How to make’ a “Great Stagnation” come true

Mathew C Kline wrote this piece for Bloomberg View:

The pattern of optimism giving way to dull reality is a familiar one for observers of U.S. markets. Just check out this great chart from analysts at Bank of America Merrill Lynch, courtesy of Saxo Bank A/S chief economist Steen Jakobsen.

GS Infinity

Each colored line shows the expected path of short-term interest rates — a decent proxy for the state of the economy — while the black line along the bottom shows what has actually happened. For the past five years, traders have consistently (and wrongly) bet that growth is about to accelerate and interest rates will rise. In other words, irrational exuberance lives. If interest rates and stocks finally do go up, it probably won’t be until everyone has stopped expecting it.

So what have traders done? They appear to be ‘adapting’, becoming less optimistic as time goes by. For example, in 2010 they expected that by the next year, 2011, the FF rate would be just as high, or higher, than what in 2014 they only expect will happen in 2017!

Maybe sooner rather than later expectations will adapt to the point that there will no longer be any future rising line, with only the black ‘horizontal’ line remaining and extending into ‘infinity’. When that happens the ‘construction’ of the “Great Stagnation” will be complete and expectations will finally become rational!

43 thoughts on “How to make’ a “Great Stagnation” come true

  1. Marcus, sorry if this is a dumb question, but I’ve always heard from MMists that expectations have been the missing ingredient, and that the Fed balance sheet wouldn’t have had to grow as much as it did if they were just able to communicate properly. David Beckworth says as much here:

    http://macromarketmusings.blogspot.com/2014/04/this-one-figure-shows-why-fed-policy.html

    “Now to be clear, all that is needed is a commitment to permanently expand the monetary base if needed. But such a commitment, if credible, would most likely raise the velocity of the monetary base. In this case, the needed permanent monetary injection would be smaller.”

    So if credible, David says that the Fed’s money injections could have been “smaller.” But from your chart here it looks like *somebody* significant thought it was credible enough that short term interest rates would rise anyway: and they thought so over and over and over again. So why didn’t they rise? What was missing?

    • Tom, one answer is in the PS of the Beckworth post you link:
      “One of the defining features of U.S. monetary policy over the past five years has been its incredibly ad hoc nature. Over this time, the FOMC has conducted monetary policy with a spate of make-it-up-as-we-go-along programs (QE1, QE2, Operation Twist, QE3, and the Evans Rule) that it hoped would spur a robust recovery. These programs did get progressively better as they became more state dependent, but they were often implemented and ended in a haphazard fashion. This stop-go approach to monetary policy was politically costly and prevented the Fed from fully utilizing its ability to manage expectations of future nominal growth.”

    • Vince, MMs have only one explanation for inflation/hyperinflation.and that´s “too much” money. The “too much” is relative to money demand. Hyperinflation is money “gone wild”. The trigger for that is usually the”breakdown” of the government budget constraint in the sense that the government´s only alternative is monetary financing of the deficit indefinetely.

      • Thanks, but can we flesh this out a bit more? If their only alternative is monetary financing of the deficit, that means that other people are no longer buying their bonds, right? Why does this “go wild” thing happen? Most of the explanations seem to have a positive feedback loop. Do you see things getting out of hand as the central bank buys more and more bonds, making people want to own then less and less, making a loop that feeds on itself? Do you see a death spiral? Do you think that you can start getting hyperinflation that you can just slow down the money creation or do you see it as a giant vortex that once caught in is hard to get out of? Thanks again.

      • Vincent, I was confused for a second because this sounded so much like you (a commentator had it in quotes), but then I realized that Simon was talking about the mirror image of what you’re talking about:

        “Economists sometimes worry about a deflationary spiral, where inflation just keeps falling into a bottomless pit. But maybe the ZLB steady state is like a ledge that can stop this descent.”

        http://mainlymacro.blogspot.co.uk/2014/03/more-thoughts-on-expectations-driven.html

        BTW, that comments section has some heavy weights in it, but not many comments: Simon Wren-Lewis, Nick Rowe, David Andolfatto (of the St. Louis Fed), and Stephen Williamson (Also of the St. Louis Fed). Perhaps the perfect place to spread your propaga… er I mean your message? (You might have a hard time convincing that crew though… even Williamson: I understand he *used* to be in the hyperinflation camp before doing a 180 and becoming a Neo-Fisherite… skipping right over NK and MM in the process).

        BTW, Scott has a really good new post up IMO, continuing on this Neo-Fisherite theme:

        http://www.themoneyillusion.com/?p=26677

      • One more question. Do you think that at this point Japan’s “only alternative is monetary fiancing of the deficit indefinetely”? It seems only the central bank is buying JGBs now. Could they survive an increase in interest rates? Seems about half the budget is taxes and the other really comes from new money at this point. Would you predict hyperinflation for Japan?

      • Vincent I know you asked Marcus, but I’m going to make a bold prediction on what his response will be to this:
        “Would you predict hyperinflation for Japan?”
        My prediction: “No.”

      • Vincent, you’re welcome. As for biasing Marcus, do you seriously think he’d be biased at all by a nobody like me? Lol… no, that was just purely for fun on my part. I’ll be truly surprised if he says something substantially different, but I’m sure that doesn’t make any difference to him. :D

      • But if he says “no” and then Japan gets hyperinflation it is 5 points against MM, so he it seems he is deliberating carefully on his answer, as he should.

      • You said, “MMs have only one explanation”. I am curious if you see any flaws in the 30+ explanations I have collected. Is there anything false in any of them? Or is there historical data that would contradict any of them?

    • Vincent!… Marcus is well aware of who you are and that you’re collecting “different economic theories” of hyperinflation. You are going to have to re-program your auto-blog-posting-bot to sound more human… Lol. (BTW, I know the *real* Vincent Cate is very much human). Well, I guess you are asking a bit different question than usual maybe (your final sentence)… but the lead in sounds like one of your boilerplate posts, which have a chance of sounding fresh and interesting exactly once. I’m telling you, reprogram that thing and you may have more success getting some engagement! :D

      • Shoot in the time it took me to scold you Marcus was already on it! Well then never mind then.

      • Vince, you must have a lot of time to spare. That´s because you make up 30 different stories that are easily collapsible into a single one: Money printing!

      • Yes, there is always too much money printing. But these 30 stories flesh out the details of how things get out of control and there is then too much money printing. This is the interesting thing, how/why/when things get out of control.

  2. Sure it is money printing but how does the money printing get out of control? This is the interesting thing. Hyperinflation is out of control inflation. How does the central bank lose control of the money supply? What is the MM explanation for “things go wild”?

    • Vince, There are N (large number) possible dysfunctionalities that can end up putting money printing out of control. The interesting thing is that mostly (really always) they are processed through the liver (I mean government) and thus through the budget. But remember, the end result must be money printing out of control. So look out to see if that´s happening anywhere.

      • Marcus, I think Vincent would claim that money printing is approaching “out of control” status in Japan and perhaps in the United States too. He’s says that it isn’t out of control quite yet, but getting very close. Take Japan for instance: what do you say about the money printing there? Vincent says that the annual inflation will be greater > 26% within a year and 10 months: and furthermore once that starts that the Yen will be devalued by a factor of 10X within five years (so that’s 58% annual inflation for five years). What do you say?

      • In Japan they are spending twice what they get in taxes. Doesn’t this count as a government with a budget that is out of control? Nobody but the central bank is buying government bonds. Doesn’t this count as money printing out of control? If this does not count, at what level would you say that a government budget is out of control?

      • Tom, you have to work with what he has already agreed to and work gently toward the exciting conclusion. Don’t jump ahead where he will probably just say no. :-)

  3. The budget has been “out of control” for almost 2 decades. Where´s the inflation? where´s the runaway growth in the money supply? For most of that time they had deflation!

    • Good cop, bad cop treatment? What you guys have to do is pick another MM, question him separately and see who “confesses” first to your “pejudices”! A Prisoners Dilemma (sort of) Game.

      • “Good cop, bad cop treatment?” No actually, I just think Vincent needs to get out more and socialize on the other blogs… so I try to lend a hand. Lol. (I’m joking Vincent… I know you get out plenty). I’m not actually a hyperinflation fan myself, but Vincent must get tired of arguing with me… I have very little new to offer at this point, except to point him to others (such as yourself) with something truly interesting to say.

        BTW, is Lars Svensson an MMist? His profile in Wikipedia didn’t make me think he was. It said he was an advocate of inflation rate targeting. I can see why the MMs like him though. I pointed out to Vincent that Sweden is actually experiencing some deflation right now. He pointed out that it was about half a percent, excluding food and fuel (I think): the implication being it wasn’t a big deal (Vincent, sorry if that’s not what your implication was, but that’s how I took it). I thought Lars could probably offer a rebuttal. He does put his email address up on his blog… awfully tempting… should we go there, or leave the poor man alone? Anything, so long as we leave you alone maybe? Lol…

        Well I guess I’ll leave it up to Vincent. The Lars thing was my idea… Vincent may not be very interested in deflation: It’s not his thing.

      • How do you define “out of control” Gov Budgets? That´s only true if you observe “out of control” money printing. Otherwise the budget is not “out of control”.

  4. If you can not use out of control budgets to predict out of control money printing, then do you have any way to predict out of control money printing?

    • It´s not a question of predicting. Just observation. If high debt or high deficit is not matched with “high’ (relative to demand) money growth, the budget is not “out of control”.

      • In real science your theory lets you make predictions. The better you understand something the more accurate your predictions turn out to be. If you can not make any predictions, then you don’t really have a theory of what is going on. If you have no way to tell when hyperinflation is a real risk, or coming soon, or imminant danger, then you just don’t understand hyperinflation. I contend this is the normal case for economists today and a sad state of affairs.

      • Vince, you´ve made your prediction: >26% inflation in Japan by the start of 2016. I would be surprised if in the same time span inflation in Japan goes above 2% or 3%! (I´ve registered the wager)!

  5. Fine. But you have not explained enough of a theory to really help someone else in deciding if, by your understanding of things, there will be hyperinflation in Japan or not. You have not explained the thinking behind why you would be surprised to see hyperinflation in Japan. The bit you did explain seemed to fit Japan. A wager without a the theory behind it is still not very satisfying.

    • Vincent, I found this statement from Marcus to be interesting:

      “If high debt or high deficit is not matched with “high’ (relative to demand) money growth, the budget is not “out of control”.”

      Doesn’t your question to him amount to: “How can we tell if money growth is high relative to demand or not?”

      And perhaps what Marcus is saying is “Well, just look at what’s happening. Is inflation low? Are interest rates already low?” etc. If inflation is low and has been low and you’re at the ZLB, those are indications, perhaps, that money demand is high relative to money growth, or vice versa, that money growth is low relative to money demand. Maybe what he’s saying is that’s a much better observation than the quantity of QE or who exactly is buying the government’s debt.

      • And BTW, if I butchered that and Marcus needs to correct me, that will be super helpful (for me)!… I actually like your line of questioning here Vincent. I don’t share your prediction of hyperinflation, but I love this thread.

      • So I think an out of control budget, like in Japan, and out of control debt, like in Japan, are predictive of hyperinflation. To me if taxes only cover half the spending and the debt is over 200% of GNP then they are both out of control. Outside of Japan I don’t think any country has gotten these kinds of numbers without getting hyperinflation. I think eventually Japan will get hyperinflation too. But if he is saying the only way to judge if things are out of control is if we have hyperinflation, then he has no ability to predict hyperinflation. To me the whole point of theory and understanding is to be able to predict how things will happen.

        Yes, it is one of the better threads. At least Marcus is engaging. :-) Most just completely ignore hyperinflation and any questions about it. Even though there are probably more than 5 countries with hyperinflation at the moment, it is just not taken seriously by most economists. I think they know it is from too much money and don’t bother looking into it more than that. There are more interesting parts to the puzzle and trap of hyperinflation.

      • You don’t necessarily have to have hyperinflation before you can predict hyperinflation if you’re trying to judge the size of money printing relative to money demand perhaps: Maybe that’s where Mark Sadowski’s suggesting that you look for a pattern of multiple years worth of high inflation comes in!… that’s a good indication that money demand might be falling, making the relative amount of money growth start to look bigger: and thus making a hyperinflation prediction more plausible.

    • Honestly, ~1.5 years ago I thought it would have it by Jan 2014. But the understanding of the feedback loop and predicting when the feedback loop will start are two different things. I claim that I do understand the mechanism by which hyperinflation “kicks in” all the sudden. There are a bunch of feedback loops. I claim that I can tell when there is a high risk of these kicking in (high debt and deficit with central bank monetizing). I do not claim I can accurately predict the start date.

      I say it is like understanding how a forest fire spreads from a small ignition, but not being able to say when a fire will start. It is like you can say, “high fire risk” without knowing which day a fire will start.

      So I think it is a useful level of understanding (and more than the average economist) but not full understanding.

      • Vincent, using your “high fire risk” analogy, perhaps there’s a factor you’re missing. In the framework of your analogy, maybe there hasn’t been much rain, but perhaps you’re ignoring the fact that it’s still snowing (i.e. that money demand is still very high… and there’s a sequence of events, a process, by which money demand decreases (i.e. it stops snowing and the snow melts), and it’s unlikely that we’ll miss it when it happens).

      • Tom, part of the reason I keep looking for someone to debate is that I do consider the possibility that I am wrong or missing something somehow. I think if I am wrong that someone should be able to point out where.

        To me the sequence of events to look for is:
        1) Out of control government budget deficit (like more than 1/3rd is borrowed)
        2) Build up of large government debt (more than 100% of GNP including excess reserves at central bank as debt)
        3) Mainly central bank buying bonds
        4) Big drop in currency in forex markets
        5) high inflation

        To me Japan seems on 3.

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