MONETARY EQUILIBRIUM AND NOMINAL INCOME TARGETING

NICOLAS CACHANOSKYAssociate Professor

Department of Economicsncachano@msudenver.edu

OUTLINE

• Why the book?

• Book structure

• Lessons from free banking cases

• NGDP Targeting rule

• The 2008 Crisis

• Monetary reforms

2

WHY THE BOOK?

3

WHY THE BOOK?

• 2008 Crisis

– Price level stability suffered a major empirical disconfirmation (again)

– Renewed interest in nominal income targeting

– First book on the subject

• Put together a more comprehensive presentation on nominal income targeting

• How does it fit with the rest of the literature

4

WHY THE BOOK?

• Table of contents1. Free banking and monetary equilibrium

2. Nominal income targeting and the productivity norm

3. Nominal income targeting and monetary rules

4. Nominal income targeting and monetary disequilibrium

5. Nominal income targeting as market outcome versus policy outcome

6. The 2008 financial crisis

7. Monetary reforms towards nominal income targeting

5

LESSONS FROM FREE BANKING CASES

6

LESSONS FROM FREE BANKING CASES

• A free market in money and banking is endogenously stable

– Equilibrium: Nominal income stable per capita

• Some arguments against free banking

– U.S. “free banking” period

– Great Depression in the U.S. vs Canada

– Diamond-Dyvbig Model

7

NGDP TARGETING RULE

8

NGDP TARGETING RULE

• 𝑀𝑉 = ณ𝑃↓

ณ𝑌↑

: Productivity Norm

▪ 𝑌 = 𝐴 ∙ 𝐹(𝐾; 𝑒𝐿)

• ณ𝑀↑

ณ𝑉↓

= 𝑃𝑌: Monetary rule

9

NGDP TARGETING RULE

• Productivity shock with NGDP Targeting

10

𝐴𝐷 = 𝑀𝑉 = ณ𝑃↓

ณ𝑌↑

= 𝑁𝐺𝐷𝑃 = 𝐶 + 𝐼 + 𝐺 + 𝑁𝑋

LRAS

𝑃0

P

Y

LRAS’

𝑃1

Good deflation

𝑌0 𝑌1

NGDP TARGETING RULE

• Productivity shock with price level stability

11

𝐴𝐷 = ณ𝑀↑

ത𝑉 = ത𝑃 ณ𝑌↑

= 𝑁𝐺𝐷𝑃 = 𝐶 + 𝐼 + 𝐺 + 𝑁𝑋

LRAS

𝑃0

P

Y

LRAS’

𝑃1

Implied inflation

𝑌0 𝑌1

NGDP TARGETING RULE

• Where is the excess of money supply going?– To offset a fall in the price level

– Increase of prices not captured in price level indices (CPI, GDP deflator, etc.)• Stock prices (Great Depression)

• Housing prices (Great Recession)

• Imports (trade deficit)

• The main difference of a nominal income targeting rule is not what to do if AD falls, but what to do if there is a AS shock

12

THE 2008 CRISIS

13

THE 2008 CRISIS

• What happened? Short story

– Before the crash

– During and after the crash

14

THE 2008 CRISIS

• 2001: Dot-com bubble and 9/11

– Federal Reserve lowers interest rates

– Regulatory framework channels credit expansion towards the housing market

• 1993: DHUD starts legal actions against banks

• 1996: Regulators are allowed to penalize banks with low CRA ratings

• 2000: DHUD requires larger allocation of mortgages to high-risk clients

15

THE 2008 CRISIS

• Mortgage rates– Fixed rate

– ARM• Affected by the Federal funds rate

– New mortgages were issued with ARM rates

– Existing fixed rate mortgages were transformed into ARM mortgages

• Implicit bailout through Fannie Mac and Freddie Mae

16

17

0

1

2

3

4

5

6

7

8

9

10

11

121

99

0-0

11

99

0-0

71

99

1-0

11

99

1-0

71

99

2-0

11

99

2-0

71

99

3-0

11

99

3-0

71

99

4-0

11

99

4-0

71

99

5-0

11

99

5-0

71

99

6-0

11

99

6-0

71

99

7-0

11

99

7-0

71

99

8-0

11

99

8-0

71

99

9-0

11

99

9-0

72

00

0-0

12

00

0-0

72

00

1-0

12

00

1-0

72

00

2-0

12

00

2-0

72

00

3-0

12

00

3-0

72

00

4-0

12

00

4-0

72

00

5-0

12

00

5-0

72

00

6-0

12

00

6-0

72

00

7-0

12

00

7-0

72

00

8-0

12

00

8-0

72

00

9-0

12

00

9-0

72

01

0-0

12

01

0-0

72

01

1-0

12

01

1-0

72

01

2-0

12

01

2-0

72

01

3-0

12

01

3-0

72

01

4-0

12

01

4-0

7

1-year ARM 30-years fixed rate mortgage (% of disposable income)

NGDP TARGETING RULE

18

19

0

5,000

10,000

15,000

20,000

25,000

19

90

Q1

19

90

Q4

19

91

Q3

19

92

Q2

19

93

Q1

19

93

Q4

19

94

Q3

19

95

Q2

19

96

Q1

19

96

Q4

19

97

Q3

19

98

Q2

19

99

Q1

19

99

Q4

20

00

Q3

20

01

Q2

20

02

Q1

20

02

Q4

20

03

Q3

20

04

Q2

20

05

Q1

20

05

Q4

20

06

Q3

20

07

Q2

20

08

Q1

20

08

Q4

20

09

Q3

20

10

Q2

20

11

Q1

20

11

Q4

20

12

Q3

20

13

Q2

20

14

Q1

20

14

Q4

20

15

Q3

20

16

Q2

NGDP Hypothethical NGDP

20

0

20

40

60

80

100

120

140

160

1801

98

5-0

1

19

85

-12

19

86

-11

19

87

-10

19

88

-09

19

89

-08

19

90

-07

19

91

-06

19

92

-05

19

93

-04

19

94

-03

19

95

-02

19

96

-01

19

96

-12

19

97

-11

19

98

-10

19

99

-09

20

00

-08

20

01

-07

20

02

-06

20

03

-05

20

04

-04

20

05

-03

20

06

-02

20

07

-01

20

07

-12

20

08

-11

20

09

-10

20

10

-09

20

11

-08

20

12

-07

20

13

-06

20

14

-05

20

15

-04

20

16

-03

CPI PPI

THE 2008 CRISIS

• Bailouts

– Too big too fail doctrine (TBTF)

– Keep chain of payments from collapsing

• Change in monetary policy framework

– Bailout (QEs) where so large that monetary policy “fall out” of the downward slope zone of the federal funds market

– Start paying interest on excess reserves (IOER)

21

THE 2008 CRISIS

• The corridor system

22

𝑖

𝑖𝐷

𝑖𝐼𝑂𝐸𝑅D

q($)

𝑖𝐹𝐹

Conventional monetary policy(pre-2008)

Goes to excess reserves

S S’ S’’

23

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

3,500,000

4,000,000

4,500,000

5,000,000

Jan

-03

Jul-

03

Jan

-04

Jul-

04

Jan

-05

Jul-

05

Jan

-06

Jul-

06

Jan

-07

Jul-

07

Jan

-08

Jul-

08

Jan

-09

Jul-

09

Jan

-10

Jul-

10

Jan

-11

Jul-

11

Jan

-12

Jul-

12

Jan

-13

Jul-

13

Jan

-14

Jul-

14

Jan

-15

Jul-

15

Jan

-16

Jul-

16

Jan

-17

Jul-

17

Jan

-18

FEDERAL RESERVE, ASSETS(MILLIONS)

Gold + SDR + Coins US Treasury Securities MBS Other securities Maiden Lane LLC Central Banks Swaps Others

NICOLAS CACHANOSKYMETROPOLITAN STATE UNIVERSITY OT DENVER | DEPARTMENT OF ECONOMICSAMERICAN INSTITUTE OF ECONOMIC RESEARCH | SOUND MONEY PROJECT FELLOWncachano@msudenver.edu | www.ncachanosky.comSource: Board of Governors of the Federal Reserve System. Factors Affecting Reserve Balances (H.4.1)qe1

QE1 QE2 QE3OP. TWIST

ALAN GREENSPAN BEN BERNANKE JANET YELLEN

24

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

3,500,000

4,000,000

4,500,000

5,000,000

Jan

-03

Jul-

03

Jan

-04

Jul-

04

Jan

-05

Jul-

05

Jan

-06

Jul-

06

Jan

-07

Jul-

07

Jan

-08

Jul-

08

Jan

-09

Jul-

09

Jan

-10

Jul-

10

Jan

-11

Jul-

11

Jan

-12

Jul-

12

Jan

-13

Jul-

13

Jan

-14

Jul-

14

Jan

-15

Jul-

15

Jan

-16

Jul-

16

Jan

-17

Jul-

17

Jan

-18

FEDERAL RESERVE, LIABILITES(MILLIONS)

Federal Reserve Notes REPOs Deposits Deferred availability Other and accrued dividiends

NICOLAS CACHANOSKYMETROPOLITAN STATE UNIVERSITY OT DENVER | DEPARTMENT OF ECONOMICSAMERICAN INSTITUTE OF ECONOMIC RESEARCH | SOUND MONEY PROJECT FELLOWncachano@msudenver.edu | www.ncachanosky.comSource: Board of Governors of the Federal Reserve System. Factors Affecting Reserve Balances (H.4.1)

QE1 QE2 QE3OP. TWIST

ALAN GREENSPAN BEN BERNANKE JANET YELLEN

MONETARY REFORMS

25

MONETARY REFORMS

• Free banking with U.S. dollar as base money

• Hayek’s currency competition

• NGDP Futures market

26

NICOLAS CACHANOSKY

• Thank you

ASSOCIATE PROFESSOR

DEPARTMENT OF ECONOMICS

METROPOLITAN STATE UNIVERSITY OF DENVER

NCACHANO@MSUDENVER.EDU

WWW.NCACHANOSKY.COM

27