Professor John Cochrane and Money Manager Peter Schiff Agree: Zero Percent Hyperinflation Ahead

A Benjamin Cole post

“Of course, the idea that governments can hold inflation to just 2% per annum is preposterous. Once it breaches that level, governments will be powerless to contain it. The endgame will be hyperinflation…. Since the central banks are now destined to forever remain behind the inflation curve, it will continue to accelerate until the real threat of hyperinflation looms much larger than did the contrived threat of deflation.”

You might think above diatribe was delivered, well, 2008-9 or so.

No.

Try Oct. 16, 2014, by Peter Schiff, CEO of EuroPacific Capital, in blogland RealClearMarkets. That is when he thundered against monetary laxness and the dire pending results.

The oddity is the Schiff blog was highly recommended by John Cochrane, the University of Chicago professor who has been pushing a neo-Fisherian view that huge QE and lower interest rates are the road to the desired nirvana of exactly dead prices.

Cochrane has blogged to the effect the market will think the Fed has “expectations” of lower inflation if it stays with QE and low interest rates, and so the market will tag along to a non-inflationary path, tricked by the Fed.

While we mull the odds of that, there is another tangle in the Schiff piece: Schiff says only governments want inflation, as it makes government debt easier to pay off. (Homebuyers? Leveraged enterprises? Employers? Oh, shut my mouth).

But then Schiff says that galloping inflation will lead to skyrocketing interest rates, and that will make it impossible for governments to pay off their ballooning debts. Huge amounts outstanding of 10+% government bonds will break governments and taxpayers.

I guess Schiff is saying governments want lots of inflation to make debt cheaper, but they do not foresee the higher interest costs that will break government. You know those central bankers and treasury officials are rather shortsighted, given what Schiff says.

Schiff has some views that might be controversial, which is to put it mildly. “But given the strict monetary restrictions that were needed to grease the skids toward [European] union,” Schiff says, “the European Central Bank has not been able to create inflation as freely as the U.S. or Japan.”

Most people note that the Japanese economy actually shrank over the past two decades in nominal terms, caught as it was in a long, persistent deflationary perma-recession. In the U.S., the inflation rate has been below target almost continuously since 2008, and is sinking again.

And nowhere in modern economies has deflation bedded down with prosperity.

QE Has Driven the Right-Wing Nuts

For whatever reason, the right-wing (except for maybe John Cochrane) detests QE and they detest low interest rates.

But low interest rates and QE we have had since 2008 in the U.S., and rather than hyperinflation, we see microscopic inflation rates. The Fed has consistently undershot even its anemic 2 percent inflation target. In terms of containing inflation, Fed Chief Janet Yellen makes heroic Fed Chief Paul Volcker look like a liberal pansy.

The left-wing is clueless, militating for more and more federal deficits.

But if we believe the right-wing duo of Schiff and Cochrane, we are headed straight into the gut of zero-percent hyperinflation.

Huh?

Matt O´Brien posits the wrong choice

In “The terrifying idea that the economy might stay stuck forever just got more terrifying” Matt evokes Reinhart & Rogoff plus Summer to argue:

The U.S. economy has fallen, and it can’t get up.

At least that’s the way it seems. That’s because our slump hasn’t really ended, even though the Great Recession officially did more than five years ago. Growth has been low, unemployment is still high, and it’d be even more so if the labor force hadn’t shrunk so much. And all this, remember, has happened despite interest rates being zero the whole time. It’s the opposite of what we would have expected: big crashes are usually followed by big comebacks. So why has this time been different?

Well, it hasn’t — not if you compare it to other recoveries from financial crises. These, as economists Carmen Reinhart and Ken Rogoff have shown, tend to be nasty, brutish, and long.

At the conclusion he borrows my “it´s a choice” concept:

It’s a grim picture of a recession stamping on a human face — forever. But it wouldn’t be too hard to save ourselves from this dystopian future. All it would take is a higher inflation target that would let real rates go lower, and help households reduce their debt burdens. Immigration reform that boosted the workforce wouldn’t hurt either.

Stagnation, in other words, is a choice.

But the choice is not about a higher inflation target. It´s really about choosing higher level of spending, or NGDP, target.

Summers likely wrong again

In June 1984 he published (with Blanchard) “Perspectives on High World Real Interest Rates”, and concludes:

This analysis leads us to the following conclusions. High real rates are not due to fiscal policy alone. They are probably partly due to a fiscal-monetary mix, and smaller U. S. deficits would, other things equal, bring down interest rates. Interest rates would, therefore, decline either if Europe accepted further depreciation or if the U.S. recovery slowed down so that U. S. monetary policy was not anticipated to tighten further.

Underlying these developments and explaining the performance both of stock markets and of investment is a shift in profitability. This suggests that, were the other factors to disappear, real rates would probably remain higher than in the 1970s.

In 2014 he writes: “Reflections on the ‘New Secular Stagnation Hypothesis’”

The case made here, if valid, is troubling. It suggests that monetary policy as currently structured and operated may have difficulty maintaining a posture of full employment and production at potential, and that if these goals are attained there is likely to be a price paid in terms of financial stability.

Thirty years ago, monetary policy would work to make real rates remain high. Today, monetary policy cannot be loose enough, and if it is it will bring financial instability!

The relevant chart:

Summers SS

One more reason to make monetary policy geared to maintain Nominal Stability!

HT Ryan Avent

There´s no “proper” inflation target, just a “proper” nominal spending level target

Brad DeLong writes “On the Proper Inflation Target”. After some “basis points” gymnastics he wraps up:

If you don’t mind kissing the zero lower bound when you cut interest rates by 600 basis points, you could get away with a 4%/year inflation target.

And if you don’t mind dissing the zero lower bound and do not buy the argument that the “natural” short-term safe real interest rate when the economy is in the growth-along-the-potential-path phase of the business cycle is now not 3%/year but 2%/year, then you could get away with a 3%/year inflation target.

But I do not see how you can justify a 2%/year inflation target today.

Suppose that you want a 200-basis point cushion–that you are not happy with putting your commercial banks in a situation in which their business model requires that they take huge risks to even try to cover the costs of maintaining their ATMs and their branches–and buy the 2%/year “natural” short-term safe real interest rate when the economy is in the growth-along-the-potential-path phase of the business cycle, but recoil at a 6%/year inflation target as too high? What then? Then you have to go for régime change:

  1. Reform fiscal policy so that–unlike 2008-present–it does its stimulative job to boost aggregate demand when interest rates are at their zero lower bound.

  2. Move to some form of level targeting so that the inflation target is no longer fixed, but rises and rises sharply whenever aggregate demand or the price level undershoots its previously-expected growth path.

  3. Allow the central bank to engage in expansionary fiscal policy on a large scale on its own say-so, via helicopter drops–the Social Credit solution.

  4. Move to Miles Kimball Land

I won´t consider Miles Kimball´s “e-money”. Of the other three alternatives for a régime change, two deal with fiscal policy and one with “some form of level targeting”.

But notice that inflation is still very much present, only the “inflation target is no longer fixed”! I´ll concentrate on the suggested Aggregate Demand (or NGDP) level target. The historical evidence is compelling. When the Fed manages to provide Nominal Stability, all the pieces fall into place: NGDP growth is stabilized (the essence of what I mean by Nominal Stability (along a level path), real output growth is stabilized close to “potential” AND inflation remains low and stable. In this set-up, there´s no role for fiscal policy as a stabilization tool!

The panels below, constructed as “phase space”, comparing variations (growth or inflation) in quarter t with those in quarter t+1,well illustrate mean variations and its volatilities. The periods are divided closely matching what has become known as the “Golden Age” (1960s) when the Fed was manned by ‎William Martin , the “Great Inflation” (1970s) when the Fed was manned by Arthur Burns (and G William Miller for a brief span), Paul Volcker´s (1979-87) “Transition” from high to low inflation, Greenspan´s  1987 – 05 “Great Moderation” and Bernanke´s (more recently Yellen) “Great Recession” 2006-14.

Proper Target_1

 

Proper Target_2

Proper Target_3

Observe that the increasingly nominal instability from the 1960s to the 1970s does not impact real growth or its (in)stability significantly, but the rising nominal instability has a strong effect on inflation.

In the more recent period (“Great Recession”) we have first a loss of nominal stability, with NGDP growth dropping strongly. Note that nominal stability has been “regained”, but at a lower average growth and not having compensated for the previous loss in the LEVEL of spending. Real growth has gone back into the “circle of stability”, also at a lower average level and inflation has been “crammed down”.

This is why many are calling the more recent period “Great Moderation 2”, but it importantly leaves out the level target. The consequence is low real growth and employment.

It is clear that to regain a “Great Moderation”, monetary policy has to place the economy at a higher trend level and then keep it there!

Update: As this just released Economist article makes clear – Politicians and central bankers are not providing the world with the inflation it needs some economies face damaging deflation instead – the focus on inflation targets is misplaced:

IT IS a pernicious threat, all the more so because, at its onset, it seems almost benign. After two generations of fighting against inflation, why be worried if the victory looks just a bit too complete, if the ancient enemy is so cowed as to no longer strain against the chains in which it is bound? But the stable low inflation fought for in the 1980s and 1990s and inflation hazardously close to zero are not so far apart. And as inflation drops, slipping into deflation becomes ever easier. It is in that dangerous position that the world now stands.

A “Swedish Governor” at the RBA?

It would be pretty depressing, so late in the game, to see “gold medalist” Australia fall into a Swedish-type trap. I hope Mr Lowe is a lone voice:

Australian central bank Deputy Governor Philip Lowe urged vigilance on asset prices inflated by record-low interest rates and said government action is needed to encourage companies to invest.

“Very low global interest rates have been with us for some time. And it is likely that they will stay with us,” Lowe said in a speech in Sydney late yesterday. “But the longer it runs on without a pickup in the appetite for real investment, the greater is the potential for new risks to develop.”

Australia´s X-ray:

Australia-Swedish

Much healthier than any other advanced economy. So please Mr Lowe, shut-up or go home!

Getting “inoculated”

How can you define the sort of sentiment expressed by SF Fed chief John Williams, who begins his speech with this “pearl of wisdom”:

I’ll be honest: These speeches get more and more enjoyable as time goes by because the economic outlook keeps getting better and better. Instead of gloom and doom with a scattering of hopeful notes, things are now pretty upbeat, with only a couple of standard economist’s caveats thrown in.

I know that humans have an enormous capacity for survival, being able to get used to (and survive) the grimmest conditions. But I would expect a highly educated and experienced monetary policymaker to be more sophisticated.

I turn to an overused chart to explain the sentiment. It´s simple: When your olfatics cannot discriminate “bad odors”, you can enjoy things again! That´s probably what happens when you have spent more than six years inside a “monotonic depression”, where the sense of direction is positive, even if you are deep inside the sh–hole!

Innoculated

The “Bullard Factor”

I may be reading too much into this, but it´s worth a chart.

On October 9 Bullard mused:

Right now, “the markets are making a mistake” and expect the Fed to maintain its ultra-easy policy stance longer than Fed officials themselves currently expect, Mr. Bullard said. When it comes to these expectations, “I would prefer that those be better aligned than they are.”

And one week later, on the 16th he pulled on “sheep clothes”:

The Federal Reserve may want to extend its bond-buying program beyond October to keep its policy options open given falling U.S. inflation expectations.

The markets “reaction”:

Bullard Factor

Having been sent only the second piece, Scott Sumner refers to JB thus:

I don’t always agree with Bullard, but to his credit his views are always data driven. He’s an important swing vote at the Fed, as he’s one of the moderates.

And the market “swings” along!

A “Faustian” reading of history

From John Hopkins´Jon Faust:

Let’s look at what history tells us about episodes like this—that is, episodes in which large economies were mired for a long period with the main monetary policy interest rate at its zero lower bound. In such circumstances, traditional interest rate ease by the central bank is impossible, and the inability to lower rates brings a powerful asymmetry to the policy problem. If the economy were to boom or inflation to rise, the central bank could pursue the standard approach of raising interest rates. There is little mystery here: Sufficient rate increases reliably slow the pace of economic activity and relieve upward pressure on wages and prices.

If, in contrast, the economy were to falter, the traditional response of lowering rates is foreclosed. The central bank would be forced to dig even deeper into its toolbox of nontraditional policy measures. This is a very unattractive option: we have extremely limited experience with these tools, we are unsure about their potency, and we must acknowledge that they may have unintended consequences.

So what does history teach us about how central banks of large economies have dealt with this asymmetry? Setting aside some episodes in smaller economies, there are only a handful of episodes: the Great Depression, Japan after the collapse of the asset bubble in the early 1990s, and the U.S. and euro area at present. Of these, only the Great Depression provides an example of escape from the zero bound, and arguably that escape should be attributed to World War II. There is no clear precedent for a large economy escaping the bound in anything resembling a benign manner.

When you don´t recognize evidence staring in your face, saying “arguably that escape should be attributed to World War II”, there´s really not much hope someone, someday, will do the right thing!

Meanwhile, not understanding how the Great Depression was reversed by monetary policy (FDR´s devaluation by delinking from the gold standard), the US is mired in a “monotonic depression” as illustrated below. But nevertheless, the US is” applauded” because others, like the EZ, are trapped in an “increasing depression”!

Monotonic Depression

Does Israel want to become Sweden?

It may sound strange, but that´s what comes to mind when central bankers start playing “alternative roles”. In the case of Sweden things started unraveling when the Riksbank decided to “prick” a housing “bubble”. According to the FT:

Sweden’s central bank has been lambasted by critics for trying to use interest rates to combat signs of a housing bubble. It lifted rates in 2010 and 2011 as it publicly worried about what it saw as high household debt levels.

In the case of Israel, it may not be coincidence that NGDP began a systematic deviation from trend when Ms Flug took over at the Bank of Israel. Maybe she prefers the role of Finance Minister:

Speaking at a Calcalist conference, Governor of the Bank of Israel said today, “Exceeding the 3% fiscal deficit target will expose the Israeli economy to significant risk and will be liable to harm us citizens. We must show responsibility and take into account the consequences of our decisions over time. Israel’s structural deficit, the deficit not subject to one-time shocks, is already one of the highest in the western world.”

As the charts show, Israel was one of a very small group of countries that managed to avoid the more crippling effects of the 2008-09 crisis. And it did that by managing to keep NGDP parading very close to trend.

Israel-Sweden_1

Sweden was “making-up” for its early mistake but then “bubble phobia” took over (leading to Lars Svensson´s resignation).

It would appear that until Ms Flug took over in July 2013, that Israel had an implicit NGDP level target rule. Up until then, Stanley Fischer was the BoI head honcho. But appearances can be misleading because shortly before stepping down Fischer said in a speech:

There are those who support setting a nominal GDP target. I think that this is very impractical. The data that we receive on nominal GDP are very unstable.  There are changes of whole percentage points between the various estimates of GDP. For this reason, I think that there is no reason to use nominal GDP as a target.

Maybe he thinks “output gaps” and “natural rates” are precisely estimated and known quantities!

By worrying about other stuff, like government spending and deficits, Ms Flug is signaling that the BoI will “neutralize” the move by contracting aggregate demand. And this is happening already!

When oil price jumped late in 2010 (after having dropped during the crisis), inflation went up and real growth down. But note (see charts below) that NGDP growth was sustained. Unfortunately, when real growth began to recover Ms Flug came on board and NGDP growth tanked, bringing down real growth and inflation, with the latter having now breached (0,8%) the lower limit of the 1% – 3% target band!

Israel-Sweden_2

 

Professor John Cochrane Says Chairman Paul Volcker Had It Backwards

A Benjamin Cole post

I admire Professor John Cochrane of the University of Chicago, an economist who has an open mind, a rarity when macroeconomics is usually politics in drag, and right-wingers are cowed into conventional and conservative dress by their brethren.

But they have not cowed Cochrane.

So we have Cochrane calling for converting of the entire national debt into commercial bank reserves (through quantitative easing, no less!), and for all bank lending in the U.S. to be 100% equity-backed. By law, regulation and federal diktat, no less.

Okay, while we mull that, Cochrane then reiterates the right-wing fetish for the zero-inflation or even deflation imperative, but then he comes out a with a flaming wild lulu on how to get to the dead-prices promised land: lower interest rates!

The Fed should impose lower and lower interest rates to fight inflation, asserts Cochrane.

Huh?

Well, maybe we can comprehend what Cochrane is saying, and maybe not. Cochrane’s unusual perspective on interest rates is matched by his take on QE, which he has also posited is anti-inflationary.

On rates, Cochrane cites a recent study by Stephanie Schmitt-Grohé and Martín Uribe, entitled The Making Of A Great Contraction With A Liquidity Trap and A Jobless Recovery. Then Cochrane blogs, “raising the nominal interest rate to its intended target for an extended period of time, rather than exacerbating the recession as conventional wisdom would have it, can boost inflationary expectations and thereby foster employment.”

The pair of authors add that the Taylor Rule is uninformed, as it calls for dropping rates in deflationary recessions. Indeed, Taylor knows nothing: A Fed rate hike to, say, 6% is the right elixir now for the U.S., proffers Cochrane. Toilet-time for the Taylor Rule.

The rate hike would be effective Fed signaling despite the head fake, avers Cochrane. See, the Fed is saying it expects higher inflation and growth, when it raises rates. “By pegging the interest rate at a higher level and just leaving it there, the Fed communicates that expected inflation had better rise in the Fisher equation,” explains Cochrane.

Chairman Paul Volcker Had It Wrong?

Of course, Cochrane’s bold new stance pulls the rug out from under one of greatest, most glorious and hoariest of inflation-fighting stories of all time, that of Fed Chairman Paul Volcker smiting inflation in the early 1980s.

In 1981, inflation was 13.5%, but Volcker tightened the screws like never before, and inflation tanked to 3.5% by 1983. The prime rate topped 20% for a while, when Volcker was Volcker. In those glory days, I can remember 15% home mortgages. Unemployment hit double-digits too. Truth is, it was ugly.

But We Suffered For Nothing

Based on enlightenment via Cochrane, I surmise now Volcker had it all wrong, and we suffered back in the early 1980s for nothing.

Had Volcker lowered rates, that would have signaled to the market that inflation was in retreat, and we could have sauntered into lower inflation and higher employment without the pain of recession. Like Fed jujitsu!

If only we had known.