Friday, February 22, 2013

Still not calm about Monetary Policy

David Glasner has a post here commenting on an earlier post of mine.  I can't decide what to quote so please just read it if you want to make any sense of what follows.

One question I forgot to ask in comments:  what does WADR stand for ?

I wrote two comments which I am basically storing here for future reference.  Also the first was typed on an iPad with autocorrect (BLEG how does one turn that off) which corrects my English to Italian and makes worse gobbledygook than I do by myself.  I have corrected the spelling here using the new improved super technology called "a keyboard"

I haven’t really read this post (just skimmed it). I note your question on breakevens and stock prices. I haven’t 2 through to which are, at legasti, sincere.
1) I don’t think that stock prices tell us much about anything. In particolar they have a low correlation with future GDP and employment growth IIRC. I through this question was settled in 1987.
2) I don’t think that monetary policy has much effect on expected inflation (except through past inflation). I note that event studies (in the huge Woodford paper) show Tiny effects 3 out of 4 (or 4 out of 5) have the expected sign.
3) I think breakevens are vero well explained by lagged inflation, lagged core inflation and lagged changes in the price of petrolem. I don’t see any effects of shifts of monetary policy in this graph
4) I also think that in the early 80s that monetary policy shifts affected expected inflation via high interest ratea caused high unemployment which caused low inflation which caused low expected inflation.
5) I am not convinced that any model developer other than * adaptive* expectations augmented Phillips curve is as empirically successful.
Are you sure that we don’t disagree all that much ?
I promise this comment is sincere and not exaggerated.

Here I am again.  I have now read the post.  I have two observations

1) Get the null on your side is my motto (I admit it).  You follow this.  You suggest that your hypothesis is the hull hypothesis then abuse Neyman and Person by implying that we can draw interesting conclusions from failure to reject the null.  Basically the sentence which includes the word "null" is the assertion that we should assume you are right and I am wrong until I offer solid proof.  To be briefer, since we are working in social science, you are asking that I assume you are right.  This is not an ideal approach to debate.
I ask you to review your sentence which contains the word "null" and reconsider if you really believe it.  The choice of the null should be harmless (it is an a priori choice without a prior).  How about we make the usual null hypothesis that an effect is zero.  Can you reject the null that monetary policy since 2009 has had no effect ? At what confidence level is the null rejected ?  Did you use a t-test ? an f-test ?  "null" is a technical term and I ask again if you would be willing to retract the sentence including the word "null".

2) using expected inflation to identify monetary policy is only a valid statistical procedure if one is willing to assume that nothing else affects expected inflation.  If you think that say OPEC ever had any influence on expected inflation, then you can't use your identifying assumption.  In particular TIPS breakevens can be fairly well fit (not predicted because not out of sample) using lagged data other than data on what the FOMC did.

again I refer to

(legend here red is the 5 year TIPS breakeven or expected inflation, Blue is the change over the *past* year of the price of a barrel of oil times 0.1 plus 1.6, green is the geometric mean of the change over the *past year* of the personal consumption deflator and the personal consumption minus food and energy deflator.

I find the brief and boring period 203-2007 most interesting.   Expected inflation is almost perfectly fit by lagged inflation (geomentric mean of core and total).

I don't see how anyone could look at this graph and then claim we can identify monetary policy by the TIPS breakeven.  That is only valid if nothing but monetary policy affects inflation expectations.

Similarly in 1933 monetary policy wasn't the only thing that changed.  I understand that there was considerable policy reform in the so called "first hundred days.  " The idea that we can identify the effect of monetary policy by looking at the USA in 1933 is based on the assumption that Roosevelt did nothing else.  This is not reasonable.

But I think we can detect the effect of recent monetary policy on TIPS breakevens if we agree that it (including QE) is working principally through forward guidance.  There should be quick effects on asset prices when surprising shifts are announced.  QE 4 (December 2012) was definitely a surprise.  The TIPS spread barely moved (within the range of normal fluctuations).  I think the question is settled.  I do not think it is optimal to ignore daily data when you have it and treat same quarter as the same instant.  Some prices are sticky and some aren't.  Bond prices aren't.

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