“Markets are telling where NGDP growth is heading” – an update

We´ll pretty soon have the first estimate of GDP for the first quarter of 2014. Coincidentally, a friend yesterday sent me an e-mail in which he mentioned a post by Lars Christensen from 2012 – “Markets are telling us where NGDP growth is heading”. In that post Lars writes:

To try to illustrate the connection between the markets and NGDP I have constructed a very simple index to track market expectations of future NGDP. I have only used two market indicators – a dollar index and the S&P500. I constructed an index based on these two indicators – I have looked at year over year percentage change in both indices. I have standardized the indices and deducted them from each other – remember higher S&P500 means higher NGDP, but a stronger dollar (a higher USD index) means lower NGDP. I call this index the NGDP Market Indicator.

My indicator is only a slight modification from the one Lars constructed. The chart below spans the period from 1990Q1 to 2014Q1 (NGDP is available to 2013Q4).

NGDP Indicator_1

The next chart shows only the more recent period. What the indicator appears to be telling us is that NGDP is likely to remain growing close to 4% (YoY).

NGDP Indicator_2

This is why the notion of a “Great Moderation 2.0” is being widely discussed. Unfortunately, people are discarding the level of NGDP too quickly and saying this is the “new normal” or “Great Stagnation”. But the “Great Moderation 1.0” was the combination of both a stable NGDP growth rate AND an appropriate level path along which it travelled. At the moment we have only the stable growth. The level path is clearly unsatisfactory; just look at the low employment level and way below target inflation.

When “medium term” becomes “open-ended”

The WSJ is kind to assure everyone that the “ECB Ready to Act if Inflation Misses Target”:

The European Central Bank is ready to take action if inflation rates fall too far below its forecast, Ardo Hansson, the governor of Estonia’s central bank and a member of the ECB’s Governing Council said in an interview with The Wall Street Journal Wednesday.

What are the ECB forecasts?

The most recent forecasts, issued in March, project inflation rates of 1% this year, 1.3% in 2015 and 1.5% in 2016. Annual inflation was 0.5% last month, the lowest for more than four years. The ECB targets inflation of just below 2% over the medium term.

Any sensible person would already have seen that the (medium-term) target not only  has been grossly missed but keeps moving in the wrong direction! To save face, even while prolonging the suffering, now the “target” is the “forecast”! I wonder what they will say in 9 months’ time when the 1% forecast is missed on the downside.

Funny to observe in the chart that whenever inflation goes above the “medium term” target, even if it´s because of a negative supply (oil) shock, the ECB is quick to increase the policy rate. Like Hercule Poirot, they should favor symmetry.

Open ended

The Fed has (unofficially) adopted a triple mandate

According to San Francisco Fed president John Williams (and he´s far from being a lone voice) it seems “financial stability” is right up there together with inflation and unemployment:

Federal Reserve Bank of San Francisco President John Williams said the central bank should avoid encouraging excessive financial risk-taking as it pursues its goals of full employment and stable prices.

We’re exactly on the right track” with current policy, Williams said in an interview yesterday in San Francisco, predicting unemployment will fall to 5.5 percent by the end of next year and inflation will accelerate to about 1.7 percent. Trying to achieve the Fed’s goals sooner “would take policy actions that might have more negative effects,” he said.

Williams, who has consistently supported record(!) stimulus, said the Fed will probably continue paring its asset purchases and end them late this year. Central bankers should take care not to change their forward guidance on the path of interest rates in a way that eases policy too much, he said.

“Adding more and more stimulus either through asset purchases or even trying to put even stronger forward guidance does create more risks about getting policy right on the exit,” said Williams, who is scheduled to vote on monetary policy next year. It also raises questions about whether the Fed is “contributing to potential risks with financial stability, excessive risk-taking.”

Regarding monetary economics in general and and monetary policy in particular, things seem to be regressing instead of progressing!

The anatomy of a monetary collapse

Regarding the “Great Depression” there are many, including Bernanke, who thought the “Great” prefix was the result of the bank failures. Never mind that the first bank failures happened more than one year after the start of the depression.

Just as then, regarding today´s “Great Recession”, the conventional wisdom has it that the prefix “Great” was the outcome of the financial crisis.

Scott Sumner and Brad DeLong debate the point. Brad´s view is somewhat different from the usual house-price-bust-financial-crisis-“Great Recession” causal chain. To Brad the crisis was the result of the failure to implement an adequate (optimal) resolution like it was done in the late 1980s and early 1990s on the heels of the S&L fiasco. As he says:

…the heightening of lending standards and the unwillingness of people to make further NINJA (no income, no job or assets) loans had not sent the economy into any sort of a recession.

Scott´s view is that a severe recession in late 2008 could have happened even if the financial turmoil had been handled optimally because monetary policy was extremely tight.

I´ll argue for the “monetary view”.

The first chart shows that six months after the start of the “Great Recession” in December 2007 the fall in employment was the mildest compared to both the more recent and more ancient recessions. No “Great” there!

Anatomy Collapse_1

Then things start going badly. The next chat compares employment in two deep recessions (1981 and 2007) extending the period to two years after the start of the respective recessions. Something really jolted the present one!

Anatomy Collapse_2

The third chart extends the period to three years after the start of the recession and provides a good indication that monetary policy is behind the prefix “Great”. When NGDP tumbles (below trend) so does employment. A better resolution to the financial difficulties would likely have made the recession less deep but likely it would still have been “Great”, given the monetary policy implemented which allowed NGDP to plunge below trend.

Note that QE1 was sufficient to brake the fall in NGDP and the subsequent ‘cocktails’ invoving QE, forward guidance and thresholds were just enough to keep the economy evolving in a stable manner along a much lower trend path. Because of this stability (low volatilities of real growth and inflation) many are saying “we have regained the “Great Moderation”. Unfortunately, it´s one “on the poor side of town”!

Anatomy Collapse_3

The next chart shows what happened over an equivalent period (3 years) at the time of the 2001 recession, and serves to ‘confirm’ the power of monetary policy in defining the cyclical pattern.

The 2001 recession was shallow but protracted, with the recovery beginning in November 2001 being dubbed a “jobless recovery”. Note that employment only picks up after the Fed loosened monetary policy with the introduction of forward guidance (FG). Almost record-low interest rates (1%) just were not doing the job. Forward Guidance was the trigger for NGDP to begin climbing back to trend (which was reached in late 2005).

Anatomy Collapse_4

While in 2001 the rationalization for the slow recovery was “jobless”, and attributed to structural factors, the much more serious failings in the present cycle are rationalized by “demographic factors” and lately by the selling that we are in a “Secular Stagnation”. With those rationalizations policymakers get off ‘scot-free’!

Words beat weapons

Lars has a very interesting post “The Cuban missile crisis never happened (or at least the stock markets didn’t care)“:

According to the history books one of the scariest events during the Cold War was the so-called Cuban missile crisis, where according to the history books the world was on the brink of nuclear Armageddon.

However, the history books might be wrong – at least if you look at what happened to the US stock market during the crisis. If we indeed were on the brink of the third world war we would certainly have expected the US stock market to drop like a stone.

What really happened, however, was that S&P500 didn’t drop – it flat lined during the 13 days in October 1962 the stand-off between the US and the Soviet Union lasted. That to me is pretty remarkable given what could have happened.

The early 1960s were a period of geopolitical turmoil, what with the escalation of the cold war, the “Cuban question”, the first innings in Vietnam, space race and presidential assassination.

The picture illustrates Lars´ conjecture about the stock market. For example, the day before President Kennedy´s assassination the S&P closed at 71.62 points, falling to 69.61 points or 2.8% on the fatal day (a Friday). On Monday the 25th of November 1963 the market remained closed and by the closing of the next day it had climbed to 72.38 points!

The “Missile crisis” played out during 13 days in the second half of October 1962, There´s even a good movie about it “Thirteen Days”. But it had started several weeks earlier when on September 4th President Kennedy issued a public warning against the introduction of offensive weapons into Cuba. The stock market was wobbly in face of the uncertainty, but it certainly did not believe the threats and counter threats would end in nuclear confrontation.

What the stock market really reacted to was President Kennedy´s famous press conference attacking the steel industry. Over a period of 10 weeks the market dropped 24%. Why?

A short answer is that unlike the President´s assassination, Kennedy´s speech signaled the possibility of a major institutional break: Executive interference in firm´s pricing policies!

Thirteen Days

So there you have it: for the stock market Words can be much more powerful than a show of Weapons!

The Easter bunny, once again, will not be visiting the long-term unemployed

Ben Casselman at FiveThirtyEight Economics has an interesting piece on long-term unemployment - The Biggest Predictor of How Long You’ll Be Unemployed Is When You Lose Your Job:

One characteristic distinguishes the long-term unemployed from the rest of America’s jobless. It isn’t how many hours they worked at their old job, or what industry they came from, or even their level of education.

Its bad timing.

A FiveThirtyEight analysis shows that by far the single biggest predictor of whether someone will be out of work for a year or more is the state of the economy when he or she loses his or her job.1 Over the past 15 years, a period spanning two recessions, a one-point increase in the unemployment rate increased an individual’s odds of remaining unemployed for at least a year by about 35 percent. No other characteristic — age, sex, race, marital status, education or occupation, among others — had even close to that big an effect.

Americans who had the misfortune of losing their jobs during the height of the most recent recession in 2009 were more than four times as likely to end up out of work for a year or longer than those who lost their jobs during the comparatively good economy of 2007. Extended unemployment benefits, which are often cited as a driver of the persistently high levels of long-term joblessness, don’t appear to be a major cause of the pattern.

More than 2.5 million Americans have been out of work for a year or more. That’s down from more than 4.5 million in 2010 but nonetheless represents a crisis of long-term unemployment that’s unprecedented in the U.S. since World War II. The plight of the long-term jobless has gotten renewed attention in recent weeks in part due to mounting evidence that they are being left out of the economic recovery.

After a long discussion (with data), they arrive at the following conclusion:

Taken together, these are discouraging findings. A weak economy can cause long-term unemployment, but a stronger economy can’t fix it. That suggests policymakers’ top priority needs to be preventing the kind of long, slow recovery that leads to high levels of long-term unemployment in the first place. A stronger economic rebound in recent years would likely have put many of the recession’s victims back to work before they became long-term unemployed. That lesson won’t do much to help today’s jobless, but it might help prevent a similar crisis in the future.

I´ll concentrate on their conclusion.

I have no beef with “a weak economy can cause long-term unemployment” (it sure can and does), but what exactly is meant by “but a stronger economy can´t fix it”?

That´s Alan Krueger´s view, not theirs. They really believe a stronger economic rebound would have done wonders.

But is it really too late? No matter what people say, write and theorize, we´ll only know for sure if we (rather the policymakers) try.

The charts below may help give a feeling for the loss that´s been imposed on the economy by monetary procrastination.

I compare four different cycles for a period of twenty four quarters following the cycle peak. There´s one cycle in the 1970s (the oil-shock induced recession of 1973/75), one cycle in the 1980s (the Volcker “get-rid-of-inflation” induced recession of 1981/82) and two in the 2000s (the “growth-is-too-high” induced recession of 2001 and the “inflation-obsession” induced recession of 2007/09).

I´m just giving easily understandable “inducements”, but monetary policy errors of different nature was the real culprit, although I´ll not go into that to keep the focus on the plight of the long-term unemployed. In fact, as will become clear, it was only when monetary policy was “eased up” (by which I mean getting nominal spending (NGDP) to grow faster) that long-term unemployment subsided.

You´ll also see the behavior of long-term unemployment gives a good characterization of type of recovery: if it was V-shaped, U-shaped or L-shaped. For reasons that will become clear, the 2007 recession had a long “drop” and an also long “base”, mimicking the shape of an L.

I also show the behavior of inflation during the different cycles. The one in the 1970s is characterized by a jump in core inflation, something that “naturally” happens when there´s a significant negative supply shock (oil and commodity prices in this case). But that´s “natural” only in the case you already are in an inflationary environment and one in which the Fed has no credibility.

There was a significant rise in the price of oil in 2003/05 and again in 2007/08, but no jump, or even significant increase in core inflation. That´s because the Fed had earned credibility. By becoming obsessed with the inflationary effects of oil prices the Bernanke Fed got “trigger-happy”, with the consequence being the long drop in the vertical part of the “L”.

Observe that the recovery from the 1981 recession was strong (“V” shaped) with inflation on a downtrend, a sure sign that the Volcker Fed quickly earned credibility.

The recovery from the 2001 recession is mediocre. The recession itself was “shallow” but the Fed took its time to act. Only in the second half of 2003 did it become more “proactive”, introducing forward guidance (FG). Note how the NGDP trend becomes steeper and how long-term unemployment eases up from that point. Unfortunately the rise in nominal spending was not strong or quick enough to get something like the V-shaped recoveries obtained in the 1970s and 1980s. What is truly amazing is that this happened with the Fed being afraid of inflation getting too low! (Remember Bernanke´s 2002 “Helicopter Ben” speech?).

But that was just the “warm-up” for the real screw-up that would come a few years later and, which never ceases to amaze me, under the leadership of Mr. Ben (“Great Depression”) Bernanke! The QE´s augmented by thresholds and forward guidance cocktails were only effective in stopping the “spread of the cancer”, but there´s been no real remission.

Enough words. Let the pictures tell the story. For ease of comparison all the NGDP-Long-term Unemployment charts have the same scale both on the left side axis (NGDP) and right side axis (LTU-inverted scale). The same for the inflation charts. (Note: the top right hand side NGDP-LTU chart should read 2001-2007 (not 2006)).

Easter Bunny_1

Easter Bunny_2



There is “Scientology” and there´s also “Great Stagnationism”!

(Note: Both comprise a body of beliefs and related practices. For example: Scientology teaches that people are immortal beings who have forgotten their true nature.[9] Its method of spiritual rehabilitation is a type of counselling known as auditing, in which practitioners aim to consciously re-experience painful or traumatic events in their past in order to free themselves of their limiting effects.)

Yellen´s speech today, the first as Chair of the Federal Reserve has been extensively parsed. To minimize the risks of repeating what others have certainly written, what struck me was how, despite the subtext of her speech being how much the Fed is committed to support the recovery, that final goal is still far away:

In sum, the central tendency of FOMC participant projections for the unemployment rate at the end of 2016 is 5.2 to 5.6 percent, and for inflation the central tendency is 1.7 to 2 percent.2 If this forecast was to become reality, the economy would be approaching what my colleagues and I view as maximum employment and price stability for the first time in nearly a decade. I find this baseline outlook quite plausible.

In summary, the policy framework I have described reflects the FOMC’s commitment to systematically respond to unforeseen economic developments in order to promote a return to maximum employment in a context of price stability.

It is very welcome news that a return to these conditions has finally appeared in the medium-term outlook of many forecasters. But it will be much better news when this objective is reached. My colleagues on the FOMC and I will stay focused on doing the Federal Reserve’s part to promote this goal.

Let´s look at some statistics. The average span of expansions between 1945 and 1982 was 31 months. If we take the end of 2016 as coinciding with the end of this expansion, it will have been going on for 90 months or almost three times longer than the average length of expansions in the 1945-82 period!

But note that the average length of expansions during the Great Moderation – 1983 -07 – was 92 months (with a maximum of 120 months in the 1991-01 expansion).

That meshes well with the thought being put forth that we are in a “Great Moderation” 2.0, where growth (both nominal and real) and inflation volatilities are just as low as during the “Great Moderation” 1.0.

If so that also implies that policymakers have “chosen” to keep the economy trapped in what is being called a “Great Stagnation”, a path that is distancing itself quarter by quarter from a more suitable and attainable level path. And given path-dependency, there will come a time when the “Great Stagnation” will become not the “new” but simply the “normal” state of affairs.

I never tire to illustrate this scenario because it´s the best pointer to where we´re going!

Yellens First

By the end of 2016 inflation and unemployment may be hugging their respective “ideals”. But the economy itself will be a whole different animal from what it was in the post-war to 2007, and particularly, despite similar volatilities, very different from what it was during the GM 1.0.

Jürgen Stark looks only at Germany, but does so with ‘rose-tinted’ glasses

Writing in the FT “Doomsayers risk a self-fulfilling prophecy”:

It is likely we are living in an extended period of price stability. This is good news. It boosts real disposable income and will eventually support private consumption. Inflation expectations are well anchored, and there is no evidence households and companies are delaying purchases because of negative expectations. Warnings about outright deflation and calls for ECB action are misguided and irresponsible. The longer this discussion continues, and the more intense it becomes, the more likely the risk of a self-fulfilling prophecy.

He´s looking at and thinking only of Germany! I won´t even bother with the conceptual errors (like the real income boosting property of price stability/low inflation).

Why do I believe he´s “Germany-centered”? The charts tell the story. While Germany has been back on trend for some time, the “others” languish. It is also clear that the ECB is EXCLUSIVELY concerned with inflation, at least when its (even slightly) above trend, but much more cavalier when it´s some ways below! Unemployment has zero weight.

Jurgen Stark_1

Jurgen Stark_2

Jurgen Stark_3

Jurgen Stark_4

All that is pretty well known. Nevertheless, over the past two years (remember Draghi´s “whatever it takes” in July 2012?) the ECB says it´s being highly “accommodative” and is debating further “accommodation” (that´s one reason people like Stark are voicing a contrary opinion). But all that “accommodation” does not seem to be working!

Also, how long will Germany manage to “hold-out”?

Svensson is disgusted with the Riksbank

In his blog he writes “Deflation in Sweden: Questions and answers”:

Sweden has deflation, that is, negative inflation…What has caused the deflation, what are its consequences, could Sweden end up in a similar situation as Japan, and what can be done about the problem?

What has caused the deflation?

The deflation has been caused by the Riksbank´s tight monetary policy since the summer of 2010. The majority of the executive board chose in the summer of 2010 to start increasing the policy rate, which was then at 0.25 percent. The policy rate was increased at steady and fast rate to 2 percent in the summer of 2011. The increases started, in spite of the forecast in the summer of 2010 for inflation the next few years lying below the inflation target and the forecast for unemployment lying far above a long-run sustainable rate.

My summary of the Riksbank´s monetary policy is damning to the policymakers (see the charts)

Up to mid-2010 they were doing the ‘right thing’. In fact, they appeared to follow in the footsteps of Australia and in any case were much more proactive than the Fed, BoE or ECB. These were setting a ‘bad example’ by allowing NGDP to remain comfortably below trend and showing no desire to “try for the gold”. Unfortunately, Sweden decided to follow their example!

Deflation in Sweden_1

Deflation in Sweden_2

Deflation in Sweden_3