What Triffin dilemma?!

Time and again you read these days many a commentator arguing that the recent global imbalances have been the inevitable corollary of the dollar’s role as a reserve currency.

It’s the Triffin dilemma, they say, after economist Robert Triffin, who, back in the 1960s, maintained that the country issuing the global reserve currency must be willing to run trade deficits, in order to supply the world with enough of its currency to meet the global demand for reserves. The “dilemma” arises from the fact that, the more dollars, say, are supplied to the world through US trade deficits, the more the value of the dollar is undermined, threatening its role as a reserve currency.

So, as it happens, I disagree both with Triffin (notwithstanding his Yale credentials)… as well as with the premise that it’s that very dilemma that has led to the global imbalances we still see today. Here is why…

First, probably a lesser point but, as a matter of principle, the supplier of the reserve currency (let’s call it United States) doesn’t have to run trade deficits. Countries wishing to accumulate FX reserves can do so by accumulating foreign liabilities. China’s central bank, for example, can buy the dollars entering China through foreign direct investment, and invest these in US Treasuries. Alternatively, countries can borrow dollars long-term from the official sector or even the private sector, and keep them invested in Treasuries in case there is a crisis.

Understandably, the latter (ie borrowing) option is anathema to most countries, due to the implicit or explicit conditions attached to these loans. Similarly, countries may need to hold more precautionary reserves than the foreign currency entering their market in the form of more stable, long-term liabilities such as FDI. So what’s the alternative?

It’s what some emerging markets have been doing in recent years: Namely, accumulating reserves partly through running trade surpluses. But is that sufficient to undermine the value of the US dollar? Not necessarily.

The presumption that it “should” rests on the concept of external debt sustainability—i.e. the fact that a country cannot accumulate liabilities for ever. Countries that do, usually end up with their currencies depreciated, which helps correct the external imbalances through valuation effects on their external balance sheet. But here are a few caveats for the case at hand:

First, if it’s precautionary reserves that we’re talking about, emerging markets reaching the desired/”optimal” level of reserves would stop accumulating further dollars (beyond an annual “maintenance” amount proportional to the capital and trade flows into the country).

Second, even if the stock of (precautionary) reserves is large, this doesn’t mean that there are “too many” dollars floating around. Countries demand reserves for insurance purposes—i.e. the stock of dollar reserves is not used to splurge in European luxury goods or Brazilian bikinis, which could lead to the dollar’s depreciation. Instead, dollar reserves are saved (e.g. invested in Treasuries) and are ready to be employed if there is a sudden stop in capital inflows.

Even (even) if the dollar depreciated somewhat, that wouldn’t matter anyway—again, if it’s precautionary reserves we’re talking about; and if the bulk of a country’s external obligations (e.g. imports or debt payments) are also denominated in dollars. In other words, even if the dollar were to depreciate, this should not undermine its role as a reserve currency.

So done with the Triffin dilemma?

Not yet... we still we need to answer the question… has the dollar's status as reserve currency encouraged the circulation of “too many” dollars around the world? And if yes, was that inevitable, as per Dr Triffin?

To see if there are “too many” dollars on would need to check whether (a) the foreign private sector is flushed with more dollars than it wants or needs; (b) the foreign official sector (i.e. governments) hold excess reserves (ie reserves that would eventually be spent on goods and services). So what has been the situation in recent years?

Abstracting here from the post-crisis period, and the Fed’s massive dollar-supply operation, (a) does not seem to have been the case in recent years. Looking at the US international investment position, the net amount of dollars in private foreign hands (i.e. the US net liabilities to the foreign private sector) had actually been declining in US GDP terms since 2002 (and more so in global GDP terms, which is more relevant).

What have ballooned instead are America’s net liabilities to the foreign official sector. And provided that some of these reserves are “excess”, yes, there are “too many” dollars floating around.

But surely that’s not the result of a Triffin dilemma and the dollar’s role as reserve currency. That’s the outcome of another (well-known) dilemma altogether: The growth-model dilemma of some emerging markets (and their fixation with exports).

I shouldn't let the US completely off the hook here... Countries do not accumulate any types of foreign assets as reserves. Instead, they prefer assets that are safe, with deep and liquid markets. And the US for decades has offered the perfect product for FX reserves, namely US Treasuries (unlike the eurozone, where debt markets are liquid but fragmented due to the different creditworthiness of each eurozone member).

In this sense, the return of the US fiscal deficits post-2002 (and associated rise in the supply of Treasuries) facilitated reserve accumulation. And so did the (not-so-implicit) guarantee on the GSEs, which offered a tremendous pool of spready products with the kind of government backing that FX reserve managers love. But still, that should not divert attention from the fact that these assets were accumulated as a result of policy intent.

So where do we go from here? Well, first of all, China’s ongoing accumulation of Treasuries is only delaying the inevitable down the line. Second, its slow asset shifting from dollar to non-dollar assets (e.g. using its dollars to acquire companies in the resource sector in Africa, etc) is not really a sustainable solution: At some point, you begin to irritate the recipients of these flows, as their currencies appreciate vs. the dollar (and the renminbi for that matter), hurting exports and encouraging voices of protectionism.

Ultimately, part of the solution rests on what has become the consensus call by Western policymakers and academics alike: A conscious decision by China to replace its fake Prada bags for the real deal!

The State of Monetary

Back in August 2008, Olivier Blanchard, an undisputed “tsar” of macroeconomics, professor at MIT and currently Director of Research at the IMF, was asked to write a paper on the future of macro for the first volume of a new journal, the Annual Review of Economics.

“The state of macro is good”, he concluded--in a phrase that has since become a favorite source of laughter (or sarcasm) for many a theorist and practitioner in the field, given what happened only a month later (/1):

The near-death of the global economy, the discrediting of macroeconomists for failing to see it coming, and the eruption of internecine debates among them, so partisan in nature that made a mockery out of economics as a social “science.” The state of macro was… in disarray!

So a year later, Donald Kohn, vice-chairman at the Federal Reserve Board, knew better. At a speech last Friday for the launch of the third volume of the Handbook of Monetary Economics, Kohn humbly avoided any definitive statements on “the state of monetary”.

Rather, he talked about the strands of monetary theory that helped guide the Fed’s efforts to rescue the global economy; and the gaps in the literature that need to be addressed to make monetary policy more effective.

The state of monetary may be in flux, he might have concluded… but hail to our theorists who, over the years, have built a valuable body of literature to guide our decisions, even when the worst of stuff hits the fan.

Hard to disagree... But here is where I see the problem: Not with monetary theory itself, which, for all its limitations, is the best we have… but with the theory’s execution.

Basically, despite its success in resurrecting the financial system, the Fed made a number of fundamental misjudgments during (and even before) the crisis that had little to do with the failings of theory to capture *the* truth.

Instead, they were the result of institutional constraints, naïve neglect, or a sclerotic adherence to theoretical models, the limitations of which were spectacularly ignored.

Let me begin.

The first blunder was the failure to accept early on that the crisis was one of insolvency rather than illiquidity. OK, maybe, there is a blurry line between the two concepts, which can become even blurrier when a liquidity crisis transforms itself, like a self-fulfilling prophecy, into an insolvency crisis. Maybe the authorities’ understanding of systemic risks was compromised by the explosion of securitization and its ostensibly efficient distribution of risk across a wide gamut of investors. Maybe I have the benefit of hindsight here.. Maybe.. but…

…The policy debate never really went in that direction, until it was too late.. The Fed effectively turned a blind eye to sources of insolvency in the system, going about with its ample liquidity provision, thus postponing an inevitable crisis to a later date. And that movie went on even after the failure of an institution as big as Bear Stearns.

True, the Fed did not have regulatory authority over many of the financial institutions that almost went under in the Fall of 2008. True, the issue of insolvency should be addressed by the fiscal authority (aka US Treasury), not the Fed. But why was the issue ever ignored by either institution? Why did it take a ginormous crisis and one full year later for banks to be forced to raise capital?

In this sense, Kohn’s reference to Bagehot’s writings as the Fed’s guide in fighting the Panic of 2008 is all but ironic. Rather than “lend[ing] early and freely to solvent institutions, against good collateral and at high rates”, the Fed lent freely to a number of insolvent institutions at low rates and lenient collateral in what really was a bailout of gigantic proportions. (Mind you, the bailout still goes on, in the form of ultra low rates for an extended period, which is allowing financial institutions to beef up their earnings through a steeper yield curve.)

Effective? Yes, (alas!). But let’s not kid ourselves, this was not exactly the most dexterous application of monetary theory to practice!

Then you have the whole quantitative easing (QE) saga and the Fed’s back-and-forths with Treasury purchases. Not only was theory inconclusive about the effectiveness of Treasury purchases in lowering private long-term borrowing rates; not only did the measure ignore the fact that, when extreme demand for liquidity is *the* problem, Treasuries and cash are near-perfect substitutes, making QE useless...

...The Fed just failed to explain why purchasing Treasuries was a good idea in its own right, rather than an act of despair in its rush to “employ all available tools to promote economic recovery.” And in the process, it also underestimated the impact the “monetization” of government debt would have on the American psyche, which undermined, at least temporarily, the long-fought battle of anchoring inflation expectations.

Then you have the whole infatuation with inflation targeting—as in, product-price inflation targeting, as opposed to a monetary policy framework that embeds asset prices in it. Now that’s my favorite baby, and I’m glad to see that things seem to be moving on that front (even if at a glacial speed!). But..

..I cant help noting that I’m still amazed with the headlong adherence of some policymakers to the prescriptions of the available literature (like, “do nothing until it’s time to clean”). Might have to do with the fact that the Chairman is himself is the author of a seminal paper in that literature…Might have to do with the fact that the "clean-up approach" is all we have. Still, there is no excuse, given that the assumptions supporting those prescriptions are very simplistic.

Asset bubbles exogenous to monetary policy? Hello? If that were the case, why would the Fed ever assume it can revert the “negative bubble” (as in, utter collapse in asset prices) once it happened, with its extraordinary rate cuts and other policy actions?

Asset prices affecting demand only though tiny wealth effects on consumption? You’re kidding me! What about the whole lending spree in the form of home equity loans? Or the broader credit boom, facilitated by a steadily rising collateral, that led to the build-up of large systemic risks as well as external imbalances?

The Fed has no comparative advantage vs. the markets in determining the “fair value” of asset prices?! But does it need to? If risk management is (as it should be) a necessary component of policy, the containment of large asset price swings, upward or downward, may be a worthy objective in its own right.

Anyway, don’t get me started…!

Final point: The crisis brought into the fore the absolute necessity of a transparent and disciplined relationship between the Fed, the Treasury and the other regulatory bodies governing the financial sector.

As I argued above, insolvency problems should be dealt by the Treasury (if at all)—yet the Fed found itself engaged in bailout operations, while the Treasury (and Congress) were still dragging their feet! Clarification of the roles of the two institutions, and the commitment by the Treasury’ to take over ownership of the toxic assets on the Fed’s balance sheet only came in March this year.

At least it came, you might say! But in the future, a clearer definition of each institution’s mandate would help avert concerns about the Fed’s political and financial independence. Similarly, clarity about which regulator has the ultimate say on the financial sector will allow a swifter enforcement of corrective actions—to the extent that looming problems are diagnosed early on.

More generally, even the finest economic models won't "deliver" unless the institutions are in place and ready to assume swiftly their due respective roles.

I’ll close with this note--and I know I'm no Blanchard, nor Ben Bernanke for that matter!

The state of monetary (theory) is not bad; and it’s set to become much better. But while academics are looking to find the magic serum, practitioners can make huge progress by re-shaping the landscape for the theory’s effective implementation.


/1 Blanchard’s paper is actually much more nuanced about the achievements of macroeconomic theory, and more humble about its limitations, than suggested by his ill-fated punch line.

Decoding Kevin Warsh

I’m on the verge of changing my early morning routine of TV business news for the food network… The decision has been brewing for a while, but my "aha!" moment came last Friday, during an interview with a "market-intelligence" pundit, who was asked to interpret an op-ed piece by the Fed’s Kevin Warsh the day before.

So the guy goes on a spree of conspiratorial drivel about the Fed’s “true” intentions, following which, an unquestioning anchor likens his remarkable “code-breaking” skills to those of Robert Langdon!

Truth be told, Warsh’s article, and subsequent speech in Chicago, caused a bit of commotion and confusion in the market, for being seen as somewhat contradictory to the Fed’s official line a day earlier…. “exceptionally low”, “extended period” and all that.

Yet, all that Warsh did was to state the obvious… that the Fed is currently walking on a very thin line: Unlike back in March, when the “extended period” language was first introduced, the Fed’s management of downside risks on growth may be coming increasingly at odds with the management of upside risks on inflation.

At the crux of this tension is the level of banks’ excess reserves—currently at $850 billion (from $60 billion a year ago), by virtue of the Fed’s various asset-purchase and credit-easing schemes. In turn, the monetary base skyrocketed from $85 billion in August 2008 to around $1.7 trillion by end-2008, and has hovered around those levels ever since.

Is that a problem?

The standard argument would go that, yes, it is, because once banks begin to lend these walls of money, inflation will get out of control. Indeed, if you belong to the “mulish monetarists'” camp, you’ve been probably raising red flags ever since the Fed embarked on its various emergency facilities last year.

Clearly, that would have been wrong: The Fed was simply responding to a colossal, unanticipated increase in the demand for money in its most liquid form that nobody else was able or willing to provide.

But the story is different now. Risk aversion has been receding. Cash is becoming too expensive to hold and is gradually searching for higher returns—in stocks, bonds and the like. And, while commercial bank lending to the real economy—i.e. to companies and consumers—is stagnant at best, liquidity in capital markets is slowly coming back, repo markets are showing signs of life, and companies are increasingly able to raise money in the bond markets. Asset prices are "reflating".

Now, that’s not necessarily a problem. After all, the whole point of the Fed’s credit and quantitative easing operations was to catalyze the return of private-sector liquidity, help reverse the destruction in wealth from the collapse in asset prices and avoid a deflationary spiral.

What is the problem is the uncertainty about the fundamentals: Is the markets’ recent “exuberance” reflective of a true, steady improvement in the economic outlook? Or just wishful thinking, fuelled further by cheap money, and bound to correct itself?

The implications for policy in each case are different: The latter would justify the Fed’s low-for-long mantra; the former would call for an earlier reversal of the exceptionally accommodative monetary stance.

This uncertainty about the fundamentals is complicating monetary implementation. But uncertainty is nothing new when it comes to formulating monetary policy. What is different this time is that the mountain of excess reserves in banks’ books is an obstacle to the Fed’s traditional preference for playing it safe on growth. Basically, while the Fed would love to go for the “wait and see” approach, the level of excess reserves makes this a very risky route.

The reason is simple: $850 billion of excess reserves can do a much bigger damage, faster, than, say, $50 billion, if banks regain their appetite to recycle them into the system. Put differently, it would take a much smaller increase in the money multiplier (which has collapsed since the crisis began) to cause a much bigger damage, with excess reserves at these levels.

Up till now, the Fed had downplayed the size of reserves as a potential constraint to its policy implementation. As NY Fed President Bill Dudley said back in July:

“…in a world where banks could not be paid interest on excess reserves, these persistent high reserve balances would indeed have the potential to prove inflationary. […] But that is not the world in which we now live. Because the Federal Reserve now has the ability to pay interest on excess reserves (IOER), it also now has the ability to prevent excess reserves from leading to excessive credit creation.

“[..] For this dynamic to work correctly, the Federal Reserve needs to set an IOER rate consistent with the amount of required reserves, money supply and credit outstanding consistent with its dual mandate of full employment and price stability. If demand for credit exceeds what is appropriate, the Federal Reserve raises the IOER rate to reduce demand.” (my emphasis)

Right. Only that Dudley assumes that the Fed knows what the interest rate consistent with its dual mandate is! But, as I’ve been arguing here, right now the Fed doesn’t, because of the uncertainties above—uncertainties that Fed officials have themselves acknowledged.

The risk is that, guided by standard measures of slack (unemployment, capacity utilization etc), the Fed will keep rates at zero, even while banks begin to recycle excess reserves in the system.

Clearly, there is one way to go: Begin to unwind the reserves, soon. This will allow some flexibility in the interest rate decision—some room for a “wait and see” approach—until the data coming out of the real economy begin to look resolutely better.

As a matter of fact, that’s exactly what Ben & Co. seem to be planning, with reverse repos the latest word on the street. The idea is for the Fed to avoid selling the securities it owns outright (and any undesired price impact thereof), but place them directly with money market funds, which seem to have both the balance sheet capacity and the appetite to absorb large quantities of “safe” assets like US Treasuries or Agencies.

I see Warsh’s statements precisely in this light—and, therefore, not as inconsistent with the FOMC’s “extended period” message. The Fed still wants to play it safe on growth, but would prefer to avoid screwing up in the unlikely(?) case the financial system moves faster than the Fed expects based on traditional economic fundamentals.

So what I'd expect to see in the coming weeks is the Fed to start moving to drain reserves, while postponing the interest rate increase decision until fundamentals look more compelling.

That said, if the Fed wants to avoid the possibility of destructive volatility in bond markets, it should do away with the constructive(?) ambiguity in its policy message and come out with a clear communication about the sequencing of its exit strategy (and I’m not talking about pre-announcing rate decisions here).

Capital markets are still fragile and clarity in the Fed’s message will be key for a smooth transition process… Even more so, if the Fed truly has to deal with a market that is as “perceptive” as Robert Langdon!

The plain vanilla option for bank reform

I’m taking a quick break from my blog break to throw in some food for thought re. the bank-reform debate, which has been simmering in earnest.

I also feel pretty energized after a mind-blowing trip to Asia, which has forced me to rethink the definition of “construction boom”, “shopping mall” and... “exotic cuisine”!

Anyway, at the crux of the reform debate are measures to prevent banks from engaging in the risk-taking behavior that led to, yeap, “the worst financial crisis since the Great Depression.” Proposals have targeted, inter alia, bankers’ pay, with the view of curtailing greed and short-termism; and bank capital requirements, to basically make banks’ risky activities more expensive and less procyclical.

Personally, I’m against the former, and not because I have any particular affinity for bankers (unless they are economists!). I just happen to think that, per Econ 101, employee compensation, together with the return to shareholders, should be both derived from a firm’s profit-maximization exercise—provided this exercise also internalizes the systemic implications of the bank’s own risk-taking behavior.

Put differently, if we can make financial institutions pay explicitly for what is now an implicit, unpaid-for insurance provided by the taxpayer against a systemic banking crisis, I see no reason why banks cannot distribute any left-over profits to their workers and capital owners as they please.

For this same reason, while I partly see the logic of the second proposal—to introduce counter-cyclical capital requirements—, I don’t think it’s enough to do “the job”: Yes, it might well discourage banks from engaging in “excessive” risk-taking behavior in good times; but it still does not make banks pay in advance for the next financial bailout which, believe me, will happen again at some point.

Against this backdrop, one idea for making banks pay for systemic-risk insurance was put forward in a paper presented at the 2009 Jackson Hole symposium by MIT economists Ricardo Caballero and Pablo Kurlat.

Accordingly, banks would pay a fee to the Fed in exchange for potential access to insurance, which would be triggered if systemic risk exceeded a certain threshold. This access to insurance would take the form of "TICs" (or Tradable Insurance Credits)—securities that would be issued by the Fed to the fee-paying bank, providing access to Fed guarantees on a pre-specified pool of the bank’s assets.

The paper has some interesting insights and, actually, a somewhat different tilt than the issue I’m raising in this piece (Their point is, in part, that there is a need for a new policy tool to help remove market uncertainty about the depth of bank losses during a systemic financial crisis). So I recommend that you read the whole thing.

Insights aside, I think this type of proposal suffers from a number of flaws, some of which are fundamental. On top of that, it is far more complicated than what I think is a more straightforward solution, which could not only help generate a less procyclical risk-taking behavior, but also address the need to make the now implicit insurance explicit. Let me explain:

Flaw number one in the Caballero-Kurlat approach is the fact that the guarantees would cover a financial institution’s assets (instead of its liabilities).

Why is that a problem? It is, because it would make extremely difficult the failure of any too-big-to-fail financial institution, even if such an institution “deserved” to fail. This would unduly protect the owners of such an institution, despite what might have been excessive risk-taking, lack of oversight and/or sheer incompetence on their side.

As an example, rewind to March 2008, when a (clearly systemic) financial institution in the name of Bear Stearns is at the brink of going bust. Now, an eventuality of that nature is bound to trigger a TIC-like guarantee by the Fed to every financial institution holding TICs, including Bear Stearns.

This is despite the fact that Bear Stearns may be actually insolvent and thus “deserving” to fail (yes, we can debate this, but in a separate forum). The distinction between a liquidity and a solvency crisis is practically irrelevant in the TIC framework.

So this is how it would go… Bear Stearns is about to fail, systemic risk rises unexpectedly, Fed guarantees are triggered, Bear Stearns is saved, systemic risk subsides and all ends well… only that the principle of efficient resource allocation has been wildly damaged: The most short-sighted, over-levered and incompetent bankers on Wall Street are still allowed to roam around, feeling good and getting ready to go back into the game.

To be sure, the Fed (or the relevant supervising institution) might still decide to declare Bear Stearns bankrupt and wind it up, while providing guarantees to the remaining financial institutions. But that would trigger follow-up complications:

E.g. how would we (and the Fed) know ex ante that, urrrh, Lehmans or AIG, say, are soundly-managed institutions deserving to survive, courtesy of the Fed’s guarantees? Or, if the Fed were to trigger its guarantees on a selective basis, what would that do to market uncertainty—the very problem the TIC proposal was meant to address?

But let me go to the second fundamental flaw of the Caballero/Kurlat proposal: Which is that it confuses the roles of the fiscal and monetary authorities in a crisis resolution framework. Contrary to what they suggest, the provision (and, ultimately, the cost) of any guarantees on any financial institution should be the role of the fiscal authority (ie the Treasury), NOT the Fed.

True, the Fed did provide backstops against certain assets or liabilities of financial (and non-financial) institutions during the 2008 crisis, as the crisis escalated. But that was due to (a) the absence of a systematic framework for crisis resolution; and (b) the inability of Treasury and Congress to respond proactively to the dramatic events that unfolded. Yet, what we need is not the Fed taking the lead in what is essentially a fiscal activity; but a solution that would help avoid the need for the Fed to get financially involved, for the sake of its financial and political independence.

So here is an idea: Extend the FDIC’s deposit-insurance framework to the entire financial sector. In other words, get financial institutions (i.e. not just commercial banks) to pay a fee to a dedicated FDIC-like fund, which would be financial subsumed to the Treasury. This fund would be available to cover the liabilities of a financial institution (i.e. its creditors, up to a given amount and level of seniority), if that institution failed.

If you think this provides too nice a treatment to the creditors covered, think again: These guys would now be getting paid much less for their lending to the bank, since the default risk would now be minimal thanks to the explicit insurance the bank is paying to the government.

Importantly, the scheme could be so designed to address the need to discourage excessive risk-taking as well as a heavily procyclical behavior on the part of financial institutions: For example, the fee could be a function on an institution’s leverage, appropriately defined; and it could also be time-varying, in tune with the business cycle, to discourage heavily procyclical behavior.

What are the advantages of this approach?

* First, it allows for the failure of insolvent, poorly-managed institutions, inlcuding systemically important ones.
* Second, it makes financial institutions explicitly pay for the insurance that taxpayers have been implicitly providing to them.
* Third, it can be designed to be countercyclical and incentive-compatible.
* Fourth, it provides provides a more predictable framework for crisis resolution than the status quo, notably with regard to the treatment of the different parts of the capital structure, if it were to fail. Uncertainty about the treatment of shareholders and creditors of different seniorities was a major driver of the market volatility that prevailed in 2008 and early 2009.
* Finally, it makes it clear that any net costs from the resolution of a failed financial institution will be borne by the fiscal authority instead of the Fed.

So here you go, my first wonkish piece for the first official day of Fall. Pretty plain vanilla, dare I say, compared to some of the alternatives out there. And, believe me, after weeks of heated policy debates over silk-worm skewers, bamboo fungus appetizers and live squid entrees, plain vanilla sounds good to me!

Monetary policy make-over

Dear all—

I’m about to take a break for a couple of months, maybe three, to accommodate my summer vacation, a work trip to Asia and a personal project I’ve just begun. But before I say “au revoir”, I wanted to leave you with the following thought…

There is something inherently counterintuitive, if not absurd, in the perception that a 1% increase in the inflation of my flower-pot is more damaging than the enormous swings we have all just experienced in the value of our wealth.

Translating the above into wonk-speak, if there is one major shake-up that this financial crisis should bring about, it is, in my opinion, the re-thinking of monetary policy as we know it… including the role of asset prices in the framing of policy rules and objectives.

To be sure, there have been plenty of papers arguing why asset prices should NOT be the direct focus of policy-makers (rather, an indirect objective, to the extent that they influence the prices of goods and services)—including by our Fed Chairman himself.

But I find these arguments wanting… To start with, they tend to rest on assumptions that have not been conclusively determined by economists (such as the size of wealth effects on consumption); or, they posit an asset bubble process that is exogenous, including to the policy tool itself (admittedly, the latter more reflects economists’ ignorance/ disagreement on how bubbles are formed).

But beyond these “small-scale” criticisms, the most important weakness I see has to do with what is currently a “consensus” about the objective of monetary policy itself. Unless one begins to rethink what monetary policy should be about, and what it should target, the arguments for or against asset-price targeting become frustratingly circular.

I’ll have more to say about this when I’m back.
So.. au revoir in the Fall!