Serious question: of course, I'm now reading you on your new substack, but I'm using an RSS feed reader to load your articles as they're published; so, I'm not technically 'subscribed' via substack since the only way they seem to allow is for me to be sent emails letting me know each time you publish, which I don't want in my inbox (and is needles since you'll show up in my RSS reader anyway). BUT if it helps you in some way (maybe my 'subscription' to you doesn't otherwise count) then I would let substack send those emails. Please advise.
On Moby Dick, it's great, really great! But, limiting it to American authors, Huckleberry Finn is better still. One shouts, look at how utterly amazing my writing, my insights, my catalogue of everything! The other does these things and we barely notice the doings.
On best chapter, well 42 is for sure the most famous, the most Shakespeare like. But I'd argue for chapter 10, A Bosum Friend, with the great passage that ends, "Queequeg was George Washington cannibalistically developed."
No need to subscribe at the present. I'll defer to your view on literature, which is probably better than mine. I will say that I favor good description of nature more than the average reader, which is probably why I prefer Melville to Twain.
The problem of using the concept of the natural rate of interest ( my respectfor Wicksell is enormous) is it argues a policy from the point of prices and not quantities. Your notion of targeting nominal income as a monetary guide solves that problem
“Consider the subtleness of the sea; how its most dreaded creatures glide under water, unapparent for the most part, and treacherously hidden beneath the loveliest tints of azure. Consider also the devilish brilliance and beauty of many of its most remorseless tribes, as the dainty embellished shape of many species of sharks. Consider, once more, the universal cannibalism of the sea; all whose creatures prey upon each other, carrying on eternal war since the world began.
Consider all this; and then turn to this green, gentle, and most docile earth; consider them both, the sea and the land; and do you not find a strange analogy to something in yourself? For as this appalling ocean surrounds the verdant land, so in the soul of man there lies one insular Tahiti, full of peace and joy, but encompassed by all the horrors of the half known life. God keep thee! Push not off from that isle, thou canst never return!”
Proust and Cervantes I rate the best…among Americans, it would be Faulkner and Nabokov’s English novels for me.
Certainly Melville is less skilled than at least most of the great novelists you mentioned, but greatness is about more than skill. Not saying you are wrong, but it's like comparing the crude but powerful paintings of Giotto with the more sophisticated Renaissance art that came later. In Moby Dick, everything sort of came together in a miraculous way. Reading all his other novels, it was hard to see this one coming.
In Search of Lost Time might well be my favorite novel, it's hard to say.
I think Forecastle at Midnight is a better chapter (don't know the number). It's the chapter immediately following the oath chapter. It's brilliant psychologically, with the reaction of the crew to the evil of the oath taking responding in the frivolity of an impromptu party on the ship deck. Full of humor, but also disturbingly unsettling. You can see the souls of the deck hands seeking relief from the burden of the oath they just took.
I approach this issue from a different perspective this week, having compared the growth paths of NGDP and the concurrent quarter S&P 500 earnings yield for the first time. Levels matter. Hence, the growth path comparison suggests that the economy is not running nearly as hot as a pure rate perspective would suggest. The NGDP output gap indicator indicates recent growth rates are well-above sustainable, which is useful information, but not determintive. The path comparison reveals economic growth potential. I posted two charts illustrating this in this note:
As you pointed out, interest is the price of credit. The price of money is the reciprocal of the price level.
The activation of monetary savings increases the supply of loan funds, but not the supply of money. Thus, the nominal rate of interest fluctuates conterminously, other things equal.
Banks aren't intermediaries. The source of interest-bearing deposits is other bank deposits. Banks don't loan out savings.
The 1966 interest rate inversion didn't produce a recession because the banks were driven out of the savings business. The nonbanks were given a 3/4 point interest rate differential in the first of their Reg. Q ceilings.
Whereas the 1966 Interest Rate Adjustment Act reduced the proportion of TDs to DDs by 7 percent, C-19 has reduced the proportion by 16%. This economic punch has heretofore kept us out of a recession.
What do you think of Steven Landsburg's theory of what drives (real) interest rates: "Interest rates are largely determined by the difference between prosperity now and expected prosperity in the future. If everyone expects to be a lot richer in ten years, they’ll try to borrow more now and drive interest rates up. If everyone expects to be a lot poorer in ten years, they’ll try to save more now and drive interest rates down." https://www.thebigquestions.com/2024/08/01/the-next-trump-cabinet/
Yes, that's part of it, but nominal shocks also affect interest rates (via the business cycle.) He might respond that the business cycle does affect expectations of future growth.
I think the natural rate hypothesis is theoretically intuitive, but in practice it runs into the problem you mention above about difficulty measuring the real natural rate.
Lately, I have found it more useful to compare the Fed's policy rates to the Taylor rule or other monetary policy rules. The Taylor rule benefits from being a well-known benchmark that the Fed is paying attention to internally. It also incorporates the expected inflation in your nominal neutral rate (it also incorporates a real neutral rate component, but most people just fix it at a constant). But no reason why that should be the only rule to compare Fed policy to.
Anyway, I use these comparisons more as a way to say "is Fed policy consistent with X monetary policy rule" rather than as part of an economic model. Implicitly you have a model that nominal GDP is a function of the difference between the Fed's policy rate and the nominal natural rate.
Moby Dick is one of those books that people tried to intimidate others away from reading. They would complain about its length and long chapters devoted to whale biology and such. So I don't think I ended up reading it until my late 20s. Lo and behold, I absolutely loved the book and ate up the long chapters devoted to whale biology. Since I had read a bunch of other much longer books already, I didn't even feel like it was that long of a book. This experience made me half-tempted to read Joyce's Ulysses or Finnegan's Wake, but I still remember slogging through Dubliners in high school English. Anyway, I would much rather re-read books like Moby Dick or War and Peace than something like Infinite Jest.
I won’t disagree with 1. or 3., but chapter 113 should be in consideration simply for these sentences at the end:
When the blacksmith had forged the head and welded it to the shank to complete the harpoon, he called for water to quench and temper the red-hot iron -- but Ahab said no.
"'No, no -- no water for that; I want it of the true death-temper. Ahoy, there! Tashtego, Queequeg, Daggoo! What say, ye, pagans! Will ye give me as much blood as will cover this barb?' A cluster of dark nods replied, 'Yes.'"
Quenching the hot iron in blood, Ahab howled deliriously, "I baptize thee not in the name of the Father but in the name of the devil."
And chapter 110 when its noted that Queequeg had the secrets of the universe tattooed on his body, but no one understands them and he can’t speak their language to explain.
Yes, there are lots of great examples. I am reading this just after having worked through all of his other books, and it's like a compilation of his best techniques from elsewhere.
What are the arguments that the natural rate exists, as opposed to only being a useful idea? I struggle because the natural rate isn’t something that is directly observable. Is there some way to test its existence? Or is it just a useful, but unfalsifiable heuristic? One thing that I have always liked about NGDP targeting is that NGDP isn’t a concept, it is something that is actually observable.
"What are the arguments that the natural rate exists, as opposed to only being a useful idea?"
I'd say there are none. But I suppose that's because I hold the weird philosophical view that all of our perceptions of reality are fundamentally about what is useful.
I just re read Moby Dick for the first time since High School, I agree it’s the greatest American Novel, albeit not the Great American Novel. I don’t consider Ahab uniquely American.
I think the Great American Novel is clearly the Grapes of Wrath.
That's on my very long list of great novels that I have yet to read. I'm a slow reader. Recently, I spend months on In Search of Lost Time. Life's too short.
As long as the Fed is targeting inflation, is the 5 year breakeven the best market price for them to follow? I see that the 5 year breakeven has now dropped to 1.90%, implying ~1.65% PCE over the next 5 years. In conjunction, the CME forecast for the next Fed meeting is 60% chance of 25bps and 40% chance of 50bps. Seems like that means the market views a cut of 25bps as falling behind the curve.
That might be correct. If the employment report is weak then a 50 basis point cut may be appropriate. While the 5-year breakeven is a reasonable starting point, there are ways to get a slightly better estimate. Thus when oil prices fall sharply, the TIPS spread will slightly understate the actual expected rate of inflation.
I think it's related to the lag in the adjustment of TIPS prices. Thus they reflect not just expected inflation going forward, but also recent past changes in commodity prices.
To add to Scott's comment, the nice thing about TIPs is that it is a market price and you can see how they move in real time (or delayed 15 minutes in my case). However, a major issue for TIPs is that they don't have the same liquidity profile as nominal Treasuries. During the financial crisis, some people were dumping their TIPs holdings into a market with few buyers. The effect was to send TIPs yields much higher, while Treasury yields were falling. This pushed down 5-year breakeven inflation down to less than -2%, which was inconsistent with what professional forecasters were expected at the time. There was a similar move during March 2020, but the Fed stepped in to provide liquidity.
In terms of better estimates, there are inflation expectations numbers from Cleveland Fed and the Philly Fed SPF. The Fed also updates a DKW inflation expectation. However, these are all only updated monthly or quarterly. If you're interested in market prices, you can look at information from inflation swaps. My colleague also closely follows the CPI fixing market.
There are a lot of reasons why inflation swaps are less liquid, but it helps to understand that when you enter a swap, the present value of it is zero. It may gain or lose estimated value over the course of the swap, but it's in a different category of instrument than a bond. So if a bank is looking around its balance sheet in a crisis for things to sell to raise cash, exiting inflation swaps isn't likely to be something that makes sense. By contrast, a TIP is a bond and they know how to sell that and get cash.
As far as I know, he gets it from Morgan Stanley reports. There are CPI Fixing series on Bloomberg, but I don't subscribe to it.
Yes, it is known as the TIPS-Treasury Bond Puzzle.
I found two pieces on it if you're interested. The first is well-written. I didn't read the paper that is discussed in the second one, but it has good charts.
Serious question: of course, I'm now reading you on your new substack, but I'm using an RSS feed reader to load your articles as they're published; so, I'm not technically 'subscribed' via substack since the only way they seem to allow is for me to be sent emails letting me know each time you publish, which I don't want in my inbox (and is needles since you'll show up in my RSS reader anyway). BUT if it helps you in some way (maybe my 'subscription' to you doesn't otherwise count) then I would let substack send those emails. Please advise.
On Moby Dick, it's great, really great! But, limiting it to American authors, Huckleberry Finn is better still. One shouts, look at how utterly amazing my writing, my insights, my catalogue of everything! The other does these things and we barely notice the doings.
On best chapter, well 42 is for sure the most famous, the most Shakespeare like. But I'd argue for chapter 10, A Bosum Friend, with the great passage that ends, "Queequeg was George Washington cannibalistically developed."
No need to subscribe at the present. I'll defer to your view on literature, which is probably better than mine. I will say that I favor good description of nature more than the average reader, which is probably why I prefer Melville to Twain.
The problem of using the concept of the natural rate of interest ( my respectfor Wicksell is enormous) is it argues a policy from the point of prices and not quantities. Your notion of targeting nominal income as a monetary guide solves that problem
I love this Moby Dick bit:
“Consider the subtleness of the sea; how its most dreaded creatures glide under water, unapparent for the most part, and treacherously hidden beneath the loveliest tints of azure. Consider also the devilish brilliance and beauty of many of its most remorseless tribes, as the dainty embellished shape of many species of sharks. Consider, once more, the universal cannibalism of the sea; all whose creatures prey upon each other, carrying on eternal war since the world began.
Consider all this; and then turn to this green, gentle, and most docile earth; consider them both, the sea and the land; and do you not find a strange analogy to something in yourself? For as this appalling ocean surrounds the verdant land, so in the soul of man there lies one insular Tahiti, full of peace and joy, but encompassed by all the horrors of the half known life. God keep thee! Push not off from that isle, thou canst never return!”
Proust and Cervantes I rate the best…among Americans, it would be Faulkner and Nabokov’s English novels for me.
Great choices.
Certainly Melville is less skilled than at least most of the great novelists you mentioned, but greatness is about more than skill. Not saying you are wrong, but it's like comparing the crude but powerful paintings of Giotto with the more sophisticated Renaissance art that came later. In Moby Dick, everything sort of came together in a miraculous way. Reading all his other novels, it was hard to see this one coming.
In Search of Lost Time might well be my favorite novel, it's hard to say.
I think Forecastle at Midnight is a better chapter (don't know the number). It's the chapter immediately following the oath chapter. It's brilliant psychologically, with the reaction of the crew to the evil of the oath taking responding in the frivolity of an impromptu party on the ship deck. Full of humor, but also disturbingly unsettling. You can see the souls of the deck hands seeking relief from the burden of the oath they just took.
Good points. I'd have to read it 5 more times to form an intelligent opinion.
"Unit labor costs in the nonfarm business sector increased 0.4 percent in the second quarter of 2024,
reflecting a 3.0-percent increase in hourly compensation and a 2.5-percent increase in productivity. Unit
labor costs increased 0.3 percent over the last four quarters, the lowest rate since the fourth quarter of
2013, when the measure decreased 2.2 percent. (See tables A1 and 2.)"---BLS
Unit labor costs are up 0.3% in the last four quarters...that's total. Labor markets are not the cause of inflation, at least on paper.
I approach this issue from a different perspective this week, having compared the growth paths of NGDP and the concurrent quarter S&P 500 earnings yield for the first time. Levels matter. Hence, the growth path comparison suggests that the economy is not running nearly as hot as a pure rate perspective would suggest. The NGDP output gap indicator indicates recent growth rates are well-above sustainable, which is useful information, but not determintive. The path comparison reveals economic growth potential. I posted two charts illustrating this in this note:
https://substack.com/@exactmacro/note/c-68062693
Quite clear, as long as you understand the concept of the natural/neutral rate of interest.
https://www.rba.gov.au/publications/bulletin/2017/sep/pdf/bu-0917-2-the-neutral-interest-rate.pdf
As you pointed out, interest is the price of credit. The price of money is the reciprocal of the price level.
The activation of monetary savings increases the supply of loan funds, but not the supply of money. Thus, the nominal rate of interest fluctuates conterminously, other things equal.
Banks aren't intermediaries. The source of interest-bearing deposits is other bank deposits. Banks don't loan out savings.
The 1966 interest rate inversion didn't produce a recession because the banks were driven out of the savings business. The nonbanks were given a 3/4 point interest rate differential in the first of their Reg. Q ceilings.
Whereas the 1966 Interest Rate Adjustment Act reduced the proportion of TDs to DDs by 7 percent, C-19 has reduced the proportion by 16%. This economic punch has heretofore kept us out of a recession.
What do you think of Steven Landsburg's theory of what drives (real) interest rates: "Interest rates are largely determined by the difference between prosperity now and expected prosperity in the future. If everyone expects to be a lot richer in ten years, they’ll try to borrow more now and drive interest rates up. If everyone expects to be a lot poorer in ten years, they’ll try to save more now and drive interest rates down." https://www.thebigquestions.com/2024/08/01/the-next-trump-cabinet/
Yes, that's part of it, but nominal shocks also affect interest rates (via the business cycle.) He might respond that the business cycle does affect expectations of future growth.
It's just the difference between the supply of money and the supply of loanable funds.
I think the natural rate hypothesis is theoretically intuitive, but in practice it runs into the problem you mention above about difficulty measuring the real natural rate.
Lately, I have found it more useful to compare the Fed's policy rates to the Taylor rule or other monetary policy rules. The Taylor rule benefits from being a well-known benchmark that the Fed is paying attention to internally. It also incorporates the expected inflation in your nominal neutral rate (it also incorporates a real neutral rate component, but most people just fix it at a constant). But no reason why that should be the only rule to compare Fed policy to.
Anyway, I use these comparisons more as a way to say "is Fed policy consistent with X monetary policy rule" rather than as part of an economic model. Implicitly you have a model that nominal GDP is a function of the difference between the Fed's policy rate and the nominal natural rate.
The term "natural rate hypothesis" generally refers to the natural rate of unemployment. But the two concepts are closely related.
Moby Dick is one of those books that people tried to intimidate others away from reading. They would complain about its length and long chapters devoted to whale biology and such. So I don't think I ended up reading it until my late 20s. Lo and behold, I absolutely loved the book and ate up the long chapters devoted to whale biology. Since I had read a bunch of other much longer books already, I didn't even feel like it was that long of a book. This experience made me half-tempted to read Joyce's Ulysses or Finnegan's Wake, but I still remember slogging through Dubliners in high school English. Anyway, I would much rather re-read books like Moby Dick or War and Peace than something like Infinite Jest.
I often find long books to be easier to read than short books.
I won’t disagree with 1. or 3., but chapter 113 should be in consideration simply for these sentences at the end:
When the blacksmith had forged the head and welded it to the shank to complete the harpoon, he called for water to quench and temper the red-hot iron -- but Ahab said no.
"'No, no -- no water for that; I want it of the true death-temper. Ahoy, there! Tashtego, Queequeg, Daggoo! What say, ye, pagans! Will ye give me as much blood as will cover this barb?' A cluster of dark nods replied, 'Yes.'"
Quenching the hot iron in blood, Ahab howled deliriously, "I baptize thee not in the name of the Father but in the name of the devil."
And chapter 110 when its noted that Queequeg had the secrets of the universe tattooed on his body, but no one understands them and he can’t speak their language to explain.
Yes, there are lots of great examples. I am reading this just after having worked through all of his other books, and it's like a compilation of his best techniques from elsewhere.
What are the arguments that the natural rate exists, as opposed to only being a useful idea? I struggle because the natural rate isn’t something that is directly observable. Is there some way to test its existence? Or is it just a useful, but unfalsifiable heuristic? One thing that I have always liked about NGDP targeting is that NGDP isn’t a concept, it is something that is actually observable.
"What are the arguments that the natural rate exists, as opposed to only being a useful idea?"
I'd say there are none. But I suppose that's because I hold the weird philosophical view that all of our perceptions of reality are fundamentally about what is useful.
I just re read Moby Dick for the first time since High School, I agree it’s the greatest American Novel, albeit not the Great American Novel. I don’t consider Ahab uniquely American.
I think the Great American Novel is clearly the Grapes of Wrath.
That's on my very long list of great novels that I have yet to read. I'm a slow reader. Recently, I spend months on In Search of Lost Time. Life's too short.
As long as the Fed is targeting inflation, is the 5 year breakeven the best market price for them to follow? I see that the 5 year breakeven has now dropped to 1.90%, implying ~1.65% PCE over the next 5 years. In conjunction, the CME forecast for the next Fed meeting is 60% chance of 25bps and 40% chance of 50bps. Seems like that means the market views a cut of 25bps as falling behind the curve.
That might be correct. If the employment report is weak then a 50 basis point cut may be appropriate. While the 5-year breakeven is a reasonable starting point, there are ways to get a slightly better estimate. Thus when oil prices fall sharply, the TIPS spread will slightly understate the actual expected rate of inflation.
"Thus when oil prices fall sharply, the TIPS spread will slightly understate the actual expected rate of inflation."
Why is that?
I think it's related to the lag in the adjustment of TIPS prices. Thus they reflect not just expected inflation going forward, but also recent past changes in commodity prices.
To add to Scott's comment, the nice thing about TIPs is that it is a market price and you can see how they move in real time (or delayed 15 minutes in my case). However, a major issue for TIPs is that they don't have the same liquidity profile as nominal Treasuries. During the financial crisis, some people were dumping their TIPs holdings into a market with few buyers. The effect was to send TIPs yields much higher, while Treasury yields were falling. This pushed down 5-year breakeven inflation down to less than -2%, which was inconsistent with what professional forecasters were expected at the time. There was a similar move during March 2020, but the Fed stepped in to provide liquidity.
In terms of better estimates, there are inflation expectations numbers from Cleveland Fed and the Philly Fed SPF. The Fed also updates a DKW inflation expectation. However, these are all only updated monthly or quarterly. If you're interested in market prices, you can look at information from inflation swaps. My colleague also closely follows the CPI fixing market.
Wouldn't inflation swaps also suffer from the same problem of illiquidity? Or are both legs equally illiquid so they somewhat cancel each other?
Do you know where your friend gets CPI fixing market information? I hadn't heard of this market and briefly googled it. I found this article: https://www.marketwatch.com/story/morgan-stanley-finds-a-way-to-trade-u-s-dollar-based-on-obscure-markets-accuracy-on-inflation-11658763001
There are a lot of reasons why inflation swaps are less liquid, but it helps to understand that when you enter a swap, the present value of it is zero. It may gain or lose estimated value over the course of the swap, but it's in a different category of instrument than a bond. So if a bank is looking around its balance sheet in a crisis for things to sell to raise cash, exiting inflation swaps isn't likely to be something that makes sense. By contrast, a TIP is a bond and they know how to sell that and get cash.
As far as I know, he gets it from Morgan Stanley reports. There are CPI Fixing series on Bloomberg, but I don't subscribe to it.
If CPI swaps are more accurate, can you use them to arbitrage pricing errors between TIPS and conventional bonds?
Yes, it is known as the TIPS-Treasury Bond Puzzle.
I found two pieces on it if you're interested. The first is well-written. I didn't read the paper that is discussed in the second one, but it has good charts.
https://www.anderson.ucla.edu/sites/default/files/documents/areas/fac/finance/longstaff%20TIPS.pdf
https://libertystreeteconomics.newyorkfed.org/2024/07/exploring-the-tips-treasury-valuation-puzzle/
Thanks John.
Would the natural interest rate only change in response to *unanticipated* Fed target rate adjustments?
No, other factors like fiscal policy and productivity shocks also affect the natural rate.