just might involve a deep insight. Hall used to be famous at MIT for talks along the lines of “Not many people understand this, but the IS curve actually slopes up and the LM curve slopes down” — and then, not most of the time but often enough, his apparent craziness would turn out to be a big insight that changed the way you thought about a major issue.

Market segmentation, limits to arbitrage and Wallace Neutrality

Cardiff Garcia notes that in a previous paper Arvind Krishnamurthy and Annette Vissing-Jorgen recommended that the Fed continue buying MBS while actually selling longer-term Treasuries. (This would have been like a tweaked version of the Fed’s earlier Operation Twist). In this new paper, they again emphasize the superior potency of MBS purchases vs. Treasury buying, this time stressing how they incentivize banks to originate new mortgage loans. Neil Irwin notes that the with Treasury bonds is that they fulfill a unique role at the bedrock of the financial system, allowing investors an ultra-safe place to park money that can be readily used as collateral. When the Fed buys up a big chunk of Treasury bonds, fewer other investors can enjoy that benefit. That would be fine if those investors could just shift into near-substitutes, like highly rated corporate bonds, which could lower borrowing costs for big companies and thus encourage them to invest. But the problem is that there aren’t that many AAA-rated companies, so those benefits have not percolated through the economy to the degree one might hope.

Neil Irwin writes that there is an irony here. If this analysis is right, the economic benefits of QE come from MBS purchases, not Treasuries. Yet the Fed itself prefers not to be in the role of favoring one sector (housing) over others, and so many officials there lean toward focusing heavily, or even only, on the less-effective Treasury bond market.

Arvind Krishnamurthy writes that there exists theoretically a role for LSAPs on Treasury and mortgage yields even after stripping out signaling effects. For example, in the context of mortgage-backed securities (MBS), consider a setting in which a certain set of sophisticated investors (banks, dealers, asset managers) are the only investors in the MBS market (i.e., it is costly for new investors to enter the market) and these investors have limited access to capital, so that there are limits to arbitrage. This is an environment in which MBS yields will be inflated relative to an Arrow-Debreu complete markets benchmark in which MBS risks are broadly diversified across all savers. If capital constraints are slack, there will be no effects of an MBS purchase on prices. The economy then resembles the frictionless economy of Woodford (2012) where LSAPs have no effects on asset prices. On the other hand, if capital is scarce, as was likely in 2008/2009, there will be effects on prices.

Arvind Krishnamurthy writes that asset purchases can have effects precisely because the asset is traded in a narrow and segmented market. Nevertheless, spillovers may arise in this channel. First, to the extent that the LSAP strengthens intermediaries’ balance sheets and relaxes capital constraints, other assets that are traded in a segmented market and concentrated in the portfolios of the MBS specialized investors will also rise in price. Second, there is a possible macroeconomic spillover. If the affected assets are central to economic activity, then the policy may have significant macroeconomic effects and this indirectly spills over to other asset prices.

Arvind Krishnamurthy writes that the portfolio balance channel of QE works largely through narrow channels that affect the prices of purchased assets, with spillovers depending on particulars of the assets and economic conditions. It does not, as the Fed proposes, work through broad channels such as affecting the term premium on all long-term bonds.

Pedro da Costa and Alister Bull report that James Bullard, president of the St. Louis Fed, said Krishnamurthy’s focus on market impact immediately following policy announcements was misleading. "I just wanted to push back against this conclusion that you get an effect in one single market and then there’s not that much (impact) over a variety of assets," Bullard said. Donald Kohn, a former Fed vice chair, was also skeptical saying that "the findings do not comport very well with the experience of the last couple of months".


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read article More by this author
 

Blog Post

It’s hard to live in the city: Berlin’s rent freeze and the economics of rent control

A proposal in Berlin to ban increases in rent for the next five years sparked intense debate in Germany. Similar policies to the Mietendeckel are currently being discussed in London and NYC. All three proposals reflect and raise similar concerns – the increase in per-capita incomes is not keeping pace with increases in rents, but will a cap do more harm than good? We review recent views on the matter.

By: Inês Goncalves Raposo Topic: Macroeconomic policy Date: July 8, 2019
Read article More on this topic
 

Blog Post

The breakdown of the covered interest rate parity condition

A textbook condition of international finance breaks down. Economic research identifies the interplay between divergent monetary policies and new financial regulation as the source of the puzzle, and generates concerns about unintended consequences for financing conditions and financial stability.

By: Konstantinos Efstathiou and Bruegel Topic: Banking and capital markets Date: July 1, 2019
Read article More on this topic
 

Blog Post

The June Eurogroup meeting: Reflections on BICC

The Eurogroup met on June 13th to discuss the deepening of the economic and monetary union (EMU) and prepare the discussions for the Euro Summit. From the meeting came two main deliverables: an agreement over a budgetary instrument for competitiveness and convergence and the reform of the European Stability Mechanism (ESM) treaty texts. We review economists’ first impressions.

By: Bruegel and Inês Goncalves Raposo Topic: Macroeconomic policy Date: June 24, 2019
Read article More on this topic
 

Blog Post

The campaign against ‘nonsense’ output gaps

A campaign against “nonsense” consensus output gaps has been launched on social media. It has triggered responses focusing on the implications of output gaps for fiscal policy under EU rules, especially for Italy. But the debate about the reliability of output-gap estimates is more wide-ranging.

By: Konstantinos Efstathiou and Bruegel Topic: Macroeconomic policy Date: June 17, 2019
Read article More on this topic
 

Blog Post

The inverted yield curve

Longer-term yields falling below shorter-term yields have historically preceded recessions. Last week, the US 10-year yield was 21 basis points below the 3-month yield, a feat last seen during the summer of 2007. Is the current yield curve a trustworthy barometer for future growth?

By: Inês Goncalves Raposo and Bruegel Topic: Global economy and trade Date: June 11, 2019
Read article More on this topic
 

Blog Post

The 'seven' ceiling: China's yuan in trade talks

Investors and the public have been looking at the renminbi with caution after the Trump administration threatened to increase duties on countries that intervene in the markets to devalue/undervalue their currency relative to the dollar. The fear is that China could weaponise its currency following the further increase in tariffs imposed by the United States in early May. What is the likelihood of this happening and what would be the consequences for the existing tensions with the United States, as well as for the global economy?

By: Inês Goncalves Raposo and Bruegel Topic: Global economy and trade Date: June 3, 2019
Read article More on this topic
 

Blog Post

The next ECB president

On May 28th, EU heads of state and government will start the nomination process for the next ECB president. Leaving names of possible candidates aside, this review tries to isolate the arguments about what qualifications the new president should have and what challenges he or she is likely to face.

By: Bruegel and Konstantinos Efstathiou Topic: Macroeconomic policy Date: May 27, 2019
Read article More on this topic More by this author
 

Blog Post

The latest European growth-rate estimates

The quarterly growth rate of the euro area in Q1 2019 was 0.4% (1.5% annualized), considerably higher than the low growth rates of the previous two quarters. This blog reviews the reaction to the release of these numbers and the discussion they have triggered about the euro area’s economic challenges.

By: Konstantinos Efstathiou Topic: Macroeconomic policy Date: May 20, 2019
Read article More by this author
 

Blog Post

Is an electric car a cleaner car?

An article published by the Ifo Institute in Germany compares the carbon footprint of a battery-electric car to that of a diesel car, and argues a higher share of electric cars will not contribute to reducing German carbon dioxide emissions. Respondents rejected the authors’ calculations as unrealistic and biased, and pointed to a series of studies that conclude the opposite. We summarise the article and responses to it.

By: Michael Baltensperger Topic: Digital economy and innovation, Green economy Date: May 13, 2019
Read article More on this topic More by this author
 

Blog Post

All eyes on the Fed

Last week the US Federal Reserve left the federal funds rate unchanged and lowered the interest rate on excess reserves. We review economists’ recent views on the monetary policy conduct and priorities of the United States’ central bank system.

By: Inês Goncalves Raposo Topic: Global economy and trade Date: May 6, 2019
Read article More on this topic More by this author
 

Blog Post

Is this blog post legal (under new EU copyright law)?

How new EU rules on using snippets from news publishers and on copyright infringement liability might affect circulation of information, revenue distribution, market power and EU business competitiveness.

By: Catarina Midões Topic: Macroeconomic policy Date: April 8, 2019
Read article More on this topic
 

Blog Post

Secular stagnation and the future of economic stabilisation

Larry Summers’ and Łukasz Rachel’s most recent study documents a secular fall in neutral real rates in advanced economies. According to the authors, this fall would be even more marked in the absence of offsetting fiscal policies. Policymaking in a world of permanently low interest rates may be hard to navigate, especially in troubled waters. We review economists’ views on the matter

By: Inês Goncalves Raposo and Bruegel Topic: Macroeconomic policy Date: April 1, 2019
Load more posts