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Friday, September 14, 2012

Rude comment on Heroic Krugman

Krugman is a hero and I am a cad.  He blogged after flying with a cold and I commented as follows

You are a total hero for blogging with a cold after flying (ugh flying with a cold what a nightmare).  Also you are one of very few commentators who even mentions that MBS are not the same thing as 7 year notes.

However, I vehemently passionately contest one word in this post -- "mainly.  There is no evidence that Bernanke agrees that QE works mainly as forward guidance.  If he thought it worked mainly through portfolio balance and a bit through forward guidance, then the right policy would be to use both.

I will now jump the gun.  We have new relevant evidence on the effectiveness of QEIII as forward guidance about future short term rates.  Medium term rates are expected average short term rates plus a risk premium.  If there is more certainty that short term rates will be very very low, both terms should decline.  The 5 year rate is now changed less han one basis point since the Wednesday close.

The point estimate of forward guidance from the announcement is zero, 0.00%.  Now it is easy to argue that bond traders pay a lot of attention to the Fed while home buyers don't, but it's harder to make the argument the other way around (as you must).  You can argue that event studies are silly, or you can praise Woodford's paper, but not both.

I think it is clear that the QEIII announcement had a dramatic effect on expectations of many things but not on expectations of future conventional monetary policy.

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