Goodhart on NGDP

Quick link to Charles Goodhart's take on this purported shift in paradigm for central bankers and monetary policy in general. This is one of those that needs to be read in full because he makes somewhat valid assertions and interesting points of caution. 

" The fear is that, once the sell-by date of these initiatives passes, central bankers will be acting contrary to everything learnt, painfully, in the 1970s. They will be relating monetary management to real variables on a longer-term basis. In the end, any short-term benefit will be dwarfed by the long-run pain as they push inflation higher in the vain pursuit of a real economic objective."

Essentially what Goodhart is reminding us of is that one shouldn't look at the whole NGDP-targeting discussion as something so radically new and brilliant that it becomes a panacea for the world. The most important point that he then goes on to make, and I think this is the most valid, is that:

" Adopting a nominal income (NGDP) target is viewed as innovative only by those unfamiliar with the debate on the design of monetary policy of the past few decades. No one has yet designed a way to make it workable given the lags in the transmission of monetary policy and the publication of national income and product. Rather, a NGDP target would be perceived as a thinly disguised way of aiming for higher inflation. As such, it would unloose the anchor to inflation expectations, which could raise, not lower, interest rates by elevating uncertainty about the central bank’s reaction function."

It is easier to make statements like the last knowing fully well that the evidence to either back it up or refute it is near-impossible to determine beforehand. 

You could think of this as an old school plea, a note of caution or whatever you will, but each of these issues - the transmission of monetary policy - inflationary expectations - and a central bank's role in maintaining credibility or issuing forward guidance to name a few -  are far more complicated than a simple or even gradual switch would indicate. 

The broader point being made, perhaps is George Santayana's - that those who cannot remember the past, are condemned to repeat it. 

I'm not entirely convinced of the parallels, but there's certainly no harm in listening!

Morgan Stanley's S***bags

Have to do this quickly as I've been fairly swamped with some work on a paper but this really caught my eye. It's one of those good Dealbook reads (entertaining, exciting and substantive) from Eisinger on the internal memos released because of a suit brought forward in the NY State SC by a Taiwanese bank. Here are some telling highlights of the piece:

"On March 16, 2007, Morgan Stanley employees working on one of the toxic assets that helped blow up the world economy discussed what to name it. Among the team members' suggestions: "Subprime Meltdown," "Hitman," "Nuclear Holocaust," "Mike Tyson's Punchout," and the simple-yet-direct: "Shitbag." 

If you think this is an attempt at journalistic humor, think again and go to the hyperlink on "Shitbag". It'll lead you to the actual memo. Yup, not that funny after all. But what exactly is the lawsuit for? I mean, why would a Taiwanese bank want to do this?

It seems like it's because that "Shitbag" stuff was given a legitimate name and packaged off to a Chinese bank. Apparently, a Taiwanese bank bought a piece of the same deal and they didn't find it funny.

"The lawsuit concerns a $500 million collateralized debt obligation called Stack 2006-1, created in the first half of 2006. Collections of mortgage-backed securities, C.D.O.'s were at the heart of the financial crisis."

Anyway, you're bound to run into the whole information asymmetry problem here. Your buyers aren't supposed to be unsuspecting. They may have less information than the seller but isn't that information enough to stay away from "Shitbag"? Shorting is valid, and that's obviously going to be Morgan Stanley's defense. 

"The firm is fighting the lawsuit, contending that the buyers were sophisticated clients and could have known what was going on in the subprime market. The C.D.O. documents disclosed, albeit obliquely, that Morgan Stanley might bet against the securities, a strategy known as shorting. The firm did not pick the assets going into the deal (though it was able to veto any assets). And any shorting of the deal was part of a larger array of trades, both long and short. Indeed, Morgan Stanley owned a big piece of Stack, in addition to its short bet."

One bottom line perhaps, is that when they packaged and gift-wrapped "Shitbag" in February 2006, they knew it represented "attractive business". 

"Why? In addition to fees, another bullet point listed: "Ability to short up to $325MM of credits into the C.D.O." In other words, Morgan Stanley could — and did — sell assets to the Stack C.D.O., intending to profit if the securities backed by those assets declined. The bank put on a $170 million bet against Stack, even as it was selling it."

So when you revisit the whole defence of an argument that you can't be willingly or maliciously selling a dangerous product if you're holding it and liable for it as well, what it comes down to is (as Eisinger rightly asks) -  "Does losing money wipe away sin?" 

Read on...

"Why might Morgan Stanley have bet against the deal? Did its traders develop a brilliant thesis by assessing the fundamentals of the housing market through careful analysis of the public data? The documents suggest something more troubling: Bankers found out that the housing market was diseased from their colleagues down the hall.

Bankers were getting information from fellow employees conducting and receiving private assessments of the quality of the mortgages that the bank would purchase to back securities. These reports weren't available to the public. It would be crucial information for trading in securities backed by those kinds of mortgages."

That acts as the counter-argument. Essentially, if it appears that Bank X pawned off a dangerous loaded product to Bank Y or Buyer Y, how much does it matter and more importantly, to what extent does it matter that Bank X held it as well. Where does this paradox get resolved? That you're selling a product you've bet against but you're holding yourself. Or are you?

Eisinger ends with a somewhat more less sophisticated tone that you hear often with respect to subprime discussions but it gets the point across nonetheless. What goes on inside the black box is hard to know because information is blurry, lines are crossed and irrational decisions are made. 

"Unfortunately for Morgan Stanley, it had so many other pieces of C.D.O.'s, so many nuclear warheads, that it couldn't find nearly enough suckers around the world to buy them all.

And so when the real collapse came, Morgan Stanley was left with billions of dollars worth of "shitbags".

That hardly seems exculpatory."

Benford on China

Picking up on some research scouted out by some folks at ANZ - picked up by Bloomberg News - and further picked up by Kate Mackenzie over at Alphaville! Am I down the pecking order or what?

As someone who deals with far too much data on a daily basis, let me unequivocally state that China-related data IS NOT very friendly. So hats off to Liu and Lam for actually testing this out.

It's quirky, don't read too much into it and please bear with me while I give you my own short primer on Benford.

Named after Frank Benford, an American physicist and engineer, the law basically relates to the frequency distribution of digits, in data. So what you have is probabilities and frequencies of how many times x will appear. Since we're dealing with digits, x belongs to {1,2....., 9} or {0,1,2,.... 9} - more on this later.

What does it tell us specifically? Essentially, that (this is the first-digit law) in a set of data, larger numbers will occur in that distribution less frequently. 1 occurs the most frequently and 9 the least. The difference in the first-digit and second-digit law is that the second digit includes 0 in the subset. Mathematically, a data set will satisfy Bernford's law if the leading digit x, where x belongs to {1,2.....,9}, occurs with probability given by

P(x) = log (1 + 1/x) 

(logs are to the base 10) but this will work with any base. Think of a binary system (b=2) which would have a trivial solution because all numbers except 0 start with 1!

Fairly simple, isn't it?

So for x = 1, 
P(1) = log 2 = 0.301, 
x = 2,
P(2) = log(1.5) = 0.176
x = 9, 
P(9) = 0.0458

If you'll notice (because P(x) is also log(x+1)-log(x), the probabilities are proportional to the difference between x and x+1 on a logarithmic scale. Most importantly, this is the distribution expected if not the numbers but the coefficient or the significant digits of the logs are uniformly and randomly distributed.

Before you dismiss this on account of triviality, naturally generated data will roughly exhibit signs of observable patterns - test a set out for yourself. Greece failed the Benford test apparently, as did Madoff. So...

Anyways, this primer's been going on too long. In a nutshell, one can use the second digit law (that includes 0 in the set and hence has a much smoother frequency distribution) to observe data sets (logically, the first digit is far too significant to be tampered with so this makes obvious sense).

Two economists at ANZ did this with Chinese data and found that the nominal GDP data was largely conforming as was the IP data (these are large numbers). However, the moment they got into rates/percentages, things went awry. Think growth rates, inflation etc. The guilty second digit showed up and zero was observed to be occurring far too frequently for Benford's liking as did 1,2,3,4 while 7,8,9 appeared lesser than expected.

Hold your horses though! How big was the sample? Quarterly growth rates from '91 to '12 so that's roughly less than 90 observation which is decent enough.

As everyone will readily admit however, statistical evidence (significant or not!) doesn't necessarily accompany a tinkering of data and numbers. But it is a bit odd because raw and nominal production/growth numbers tell a different, more standard and expected story. 

What Am I Reading

A few more quick interesting reads:

- If you've been wondering whether the move-to-chain regarding the CPI as related to social security benefits lacks transparency and doesn't add up, the NYT has a comprehensive editorial explaining what's wrong.

- Jeffrey Sachs takes the WSJ to task for (yawn!) a lack of accuracy. And that would be an understatement, I'd prefer clever and intentional manipulation of facts to present falsified information - or something to that tune at least.

- This is Charles Evans's speech at the Asian Financial Forum in Hong Kong on Monetary Policy at the Zero Lower Bound. More Fedspeak

- John Plender reviews Gary Gorton's "Misunderstanding Financial Crises".
No, I haven't read it yet.
Yes, I want to.
It's 3rd or 4th on my list after Lords of Finance.
No, I haven't read that yet either!

- Read about Josh Angrist's really interesting story here - "Yet if Angrist’s CV bears the markings of an academic star—PhD from Princeton, first job at Harvard, and a named chair at MIT, where he is the Ford Professor of Economics—his life could have been very different. Angrist left high school after the 11th grade, having completed the bare minimum of coursework needed to graduate. He took time off before deciding to go to college, dropped out of grad school, and then served in the Israeli army before pursuing a PhD in economics." 

- Okun's Law may not be as universal as that gravity law but it's standard and stable by macroeconomic standards. It's rare to call an economic relationship a "law" but Okun's has earned its name. Here's a guest post from Econbrowser from Ball, Leigh (Blanchard's multiplier co-author) and Loungani.

- And lastly, RIP Aaron Swartz.

On Japanomics and Inflationomics

Gavyn Davies has an insightful post where he looks at output gaps and asks the inflation question. He uses Krugman's thoughts at the four-person panel that I posted about earlier and agrees that downward nominal rigidity is a more significant factor than initially believed. Along these lines, he also takes into account Hatzius's inflation model regarding anchored expectations and that there is little risk of a rise until the economy starts approaching a significantly higher level of employment. Davies concludes with, "In the short term, it suggests that any rise in nominal demand, stemming from expansionary policy or a recovery in private spending, is much more likely to be reflected in rising real output than in higher inflation. Demand management policy can be expansionary."

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From the folks at Alphaville through Martin Malone at Mint Partners, here's this bloomberg chart of the yield convergence in the euro-zone between core and periphery. According to him, "this trend will continue: core yields are playing catch-up with both the foreign exchange markets (USD/YEN has moved from 75 to 90 over the past 12 months) and equites, so a core-periphery spread of 150-200bps could be on the cards if and when global growth ticks higher…"

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Krugman has some notes on Japan in a positive way. I think the gist of what is going around is that while Abe's reason's may be misguided and his stimulus could spur more pork spending etc. ultimately what this represents is a break from orthodoxy and a willingness to change direction. It's something to look forward to - as an experiment at least. Here, Krugman argues that Japan distinguishes itself from the rest of the advanced economies due to its persistent deflation and that since it needs to get itself out of this trap, a time of less economic slack might actually be the best situation to try and do so. 

In another post, he draws the line on the unemployment-population ratio and shows why there's a huge difference between charting it without the 64 age cut-off. The interesting part is, in typical Krugman fashion, on the lurking vigilantes - that "even if they show up, they won’t drive interest rates up, they’ll drive the dollar down, which is a good thing. In Japan’s case, you can think of what’s happening as a growing belief on the part of investors that Japan will end up inflating away part of its debt. This has led to a currency drop; it has *not* led to an interest rate spike"

And if you want to stay away from the numbers and the charts and read something less-wonkish, here's his column in simpler language where he says that America should be compared to Japan, not Greece and that Abe's willingness to break with orthodoxy and embark on his fiscal stimulus plan has not led to any spike in rates, rather the yen has falled and that's good news for exporters. 

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Meanwhile, Noah Smith has a great piece on Abe's intentions and his unintentional Keynesian cover. Is Abe the Great Keynesian Hope? Smith doesn't think so and he argues it well historically. And while he agrees that all these moves since the LDP victory have been to talk down the yen, he also says that with a low unemployment rate, there might not be much slack in the economy (something Krugman agrees with too). So although Japan could do with inflation, it's possible that much of this stimulus might end up as pork. 

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The Geithner Legacy

Had to put in a blurb before I sign off for the weekend. How would you rate Tim Geithner? How does one rate Treasury Secretaries? Is it easier to rate Central Bankers instead? Ben Walsh had this on Geithner:

"

Step One in the Tim Geithner Legacy Project is complete: Barack Obama delivered a ringing endorsement of the Treasury secretary, who’ll be stepping down on January 25. Here’s the president:

“With the wreckage of our economy still smoldering and unstable, I asked Tim to help put it back together. So when the history books are written, Tim Geithner is going to go down as one of our finest Secretaries of the Treasury.”

Step Two: favorable consensus opinion. Neil Irwin writes that Geithner was “one of the most important Treasury secretaries in history” — he agrees that Geithner’s primary task was to “stop the bleeding” and that Geithner’s experience at the NY Fed made him a highly capable financial first-responder.

Joe Weisenthal pulls a chart from the Oregon Office of Economic Analysis that puts Geithner’s tenure in perspective: compared to previous financial crises — and compared to other countries recovering from the current crisis — the US job market has rebounded relatively quickly. Politico joins in the praise, and includes this gem from a former colleague: “If anything, he was quite focused on the pain the country was suffering”.

Not everybody is so positive, however. Paul Krugman isn’t sad to see him go: “Geithner has consistently been a voice urging the president to cave in for fear of upsetting the markets, with no real concern for the dangers of giving in to blackmail.”

And Binyamin Appelbaum tweeted his own take on Geithner’s legacy by pointing to an August piece headlined “Cautious moves on foreclosures haunting Obama”. The administration, Appelbaum wrote, “tried to finesse the cleanup of the housing crash”, and that caution hurt economic growth. (You can read more on the Obama Treasury’s troubled housing legacy hereand here.)

What’s Step Three? Geithner told Charlie Rose that he’s unlikely to write a book after leaving office, and he’s equally unlikely to want to stay in Washington as Fed chairman. So maybe he’ll just work on his jump shot for a while before taking that inevitable highly-remunerative job at BlackRock. 

"

I didn't think much of Geithner initially but I'm looking at this from a sporting perspective, literally. The NBA, MLB and NFL that I'm aware off, have a metric that determines the impact of a replacement. i.e: how valuable a player is can be assessed by replacing him with an average player and seeing the impact it has on a team. Of course, that's impossible to do without statistics, but I'm not convinced of the significance of the difference it would have made. A difference - yes, maybe. Just how much of a difference is a matter more of opinion and less of numbers.