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.


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.

Calling a spade a spade

Tim Worstall comes out and calls a “spade a spade” in “Europe Doesn’t Have A Debt Crisis, Europe Has A Monetary Crisis”:

The stock markets plunge over concerns about the eurozone; there’s a flight from lower quality sovereign bonds; Greek, Spanish and other periphery bond yields spike. It looks like the eurozone debt crisis is back. But this time around we really should get to grips with the fact that what we’ve got here is really not a debt crisis. Sure, that’s the proximate problem, the one that is most obvious and in our faces. But the root problem, the ultimate cause, has nothing at all to do with either debt or fiscal policy: It’s monetary policy that is at error here. And yes, it is indeed all the fault of the ECB and the fools that designed Europe’s current monetary structure.

Market Monetarists have known that for a long time. And as this post shows, the analysis is also relevant for the US, albeit with different implications:

Same monetary view of the crisis but very different implications. Why? Because of the dysfunctional political and structural nature of the EZ currency union compared to the US´s own.

HT David Levey

Fed Chief Janet Yellen Gets An “F” in PR

A Benjamin Cole post

I cringed when I read The Wall Street Journal headline: “Janet Yellen Decries Widening Income Inequality.”

It got worse. U.S. Federal Reserve Chief Janet Yellen, reported the WSJ, addressed the “Conference on Economic Opportunity and Inequality, Federal Reserve Bank of Boston, Boston, Massachusetts.”

Hooo-boy. You don’t have to be a right-wing talk-show dittohead to know Yellen preached to a confab of lefties full of tax schemes and government programs to make life more equal for Americans.

Yellen may be an ace academic economist, but she has no sense of politics or public relations. This is a PR disaster, and also a substantive real-world blunder: a Fed Chief’s Job 1—and there is no Job 2—is to create conditions for sustained robust economic growth.

The topic of “income redistribution” is radioactive for any Fed chief.

The Right Wing Targets Yellen, a Fat Bullseye

Already Yellen is suspect in righty-tighty circles as a wishy-washy liberal. Yellen is the archetype of the Ivy League academic who conflates printing money with wealth generated by hard work and prudent investing in infrastructure, plant and equipment.

Thus, if Yellen dares to reverse the Fed’s current course on quantitative easing (QE)—and she probably should fire up QE again—she will be disparaged as an indecisive “flip-flopper,” a charge the Fox News-goons are leveling already.

Fox News digital hit-man Phil Flynn’s most recent column is entitled, “Fed’s QE Flip Flop,” and it condemned St. Louis Fed President James Bullard for surmising out loud that a monetary noose for the economy now makes poor sense, given gathering deflation and global slow growth. (Actually, deflation and slow growth are the new normals, in case anyone has not noticed.)

What Yellen Should Say

First, monetary doves need to eschew the sissy label “doves” and seize the label “bulls.” Egads, the battle is lost before begun with a banner like “doves.” Seizing the word “bull” also properly connotes a break-out from the outdated “hawks” and “doves” binary frame-up.

Yellen should first, last and always describe herself as a “monetary bull with resolve to see robust economic growth, lots of hiring and especially lots of profits.” Every speech she gives should contain references to profits and the need for higher profits.

Yellen should say, “The tight-money crowd wants to starve American businesses. I don’t.”

If the dollar exchange rate comes into question, Yellen should reply, “I am happy to abide by a U.S. export boom, and the Made-in-America jobs and profits that go along with that export boom.”

I could go on, but you get the picture.

Yellen’s sniveling about income equality is not going to convert the tight-money ascetic-fanatics to sanity. Maybe nothing will, but certainly handwringing about income inequality will only harden positions.


Besides, the best way to bring about a better life for Americans is robust economic growth and tight labor markets. Boomtimes, I want. Wages will rise if demand is robust—see North Dakota, where wages have been inching up. Businesses will hire if they think demand will stay strong for a long time.

Somehow in central-banking and money-ascetic circles, the idea of a robust and growing economy has become suspect, trumped by the imperative of zero inflation.

These are strange times—but Yellen can turn the increasing dementedness of the right-wing tight-money nuts against them.

She only needs to talk about profits and jobs and robust economic growth again and again.

But not “income inequality.”

Richard Fisher Declares Class War. Dallas Fed Chief Warns Wages Rising Faster Than Prices

A Benjamin Cole post

Like a lot of Americans, I tend to shrug off class warfare. Not for us. I want to make my money in boom times. Bring on Fat City.

And like most people who think about economics, I prefer the lightest taxes and regulations on productive behavior possible, and I am dubious about public programs for anything, from welfare to overseas occupations.

And so like most Market Monetarists, I am puzzled by the peevish fixation, the monomaniacal hysteria displayed by many influential right-wingers regarding inflation.

The right-wingers should be our allies. Why not?

Fisher Explains Why Tight Money

Like a dead mackerel in the moonlight, we have Richard Fisher, Dallas Fed President, to set me straight. You see, tight money is not about economics, tight money is about class warfare.

Well, call me “Mr. Chump.”

Fisher, a successful former money manager, has been going round-robin on press conferences of late, in a rising fever that wages in Texas are rising faster than inflation.

This led to the lamentable lead paragraph in the The Dallas Morning News that reads, “Richard Fisher, president of the Federal Reserve Bank of Dallas, is worried that wages are growing faster than price inflation in Texas.”

Egads. And the preferred alternative is?

Fisher then drew some inflation statistics out of a magic hat, as they do not exist anywhere except at the Dallas Fed. Fisher reported that Texas inflation was running at 2.5 percent and wages were running up by 3.5 percent, annually. The horror of it all.

Except for one problem: Such statistics do not exist at the Bureau of Labor Statistics. Reuters called the Fisher figures “Fed estimates.”

There are some CPI-U figures for Dallas and Houston, the biggest cities in the Lone Star State. Dallas is running a CPI-U at 1.2 percent in August year-over-year and Houston at 2.6 percent. The BLS “South” region, of which Texas is the largest part, is reporting a CPI of 1.7 percent. And the CPI runs about 0.5 percent higher than the PCE, the Fed’s preferred inflation measuring stick.

There is a BLS estimate for employment costs for the “Southwest Central” district that includes Texas, Arkansas, Oklahoma and Louisiana. It is up by 2.0 percent ending June 2014.

Fisher appears to be off-base.

So Why Fisher?

The spectacle of Dallas Fed President Fisher exaggerating inflation, and then fear-mongering and condemning wage growth, is undeniable. Is this why?

Labor Gets Thumped, 1982-Present

Labor Share BCole

As we can see from the above chart, labor is getting thumped. The labor losing streak started when Fed Chairman Paul Volcker famously went to tight money in the early 1980s.

Is that it? Is there a sense among the influential that tight money tilts the playing field against labor? And for the upper class, a fatter piece of a smaller pie tastes all the sweeter? That by squeezing the money supply, we now see 62 cents of business income dollar go to labor, and not 72 cents? And when that gets down to 52 cents, all the better?

Well, I hate to think the modern right-wing has sunk to this.

Obviously, U.S. owners/management have prevailed against labor in the last three decades (a most rarely discussed statistic), and the demand for labor has been tamped down continuously by the secular war on inflation waged by the Federal Reserve. A war ongoing, btw, as the Fed makes the rubble bounce.

And we have the Richard Fishers of the world to pose this question: “Well, you wouldn’t want wages to outpace inflation, would you?”

Oh my! When you reason from a price change…

Buttonwood makes the classic error in “Blessing in disguise”:

WHEN Winston Churchill, having led Britain to victory in the second world war, was defeated in the 1945 general election, his wife Clementine remarked that it might be “a blessing in disguise”. If so, the great man replied grumpily, it was “very well disguised.”

Could the same be true of yesterday’s market sell-off? Some investors were arguing the case yesterday. Eric Lonergan of M&G, an investment firm, tweeted that

Falling yields and oil price (are) far more of a stimulus than recent data is negative. Expect growth momentum to improve.

Certainly, lower oil prices are a tax cut for western consumers. Although, of course, the result is an income loss for oil producers, the marginal propensity to consume of consumers (as it were) is higher and this helps demand.  Rising oil prices have been a harbinger of recession, whether in 1973-1974, 1979-1980 or 2007. Lower government bond yields are a help, to the extent that they also bring down corporate borrowing costs.

Isn´t it confusing? Oil prices fell because oil demand fell due to contracting economic activity. So it´s not at all like a tax cut! In the 2000s, prior to 2008, oil (and commodity) prices were rising AND the world economy was booming. Is that like a tax hike or reflects greater oil demand?

In the 1970s, oil prices were rising because oil supply was constrained. That felt like a tax increase, so economic activity contracted.

Falling yields were also a reflection of falling NGDP growth expectations, and therefore cannot be a source of improvement in “growth momentum”!

Circular logic gets you nowhere!

Bullard needs psychiatric meds

After all, in the short space of one week he gave opposing outlooks.

On October 9:

In a speech that offered an upbeat assessment of the economy, Federal Reserve Bank of St. Louis President James Bullard said Thursday he is worried about what he sees as disconnect between what central bankers think will happen with monetary policy, and the view held by many in the market.

“When there is a mismatch between what the central bank is thinking and the market is thinking, that sometimes doesn’t end well, because there can be a surprise later on,” Mr. Bullard told reporters.

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.”

On October 16:

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, Federal Reserve Bank of St. Louis President James Bullard said Thursday.

It would keep the program alive,” and the Fed’s options “open as to what we want to do going forward,” Mr. Bullard said during an interview on Bloomberg TV.

Once again, the markets beat individual fantasies!

Plosser´s six year meme: “Sooner rather than later”

It started out, believe it or not, in July 2008!

In sum, this year and next will be quite challenging. The economy will grow this year but at a slow pace, and the unemployment rate is likely to get worse before it gets better. At the same time, inflation will be uncomfortably high for a while.

I am more optimistic about the outlook for 2009 and I expect we will see economic growth return to near its longer-term trend. But to prevent recent inflation from continuing(!) to plague the economy and to avoid a rise in inflation expectations, I believe the current very accommodative stance of monetary policy will need to be reversed, and depending on how economic conditions evolve, I anticipate that this reversal will likely need to begin sooner rather than later.

And has continued, uninterrupted, to today:

“I feel pretty good about the domestic economy,” Mr. Plosser said on Thursday in response to audience questions after a speech in Allentown, Penn. He acknowledged “there are risks in Europe” but added the U.S. exposure to that region is relatively small, so a recession in Europe is “not enough in and of itself” to derail the U.S. recovery.

In his formal speech, he said “I would prefer that we start to raise rates sooner rather than later.” The official added “this may allow us to increase rates more gradually as the data improve rather than face the prospect of a more abrupt increase in rates to catch up with market forces, which could be the outcome of a prolonged delay in our willingness to act,” the official said.

Plosser´s “scoreboard”:

Plosser meme

Are we back in “old times”?

In early 2012, I put up this chart:


And wrote:

Since the crisis turned “ugly” in the fall of 2008, we notice a positive correlation between the stock market and inflation expectations. This “theme” has been well covered by David Glasner. In “normal” times the two series go “their own way”, but these are not “normal” times.

As Michael Sivy argues, it´s not hard for investors to slip back to very worried pretty quickly and, as the chart shows, that has happened when inflation expectations “retreat”, which tends to happen when monetary policy is seen as failing to support economic improvement. And since the FOMC has alternated between “on” and “off”, so has the stock market and inflation expectations.

A few months later, QE3 arrived and suddenly the high positive correlation disappeared. The stock market kept climbing even after Bernanke´s May 2013 “taper talk” and the subsequent phasing out of QE3.

More recently, after the June FOMC meeting, which was heavy on “policy normalization” discussion, inflation expectations dived, and, for the most part, so has the stock market.


Despite thinking otherwise, it appears the Fed has really “tightened the screws”. The downgrading of world growth is a consequence. So we should forget about “policy normalization”, with the horizon for the first rate rise being extended to “infinity”!

I hope the Fed has another “rabbit to take out of the hat”!

Policy makers should avoid “blinkers”

For more than three decades the world, at least the countries that count, have raised “barriers” against inflation. Those “barriers” became “blinkers” during and following the 2008-09 crisis, stopping policymakers seeing that the greatest danger coming from “behind and from the side” was rapid disinflation/deflation.

Now reality has broken the spell, and we get headlines such as : Risk of Deflation Feeds Global Fears:

Behind the spate of market turmoil lurks a worry that top policy makers thought they’d beaten back a few years ago: the specter of deflation.

A general fall in consumer prices emerged as a big concern after the 2008 financial crisis because it summoned memories of deep and lingering downturns like the Great Depression and two decades of lost growth in Japan. The world’s central banks in recent years have used a variety of easy-money policies to fight its debilitating effects.

Now, fresh signs of slow global economic growth, falling commodities prices, sagging stock markets and declining bond yields suggest the deflation risk hasn’t gone away, particularly in the often-frenetic eyes of investors. These emerging threats come as the Federal Reserve is on track this month to end a bond-buying program that has been one of the main tools in its fight against falling prices.

It is clear that the “world´s central banks” have not used enough of the power available in their arsenal to successfully fight it´s “debilitating effects”. And “these emerging threats” do not come as the Federal Reserve is on track to end QE, but more likely because of it!