Yellin’ at Yellen II
First I would like to stress again that I have great respect of Janet Yellen. I try to only critize people whom I respect (my posts show just how respectful I am in general).
So this comment on her use of event studies is really a comment on event studies and not on Yellen in particular. I mainly objected to “Event studies can therefore be helpful.” That is not a strong claim and I don’t really disagree, but I would add “but not very helpful, because announcements can be declared non events on the grounds that they were anticipated, so conclusions based on event studies depend on judgment — something which they have in common with conclusions which aren’t based on data at all.”
More highly respectful verbal abuse* after the jump.
* that was meant as a joke.
I have the 7 year nominal treasury rate, the 7 year TIPS rate and the difference in this Fred graph which I don’t know how to embed. I see current rates are similar to those before the first announcement (August 2010). Looking at daily data, I think I see rates going up at the November announcement (that would correspond to investors thinking QE matters and there being less than expected). I don’t see much of any change pre-August to post November. The graph sure doesn’t look like a response to a larger open market operation than any in the 20th century. I think that money and 7 year notes are close substitutes now.
I had a methodological complaint about analysing four data points and ignoring two, because of an arguably valid claim that announcements were anticipated. Before moving on, I stress that, if QE has a fairly large fundamental effect, then the undetectably small response to the annoucement can be explained only if markets anticipated that QEII would be approximately half a trillion $ worth of purchases of long term treasuries. If the market had expected a trillion, and QE has a fairly large fundamental effect, then real interest rates should have jumped up. The actual market response to the announcement requires not only forward looking agents but also something fairly close to perfect forecasts of Fed policy.
I now ask myself if I can come up with another explanation of the data — one in which QEII would have had a small effect even if it hadn’t been anticipated ?
I have two explanations of the pattern. I present them partly to illustrate my objection to event studies.
The first is that the standard interpretation of event studies depends on the efficient markets hypothesis. The original idea is that the market knows the effect of policy, so we can learn what policy does by looking at the response of asset prices to the announcement. I don’t accept the premise, so I don’t accept the method.
It was clear that many people thought that the huge expansion of Fed liabilities would cause increased inflation. Some people predicted hyperinflation. Assume (as a modelling exercize) that about 10% of the risk bearing capacity of the market is controlled by people who believe in the quantity theory of high powered money — so a tripling of the supply of high powered money should cause almost a tripling of the price level some time soon. This implies a huge effect of QEI on expected inflation and on the spread between the return on regular nominal treasuries and CPI indexed TIPS.
Then inflation actually declined confirming Phillips curvaciouse predictions. No one admitted they had been wrong (people don’t do that) but people learned. The effect of QEI was not a fundamental effect. It wouldn’t have happened if people had rational expectations.
Then by last November people had learned and so QEII had a microscopic effect on asset prices.
It does not seem reasonable to assume that people know conditional expected values (I could stop there) conditional on events which have never occured in human history. That assumption is absolutely required in order to use two events to determine a structural fundamental effect of quantitative easing.
To try to summarize, the effect of QEI and QEI.5 could have been due to irrational belief in the quantity theory of money which no longer exists so they tell us nothing useful about the effect of future quantitative easing.
Was the effect in November microscopic because investors had correctly predicted something very close to half a trillion of purchases of 7 year notes or because they had decided that Fed purchases of 7 year notes matter very little ? I think there is no way to know.
A second problem with event studies is that one has to know which possible future events are like the past events in the data set. Yellen’s analysis and the analysis above depends on the assumption that quantitative easing is one thing. In particular it depends on the assumption that 7 year Treasury notes are just like Federal agency issued MBS which are just like commercial paper in 2008. QE involves the Fed issuing liabilities and purchasing assets, but the assets are different.
In Summer 2010, I saw no reason to think that it would matter much if the Fed bought hundreds of billions of 7 year Treasury notes. Nothing which has happened since should make me change my mind.
The effect of a given quantity of asset purchases on asset prices should depend on the elasticity of demand for those assets. The elasticity of demand for assets should depend on the covariance of their returns wwith that of the market portfolio. 7 year Treasury notes are perceived to bevery safe. MBS were not perceived to be safe at all when the Fed bought a $ trillion worth of them. Elementary theory suggests extremely different effects of QE I and QE II on asset prices. Yellen’s analysis is based on the assumption that the magnitude of the effects is known a priori to be similar. That makes no sense.
Also fall 2008 and winter 2008-9 were very different from summer 2010 and fall 2010. Many firms were desperate for liquid assets. They feared they might be subject to a run and didn’t wan’t to have to sell illiquid assets at fire sale prices. There was a huge spike in demand for high powered money. It is entirely possible that QE I was needed to keep the safe short term interest rate near zero. In other words, QE I might have been conventional policy which was extreme in scale, because market conditions were extreme.
In the end I don’t have a conclusion. I don’t claim that we can dismiss all evidence as irrelevant to the current policy debate because things were different then or because the policy is vaguely similar but not the same. But things were different then.
I believe that a sudden surprise announcement of another half trillion of purchases of 7 year Treasury notes would have a small effect on the real economy. That’s what I guessed last year and there certainly isn’t any new evidence that should cause me to change my view.
“In Summer 2010, I saw no reason to think that it would matter much if the Fed bought hundreds of billions of 7 year Treasury notes. Nothing which has happened since should make me change my mind.”
Ah, so what we have is a strong prior view which you are now arguing was correct. In fact, you hold the view strongly enough that you feel the need to state it at least twice:
“That’s what I guessed last year and there certainly isn’t any new evidence that should cause me to change my view.”
So the argument is, Yellen’s event study cannot provide reliable results because…well because of a bunch of stuff. Non-replicability of initial conditions. Inability to know what expectations were. Something.
And the conclusion is that you must have been right last summer because Yellen hasn’t convinced you that you were wrong. And you call that no conclusion.
No, no, no. Bad argument. Bad, bad argument. Don’t make that argument. You’ve basically set of a contest between Yellen’s argument and your own priors, with you as the judge of the outcome, ignoring a universe of other non-Yellen, non-you possibilities. No. Bad argument.
And maybe bad inputs to your arument. We can’t tell, because you don’t tell us. In determining whether Yellen (that is to say, the entire Fed system) has a reasonable argument, one needs to know what they knew before the new round of asset purchases was announced. For us to evaluate your assessment of Yellen’s argument, we need to know what you know. We do not. We do not know whether you know that the Fed actively surveyed dealers and other market participants to know what size and average maturity of new asset purchase they expected. They did survey extensively, but we can’t tell whether you are aware of that. We do not know whether you are aware that the Fed modelled the reaction using a number of economic models, taking into account the expectations of market participants, and taking into account results different from their expectations. That modelling gives the Fed a baseline against which to judge actual outcomes. That seems to be what Yellen was doing, though we can’t tell. But the Fed did the modelling, and we can’t tell whether you are aware of that fact.
The Fed took this as an opportunity to assess its own judgements, to assess its ability to research expectations, to assess its ability to model. Now, Yellen may simply be making stuff up when she tells us how things worked out relative to what was expected. She may not. She may be telling us that things worked out just like the Fed’s extensive work prior to results coming in suggested they would. But what is certain is that she, and a whole bunch of other Fed folk, have a set of survey and modeling results in their little analytic hands, which allow them to assess whether things went “as expected” and whether actual results make sense relative to those expectations. And that rather large exercise at establishing what market expectations were needs to be taken into account when critiquing Yellen’s assessment of market performance against expectations regarding Fed policy.
Please read the post. In fact, start by reading the bits you quoted. I wrote “Nothing” and “there certainly isn’t any new evidence”. These are not statements about the strength of my prior. I did not just say that Yellen’s “argument” didn’t convince me. I said that there is no evidence dated 2010 or later in support of the view that quantitative easing is effective.
I base that claim on the evidence as described by Yellen in the quoted passage. She introduces the phrase “event study” that has a clear defintion and it refers to the changes in asset prices immediately following an announcement. She notes that following the November announcement of QEII the market response was “minimal”. That’s her word not mine.
She didn’t even discuss the market response to the first QEII related program announcement in August. She discussed price changes over a three month interval. That is absolutely not an event study. The whole point of an event study is to use precise timing for identification.
Yellen and I agree about the evidence. The statements which you read as statements about my prior are very very strong statements about the evidence dated 2010 and later (note the words “since then”). Yellen wrote the same thing about the evidence.
Her argument is that event studies are useful but that the events in 2010 are not useful because one of them was anticipated. She is arguing that the evidence doesn’t show what it seems to show. I am not. I just wrote how to interpret the evidence described by Yellen using the method praised, then criticized by Yellen.
I noted my prediction just to argue that I am not fitting everything and explaining nothing by thinking up an argument after the data are available. I did not confess to haveing a strong prior. I didn’t have a strong prior and don’t have a strong posterior. Nothing I wrote justifies your interpretation which makes no sense given the things I wrote which you quoted. You have just decided that you can interpret what I wrote while ignoring most of the words.
Now I will attempt to introspect and give a very very thorough description of any sources of irrationality which might plausibly have affected my two posts. I will insist that you do the same. I will interpret any knowledge of what follows to amount to an oath to honestly describe your true motivation.
I repeat I will attempt to introspect and give a very very thorough description of any sources of irrationality which might plausibly have affected my two posts. I will insist that you do the same. I will interpret any knowledge of what follows to amount to an oath to honestly describe your true motivation.
1. I do not like criticism of Barack Obama. I often recognise it is valid, but I don’t like it and tend to resist it. I live in the left blogosphere and hear criticism for reappointing Bernanke (K Drum) and not nominating more people sooner to the FOMC so the Republicans in the Senate can block them (M Yglesias).
2. I am a fan of Paul Krugman. He said, in advance, that QEII is no big deal. He wrote that only dynamically inconsistent (subgame imperfect) monetary policy or fiscal policy can save us. He tends rather often to be right. This time events occured exactly as he predicted. This happens rather often. It might be a lucky coincidence but I doubt it.
3. I highly respect and often criticize Yglesias. He doesn’t seem to read comments on his blog. His views on monetary policy are completely unaffected by the argument that it is different in a liquidity trap. I have repeatedly argued that it is different in a liquidity trap (that should be obvious) and had no effect. That makes me frustrated and intemperate.
4. I looked up data on FRED on QEII and TIPS. I am inclined to think that is a relevant contribution to the debate (it is redundant because Yellen made the exact same observation on the exact same data). Therefore, for once, there is an event study which I like (cause I did the 15 minutes of work) and I am not eager to agree that it is worth very little.
Not eager doesn’t mean not willing. I do agree — in my posts I just noted that a micrscopic wrong sign event is not evidence that the QE works hypothesis is true– this claim is obviously correct and agreed by Yellen and me. Contesting it as you do is very strange. Still FRED is my new toy and I have a bit of emotional attachment to my posts here.
5. I am not totally immune to theory. I see little similarity between buying MBS and commercial paper in 2008-9 and buying 7 year Treasury notes in 2010. The complete total utter difference in the results of studies of the different events makes sense to me.
OK I have explained those of my motives which are irrational (ranging up to totally irrational). I do this in the name of absolute honesty. I am fairly proud of myself as I can’t recall the last time someone scrutinised his or her possible sources of irrationality so harshly in the middle of a polemic.
Now KHarris, if you have read this far, I demand the same. Why did you comment as you did ? I submit that it is not possible that you wrote your claims about what I wrote because they were a natural reading. There is no doubt in my mind that you have some motivation which you did not describe. If you read this comment, then you are honor bound to honestly describe you motivations (you were warned in advance).
Speaking of irrationality, you will notice that I am very very upset. It seems to me that you have questioned my rationality based on your choice to interpret what I wrote ignoring words that you quote.
I forgot one.
6. during the debate over the stimulus bill some right wing site (NRO or something) quoted Lucas as saying “non standard monetary policy hasn’t been tried” or something. I naturally assume that everything Lucas says about the real world is false. More generally, I was convinced that fiscal policy was needed (and am convinced that an increase in government spending right now would be excellent policy). That tends to make me inclined to doubt the effectiveness of monetary policy.
I have now read the entire Kharris comment. I think it is clear that Kharris didn’t read the quoted statement by Yellen. Yellen did not say that asset markets responded as expected to QEII, she said that the response was minimal.
KHarris has decided to contest that simple claim of fact made by Yellen. Yellen argued that event studies are sometimes useful and sometimes not and the study of the event in November 2010 was not useful.
The Fed’s stated aim with QEII was to cause a decline in long term interest rates. No such decline occured. This is a simple fact which Khariss chooses to contest. I have no idea why (although given my very honest explanation of all possible sources of bias which I might have I expect that if Kharris reads the to replies immediately above that I get an explanation).
I can’t have anything to do with the data on asset prices in November 2010. Yellen and I agree about that data. Kharris contests our claim.
I realize that, by blog convention, one expresses frustration at being criticized by writing “please read my post” or the like. Even when the evidence suggests that the person who criticized you did, in fact, read the post. A disingenuous reponse, but fully conventional.
You are upset. Nice of you to admit that, so I will not engage your upset argument. Not fully, anyhow. I would note, though, that since we have never met, since your credentials are not in psychology and since questioning the motives of a critic is a pretty standard response to criticism, you might want to shy away from trying to assess my motivation.
I believe it was Auden who recommended against relying on self-assessment of writing, comparing it to judging one’s own farts. The implication, if I read him right, is that we will tend to be more generous to our own output than others might be. YOU submit that my reading of your writing was not a natural one. Seriously? Little communication theory here, ducky. You only know what you intended to say. As part of the audience, I am a more proper judge of the signal you produced. Not “proper” in any moral way, but simply because I am the audience.
You’ve thrown a fit here. Go introspect.
I have read far enough to learn that you will not explain your motives as I have. You clearly read the reply which started with the warning that to read that reply was to agree to respond in kind.
You read on and did not meet th econdition.
I made the very unusual step of describing all the possible sources of bias I might have had. I don’t recall anyone doing it. I clearly stated that if you read as far as my requiest for a frank discussion of you motives, you agreed to provide it. You did not fulful that condition.
I will not read what you write again.
update: I read your entire comment before posting my reply. I won’t read anything you writing again.