Tyler Cowen is surprised by the size of the various emerging market reactions to the non-taper:
Pay special heed to quantitative magnitudes. For how long are we delaying the taper? One or two months? How much is the taper anyway, relative to the stock of relevant financial assets? Taking $10 to $15 billion off of $85 billion a month in purchases, when the asset stocks are in the trillions? Woo hoo.
. . .
I’ll say it again: none of you understand what is going on here, and neither do I. I am not seeing enough admission of this basic fact.
I certainly admit to not understanding the specific market reactions that he points to, but don’t really agree with the larger point he is making.
Monetary policy drives NGDP; nothing else really matters. But people care about real variables, not nominal variables. So how important is NGDP anyway? It turns out that in the short and medium term it’s really, really important, even in real terms. In the long run not so much.
Tyler might respond that even though monetary policy is important, the specific action taken by the Fed was so trivial that it’s hard to see why markets would have responded so strongly. But he misses the larger point. The Fed’s action was a SURPRISE. In the world of central banking surprises are actually pretty rate. Normally the Fed telegraphs what it is likely to do. But even that doesn’t fully explain why surprises matter so much.
The real reason why surprises are so important is that they cause market participants to revise their expectations of the future path of policy. Yes, the 10 or 15 billion a month is no big deal. But the future path of policy is a very big deal. It’s like someone who finds out that their spouse is lying over something trivial. Not important right? Or does it lead one to wonder if they are lying about other things too?
The markets went into Wednesday thinking the Fed was determined to taper for Larry Summers-type reasons. Fear of a big balance sheet. At the end of the day the markets realized that the Fed was serious about letting the data drive policy. That’s not just a different policy; it’s a completely different policy regime. And it will have important implications for when and under what conditions the Fed will start raising rates.
So yes, most of us can’t explain why the rupee did this or that on a given day. But who ever claimed they could? On the other hand the US stock market reaction makes perfect sense.
PS. Not much time for blogging over the next few days.
PPS. Tyler’s post has the following title:
Model this taper and show your work, if only verbally
Thank God he allows verbal answers, I used to hate it when the professor would ask for math.