QuoteOriginally posted by: Traden4AlphaAlthough I agree that the Fed nor the government creates efficient production or economic growth, that doesn't imply they have no effects on yield stability. A couple of policies that might enable more stable yields without sacrificing stable prices might include:1. A strongly countercyclical tax policy that produces moderate after-tax profits at all times rather than booms and busts at different times.2. A set of inflation/deflation modulators that don't rely on direct rate intervention (e.g., dynamic regulation of reserve requirements to control the money supply)Suppose you have a band of three bad musicians. Their objective is to play in rhythm with each other. At times it is going to completely disintegrate. Then the bass player will find a rhythm with the drummer, and the keyboard player will adjust his tempo until he is in synch. This is a boom.Are you going to tell them they are in synch when they are not, so that they do not work to adjust their tempos to become in synch, and play terrible music for a prolonged period? Are you going to try to confuse them when they start to get in synch, to maintain them in a constant state of almost finding synch?Won't operating your synch interference system be more complicated and prone to errors than any of their individual instruments? How will you even find the synch to help them get in synch if you are but a man? Will you pass a law restricting their pattern and speed?

QuoteOriginally posted by: farmerQuoteOriginally posted by: Traden4AlphaAlthough I agree that the Fed nor the government creates efficient production or economic growth, that doesn't imply they have no effects on yield stability. A couple of policies that might enable more stable yields without sacrificing stable prices might include:1. A strongly countercyclical tax policy that produces moderate after-tax profits at all times rather than booms and busts at different times.2. A set of inflation/deflation modulators that don't rely on direct rate intervention (e.g., dynamic regulation of reserve requirements to control the money supply)Suppose you have a band of three bad musicians. Their objective is to play in rhythm with each other. At times it is going to completely disintegrate. Then the bass player will find a rhythm with the drummer, and the keyboard player will adjust his tempo until he is in synch. This is a boom.Are you going to tell them they are in synch when they are not, so that they do not work to adjust their tempos to become in synch, and play terrible music for a prolonged period? Are you going to try to confuse them when they start to get in synch, to maintain them in a constant state of almost finding synch?Won't operating your synch interference system be more complicated and prone to errors than any of their individual instruments? How will you even find the synch to help them get in synch if you are but a man? Will you pass a law restricting their pattern and speed?First, I would not equate booms with harmonious music nor busts with discord. Booms are about every the same instrument (e.g., oboes) and that one instrument getting way too loud. The bust occurs when people realize they will puke if they hear another oboe.To me, the central flaw in regulating the aggregate supply of money is that it does not (and I agree that it can not) control the intra-economy flows of money. Try to give more money to the aggregate economy and it will almost certainly be diverted into over-investment in some segment.

QuoteOriginally posted by: Traden4AlphaTo me, the central flaw in regulating the aggregate supply of money is that it does not (and I agree that it can not) control the intra-economy flows of money. Try to give more money to the aggregate economy and it will almost certainly be diverted into over-investment in some segment.I expressed in another thread the idea that price stability causes over-investment in some segment.Suppose immediate price volatility is lower than long-term volatility. There will be some things where the price goes sideways year after year, and some things where the price goes up 1 cent or down 1 cent 5 years in a row. People will evolve to assume price volatility in the rising products is 1 cent, and value is 5 cents greater than current price. They will heap all their money into that thing. And to the extent that thing is part of the price-stability basket, the price will be less volatile than all the speculation implies.We have observed that a gentle yield curve stimulates investment in low-risk, low-growth assets whose returns most safely fit the liabilities inherent in the yield curve. So it is not easy money that causes bubbles through the difference between the cost of money and the historical return on an asset. It is low volatility that causes bubbles, through the difference between the historical volatility or risk of an asset, and the historical return.

Price stability reduces relative volatility of the most volatile item in the basket, while preserving relative performance. This makes riskier investments the most attractive.Suppose cars go up 1% then up 1%. And houses go up 5% then down 3%. You're investing in cars for the safer 1%. But suppose we tighten then loosen money so cars go down 1% then up 3% and houses go up 3% then down 1%. Now they appear to have identical risk and return. So you risk more in houses.

QuoteTo me, the central flaw in regulating the aggregate supply of money is that it does not (and I agree that it can not) control the intra-economy flows of money. Try to give more money to the aggregate economy and it will almost certainly be diverted into over-investment in some segment.Why would it go as 'over-investment' in some segment?

QuoteOriginally posted by: farmerPrice stability reduces relative volatility of the most volatile item in the basket, while preserving relative performance. This makes riskier investments the most attractive.Suppose cars go up 1% then up 1%. And houses go up 5% then down 3%. You're investing in cars for the safer 1%. But suppose we tighten then loosen money so cars go down 1% then up 3% and houses go up 3% then down 1%. Now they appear to have identical risk and return. So you risk more in houses.This is not a good example. If you tighten and loosen money for no good reason you'll create excess volatility. The reason houses appear less risky is they are negatively correlated with money creation. The point is to create aggregate price stability not target some specific asset. Sure, some assets will appear relatively more risky after money creation but that's because they were mispriced to begin with. Suppose we decompose the nominal return into real return and inflation: ret + inf. The variation in ret is based on fundamental supply and demand changes. Inf is based on supply and demand for money, and to make things simpler assume that it's purely exogenous: Gold is money and its production and demand is driven by what goes in other countries. The variance of the asset return will be: var(ret) + var(inf) + 2cov(ret, inf). var(ret) is good variance. var(inf) is bad variance and not related to anything going on in the economy. Some assets that hedge against fluctuations in money will have lower variance and higher value. If the FED has a magic wand and eliminates variance in money, var(inf) =0, then aggregate price volatility will be lower. This is a good thing. Those assets that were hedging money fluctuations will now have higher volatility and lower price. You can call this mis-pricing, but their value was not driven by anything fundamental. This is ignoring the credit channel or other things that the FED may be targeting, in which case you'll have real mispricing.

QuoteOriginally posted by: gardener3QuoteTo me, the central flaw in regulating the aggregate supply of money is that it does not (and I agree that it can not) control the intra-economy flows of money. Try to give more money to the aggregate economy and it will almost certainly be diverted into over-investment in some segment.Why would it go as 'over-investment' in some segment?That's a very good question. Here's my story and I'm stick'en to it (although I'd love to hear your thoughts):In an environment of low interest rates, people chase yield. But where can they find it? Although some of that loose money diffuses more broadly into the economy as each business or locale invests more in their own operations and markets, some people decide that their usual outlets for investment are overcrowded and they go looking for outside investments. That search for outside investments becomes a bit of a popularity/bandwagon game as people listen for hot tips for "the next big thing." Moreover, the flood of cheap money into some sector du jour boosts assets prices on the target sector which only serves to validate that the sector is a worthwhile investment because the early investors in the new bubble brag about their out-sized returns to their yield-chasing neighbors.A loose monetary policy circumvents the normal equilibrating influences of supply and demand because so much money floods into the boom sector that new investment occurs well before the old investment gets tested for fundamental soundness (e.g., all those dot-com businesses).If money is cheap, people gamble, and if people are gambling they'll look for the flashiest new casino in town.

QuoteIf money is cheap, people gamble, and if people are gambling they'll look for the flashiest new casino in town.Low rates would mean tight money policy not loose money. I can't make sense of the fact that when rates fall below 2%, investors and businesses who are normally rational and profit maximizing just go insane and start gambling all of a sudden. If that's the case, then the problem is not with QE but with financial literacy, and we have to think about significant financial regulations instead of monetary policy.Btw, Bill Gross was making this argument before, that when yields are low people gamble. In the letter farmer posted, he changed his tune. Now he says low yields mean that people won't take enough risk, which is the oxygen to the brain or the blood to the heart or whatever metaphor he was using. I agree with the latter Bill Gross.

QuoteOriginally posted by: gardener3QuoteIf money is cheap, people gamble, and if people are gambling they'll look for the flashiest new casino in town.Low rates would mean tight money policy not loose money. I can't make sense of the fact that when rates fall below 2%, investors and businesses who are normally rational and profit maximizing just go insane and start gambling all of a sudden. If that's the case, then the problem is not with QE but with financial literacy, and we have to think about significant financial regulations instead of monetary policy.Btw, Bill Gross was making this argument before, that when yields are low people gamble. In the letter farmer posted, he changed his tune. Now he says low yields mean that people won't take enough risk, which is the oxygen to the brain or the blood to the heart or whatever metaphor he was using. I agree with the latter Bill Gross.Hmmmm I thought low rates == loose money but the terminology isn't important.At some level the entire reason for boosting the money supply in the wake of a recession is to provoke people to gamble. It's the scarring effects of a recession that causes a synchronous decline in investment in capacity, business formation, and innovation that keeps an economy from recovering. Reducing risk aversion is good as long as the risks taken with the cheap money are well diversified. The challenge for the central banker is to prevent all that money from piling into one "sure bet" next bubble sector.Technology was the "sure thing" bubble sector after the early 1990s recession. Housing was the "sure thing" bubble sector after the early 2000s recession. I suspect Treasury bonds have been the "sure thing" in the last few years.Financial literacy won't help because it's too easy to construct a plausible explanation for why dot-coms, houses, T-bond, etc. are fairly priced no matter how high the price. The bulls have their justification for ∂Price/∂t >> 0, the bears have their justification for ∂Price/∂t << 0, and during the bubble, the empirical data supports the bulls.

QuoteOriginally posted by: Traden4AlphaQuoteOriginally posted by: gardener3QuoteIf money is cheap, people gamble, and if people are gambling they'll look for the flashiest new casino in town.Low rates would mean tight money policy not loose money. I can't make sense of the fact that when rates fall below 2%, investors and businesses who are normally rational and profit maximizing just go insane and start gambling all of a sudden. If that's the case, then the problem is not with QE but with financial literacy, and we have to think about significant financial regulations instead of monetary policy.Btw, Bill Gross was making this argument before, that when yields are low people gamble. In the letter farmer posted, he changed his tune. Now he says low yields mean that people won't take enough risk, which is the oxygen to the brain or the blood to the heart or whatever metaphor he was using. I agree with the latter Bill Gross.Hmmmm I thought low rates == loose money but the terminology isn't important.At some level the entire reason for boosting the money supply in the wake of a recession is to provoke people to gamble. It's the scarring effects of a recession that causes a synchronous decline in investment in capacity, business formation, and innovation that keeps an economy from recovering. Reducing risk aversion is good as long as the risks taken with the cheap money are well diversified. The challenge for the central banker is to prevent all that money from piling into one "sure bet" next bubble sector.Technology was the "sure thing" bubble sector after the early 1990s recession. Housing was the "sure thing" bubble sector after the early 2000s recession. I suspect Treasury bonds have been the "sure thing" in the last few years.Financial literacy won't help because it's too easy to construct a plausible explanation for why dot-coms, houses, T-bond, etc. are fairly priced no matter how high the price. The bulls have their justification for ∂Price/∂t >> 0, the bears have their justification for ∂Price/∂t << 0, and during the bubble, the empirical data supports the bulls.This is from the master himself: http://www.hoover.org/publications/hoov ... e/6549"Low interest rates are generally a sign that money has been tight, as in Japan; high interest rates, that money has been easy... After the U.S. experience during the Great Depression, and after inflation and rising interest rates in the 1970s and disinflation and falling interest rates in the 1980s, I thought the fallacy of identifying tight money with high interest rates and easy money with low interest rates was dead. Apparently, old fallacies never die."The point of boosting the money supply is no to provoke people to gamble, it's to get people to spend.

QuoteOriginally posted by: gardener3This is not a good example. If you tighten and loosen money for no good reason you'll create excess volatility.... The point is to create aggregate price stability not target some specific asset.I specifically offered an example of tight and loose money which created price stability. Without the tight and loose, the average price change was +3% in the first year, and -1% in the second year. The tight and loose created price stability as intended, for an average price gain of 1% each year, across houses and cars.QuoteOriginally posted by: gardener3Sure, some assets will appear relatively more risky after money creation but that's because they were mispriced to begin with.Cars appeared more risky because their volatility increased. This is regardless of begin or end price, or whether they were mispriced. If the goal were to get to a "correct" price that would reduce volatility. Since presumably your intervention is to stop prices from moving away from your "correct" price.QuoteOriginally posted by: gardener3Suppose we decompose the nominal return into real return and inflation: ret + inf. The variation in ret is based on fundamental supply and demand changes.The demand for houses went up in my example. The price was volatile because of changing conditions in supply and demand for houses. Changes in the supply of money hid that fact.

Today Draghi has increased interest-rate safety with the addition of forward guidance. Whereas Bernanke began dialing up interest-rate uncertainty starting May 22nd. So this could be a test case. Will US growth exceed today's projections, in total contradiction to what Bernanke fears, while Europe's growth begins to lag today's projections, in total contradiction of Draghi's hopes?My model predicted ADP employment for June would surprise on the upside, and it did.We also have Japan where unemployment recently dropped despite continued deflation, an energy shock, an increasing trade deficit, low capital spending, an extreme increase in interest-rate uncertainty, a slowdown in China and a Chinese boycott, and nothing but vapor for Abe's third-arrow economic reforms.My earlier model which did not include the beneficial effects of interest-rate risk was wrong on the direction of Japanese unemployment.