Free Exchange on the mystery of stable prices

Forgot to save a piece in the Free Exchange blog on the inflation unemployement discussion a few posts down. Here it is.

Monetary Policy’s Effect On Risk Taking

This BIS working paper provides empirical evidence for earlier posts. Abstract:

This paper investigates the relationship between short-term interest rates and bank risk. Using a unique database that includes quarterly balance sheet information for listed banks operating in the European Union and the United States in the last decade, we find evidence that unusually low interest rates over an extended period of time contributed to an increase in banks’ risk. This result holds for a wide range of measures of risk, as well as macroeconomic and institutional controls.

Monetary Policy and Financial Stability

Tim Duy has a good piece on the FED’s potential conflict between pursuing its dual mandate—full employment and price stability—and finanical stability.

Bottom Line: If Kocherlakota is correct and monetary policy can only pursue the dual mandate in the context of financial – and, by extension – macroeconomic instability, then we really need to consider which part of the dual mandate needs to be loosened to reduce the reliance on financial instability. My fear is that if Fed policy makers were asked this question, they would unanimously answer that it is the full-employment portion of the mandate that should be jettisoned.

Adam Posen on Debt and the Dismal Science

An interesting FT opinion piece by Adam Posen on the Reinhart & Rogoff discussion, the causality between debt and GDP growth and on how empirical evidence against bad economic ideas (slowly) leaves its mark on public debate and policy making.

A Model Of Risk

Karl Smith provides an interesting way to think about risk in financial markets and financial stability.

Policy makers drive down systemic background risk. This makes everyone safer. In response, each individual takes on a little more personal risk and contributes slightly to the general background risk…. Said another way, attempts to prevent bubbles from forming will only make folks more complacent about bubbles.

Where is that Deflation?

This post by Krugman links to an older piece of himself, where he discusses the possibility of wage rigidity as a cause for the lack of deflation in the current crisis. Also, it links to two new studies, both showing that inflation is low to respond to unemployment once inflation is low already.

Krugman on Writing and Beating Dead Horses

Krugman explains his approach to writing for the broader public. Helpful stuff.

Krugman and Irwin on Bitcoins and Money

Quoting Adam Smith from back in 1776, Krugman highlights one of the major shortcomings of bitcoins — it uses up real ressources to produce absolutely nothing of value. His conclusion:

And now here we are in a world of high information technology — and people think it’s smart, nay cutting-edge, to create a sort of virtual currency whose creation requires wasting real resources in a way Adam Smith considered foolish and outmoded in 1776.

He also links to a worthwhile piece by Neil Irwin at the WaPo, who — after making sure everyone knows what money actually is — lists another two major shortcomings of the techy currency. First, lacking the backing of any government, it will never eliminate the need for other currencies and second, its inelastic nature makes it prone to massive price swings. Irwin ends with an important reminder:

In effect, bitcoin is a reminder of this fundamental truth: To function in a modern economy, you’re always putting your faith in something, whether you like it or not. And you may not like putting that faith in a powerful, independent central bank imbued with power from the state, but the alternatives may just be a lot worse.

Getting Out of Debt by Adding Debt

I just re-read Paul Krugman’s post on why more debt can be a solution—actually, why it is the only solution— to debt and want to save it for future reference. (Because it seems this discussion is not going away anytime soon.)

This is part of a broader discussion on “Balance-sheet recessions” and in this context I also want to save a brilliant series of posts by Martin Wolf, that starts with this post, and makes the same point as Krugman above in this post (from which, by the way, I borrowed the title of my own post).

Finally, there is a informative looking IMF working paper on the issue that I have meant to look at but haven’t yet. In case an occasion for that presents itself, here it is.

Friedman Updates From Beirut to Jerusalem

There aren’t that many books I have meant to read for as long as Thomas Friedman’s From Beirut to Jerusalem. Now, the good news is that Friedman just finished the first substantial update since the original publication in 1989, adding some sections on the Arab Spring that he discusses on Charlie Rose. The bad news, of course, is that I still haven’t actually read the book.