Regarding Price Shocks, the Fed is “two-faced”

If oil prices rise (like in 2007-08) there´s a risk of permanently lifting inflation; but if oil prices fall, the effect on (dis)inflation is only temporary!

From Fed Watcher Tim Duy:

As I anticipated, the Fed dismissed the decline in market-based inflation expectations. They clearly believe financial markets over-reacted to the decline in oil prices, and that that decline would ultimately prove to be a one-time price shock rather than the beginning of a sustained disinflationary process.

This is why we watch core-inflation.[One would wish!]

If only symmetry held, the “Great Recession” would have been only “Recession”! And as a bonus we would not have been listening, insufferably, to “Great Stagnation” talk.

Two-faced Fed

When doing analysis it helps to get the facts straight

And Antonio Fatas in “Riksbank and ECB: Reverse asymmetry” misses badly:

The Swedish central bank just lowered interest rates to zero because of deflation risks. This action comes after ignoring repeated warnings from Lars Svensson who had joined the bank in 2007 and later resigned because of disagreements with monetary policy decisions. What it is interesting is the parallel between Riksbank decisions and ECB decisions. In both cases, these central banks went through a period of optimism(!) that make them raise interest rates to deal with inflationary pressures.

In the case of Sweden interest rates were raised from almost zero to 2% in 2012. In the case of the ECB interest rates were raised from 1% to 1.5% during 2011. Also, in both cases, after a significant expansion in their balance sheets following the 2008 crisis, there was a sharp reduction in the years that followed. During 2010 the balance sheet of the Riksbank was reduced by more than 50%. In the case of the ECB it was later in 2013 when the balance sheet shrank by about 1 Trillion Euros. Their policies stand in contrast with those of the US Federal Reserve and the Bank of England where interest rates still have to start going up after the initial actions taken during the crisis and where the expansion in their balance sheet has not started to being reversed.

The Riksbank increased rates from “almost zero” (0.25%) in mid-2009 to 2% in mid-2011. That is it increased rates much faster than Fatas thinks!

Fatas & Facts_1

It seems that throughout this period they were extremely worried about inflation. But the headline numbers were mostly reflecting oil price increases, a supply shock, something that throws sand in the gears of inflation targeting!

Fatas & Facts_2

The Fed has been “tedious” at a time it should be “exciting”

After a two day meeting you can wonder why it took 48 hours to…do nothing!

From the Statement:

The Federal Reserve on Wednesday said it would stop its long-running bond purchase program at the end of October, ending a historic experiment that has stirred intense debate about its effects in markets even though the central bank said it accomplished(!) its main goal of reducing unemployment.

At the same time, the Fed upgraded its assessment of the job market’s performance while pointing to some short-term downside risks on inflation. It stuck to an assurance that short-term interest rates will remain near zero for a “considerable time.”

Let´s see what Quarter 3 GDP (both R & N) looks like tomorrow.

QE vs Forward Guidance

From the WSJ: “The Fed Favors Guidance Over Bond Buys”:

The Federal Reserve’s forward guidance has been a lot more effective at keeping long-term rates down and stimulating the economy than its three bond-buying programs, says Eric Swanson, an economist at the University of California, Irvine, who until recently was a researcher at the San Francisco Fed.

Such low-rate promises, says Mr. Swanson, who co-authored an influential paper on unconventional Fed policy with San Francisco Fed President John Williams early last year, have had a perceptible downward effect on borrowing costs.

“The cumulative effect of the Fed’s forward guidance has surely been much more important than the effect of its long-term bond purchases,” Mr. Swanson said in an email in response to questions from The Wall Street Journal. He estimates the Fed achieved only a fairly modest 0.1 to 0.2 percentage point decrease in short-term rates from its second round of bond buys, which amounted to $600 billion.

“I think, going forward, the [Fed’s policy committee] views forward guidance as the better policy tool, which is why it’s comfortable winding down its long-term bond purchases now,” said Mr. Swanson, who was a senior research advisor at the San Francisco Fed and was previously a staffer at the Fed’s Washington-based board.

I thought this was not hard to grasp:

QE conveys the message that “we want to help the economy make a comeback”. (Pity it was done in an unproductive “on again, off again” style)

Forward Guidance is in effect telling everyone that the Fed expects the economy to remain in dire straits “forever”!

No wonder “borrowing costs” (a.k.a. interest rates) are kept down; and that doesn´t mean it is “stimulating” the economy. Quite the contrary!

Yes, Svensson was vindicated but the better part is that he showed that he could change his mind

Sweden is in the news:

As Scott Sumner has posted:

In any case, it can now be said that Lars Svensson’s critique of Riksbank policy has been proven “true” in the sense that his opponents have now recognized it as true (the following is from the excellent Ambrose Evans-Pritchard):

Sweden’s Riksbank has torn up the rulebook of global central banking, cutting interest rates to zero even though the economy is in the grip of a credit boom.

The extraordinary step is intended to stave off deflation but it comes at a time when the Swedish economy is growing at almost 2pc and property prices are rising briskly. The bank has abandoned earlier efforts to curb asset bubbles by “leaning against the wind”.

The Riksbank cut the deposit rate to -0.75pc in what looks like a preparatory move to drive down the krona. Governor Stefan Ingves said the bank has a toolkit of extreme measures in reserve, including use of the exchange rate.

If the Riksbank was caught off guard, it’s because they weren’t paying attention to the only world class monetary expert on their committee.

The Riksbank has in effect washed its hands of the credit boom, leaving it to government regulators to control household debt with mortgage curbs, liquidity limits for banks and other “macro-prudential” tools as best they can.

No one is perfect. My appreciation of Svensson is that although he was present at the moment of the “original sin”:

This is what we read from the minutes of the Riksbank Meeting of September 2008!!!:

The Executive Board of the Riksbank has decided to raise the repo rate to 4.75 per cent. The assessment is that the repo rate will remain at this level for the rest of the year… It is necessary to raise the repo rate now toprevent the increases in energy and food prices from spreading to other areas [oil and commodity prices had peaked 3 months earlier].

Inflation targeter Lars Svensson was in favor. But he later recanted and was all for more expansionary monetary policy. Unfortunately in late 2010 the Riksbank started to fret about house prices. Svensson dissented and went on dissenting until he resigned in disgust last year.

Central Bankers Are Blind to New Phillips Curve? Or Just Sadists?

A Benjamin Cole post

No, I do not have dense pages of calculus for the reader, purporting that QE would be ruin or divine salvation, or that minor deflation is the theoretical apex of an economic model.

Just some numbers from the back of The Economist. Simple stuff.

But Jeez, eyeballing the figs, it sure seems like the price of small inflation is big unemployment.  The Phillips Curve looks more like a low-trajectory missile—to get minor deflation, you need killer unemployment.

Moreover—and most importantly—low unemployment does not provoke much inflation.

Just some simple empirical observations ahead, no theories.

Low Unemployment, But Little Inflation

Take a country I know something about: Thailand. I live here now. Anyone can get a job—my sister-in-law, in a sparsely settled rural area, found a job walking distance from her house. They asked her to put in nine hours a day, extra pay on the ninth hour. Then they asked her to work six days a week. Grape farmers.

The official stats say Thailand has an unemployment rate of 0.7%, and inflation of 2.7%. The unemployment rate has been near zero for a long time, btw. The reports of Thai public companies often say they could make money if they could find more employees. The Thai inflation rate is one that would have been politically acceptable in the U.S. until recent times, perhaps as recently as 2007.

Now the U.S. Fed applies the monetary noose if the country approaches 2% inflation. Our central bankers detest unemployment below 6%. (No, they are not Putin surrogates).

Singapore has a 2.0% unemployment rate and a 1.5% inflation rate. S. Korea is at 1.5% inflation and 3.2% unemployment. China is 2.1% inflation and 4.1% unemployment. The Far East looks like this.  Low inflation and low unemployment.

Okay, that’s the other side of the globe. So let’s look at Poland. They have the utopia of low inflation at 0.2%, but also have 11.7% unemployment. To confuse matters a bit we also see Switzerland at 0.1% inflation, but 3.2% unemployment. Sweden also has 0.1% inflation, but a higher 7.4% unemployment rate.

It is possible to get to the supreme exalted state of deflation that so enchants so many right-wing economists in the U.S. In fact, Greece has done it, a hero nation with a 1.5% deflation rate, although they also have 26.4% unemployment rate. Spain gets into the deflation zone too, at negative 0.2% and 24.4% unemployment. Italy fares similarly, with 0.3% inflation and 12.3% unemployment.

There are more countries, but you get the picture.  There are some women ugly enough to deflate men, and some economies ugly enough to deflate prices. But is that the way to live?

The Upshot: Central Bankers Are Sadistic, Nuts

Comparing macroeconomic statistics across nations is fraught with difficulties. Who knows if they measure inflation in Thailand as they do in Switzerland or Poland? And unemployment figures are squishy.

But looking at these figs, my take is you have to be sadistic or nuts to unemploy millions of people, and lose trillions of dollars of output, sacrifice untold profits just to cut reported inflation rates a percent or two.  To get inflation below 2.5% is very expensive.

And low unemployment no longer appears associated with much higher inflation rates.

The global economy has changed mightily in the last 40 years, supply chains are worldly, capital flows are gigantic. Old-fashioned demand-pull inflation may be nearly impossible to obtain. It would take an awful lot of prosperity to generate that 1970s inflation again.

I wonder how much growth in the U.S it would take to get back to 4% inflation, the rate 1980s Fed Chairman Paul Volcker obtained in his great war on inflation.

President Jimmy Carter oversaw a 20% increase in real GDP from 1976 through 1979.

Maybe that is what it would take to generate inflation. Worth a stab, no?

Some are having “second thoughts” about the stance of monetary policy

Lars sends an ‘unsual’ news article published in Forbes:” Consensus Building That the Fed’s Policies Were Too Tight”

At the beginning:

Is the Fed’s current stance too “loose,” running the risk of triggering inflation? That’s the current debate, and we probably won’t get broad agreement on the answer until the recession is much further in the rearview mirror. Economic consensus tends to build slowly – frequently only in hindsight.

Only now, for example, does consensus seem to be developing among conservative economists over how the Federal Reserve’s monetary policy during 2008 affected the recession. The general feeling now is that the Fed contributed to – and likely worsened – the crisis by keeping money too tight.

At the end:

Even for those who insist on clinging to the interest rate fallacy, there’s a problem: the Fed started raising its target rate in the middle of 2004, and never lowered it again until September 2007.  Over that period, the fed funds target rose from 1 percent all the way to 5.25 percent.

This trend may well indicate the Fed held its target too high for too long.  Regardless, the economy collapsed on the Fed’s watch, and preventing economic collapse is the reason Washington created the Fed in the first place.

The “in between” is well worth reading.

The chart illustrates, showing the three important components from a market monetarist perspective: Broad Money Supply growth, Money Demand (velocity) and NGDP growth.

Forbes on MP

See, when the Fed allows money supply to contract while money demand is rising (velocity falling), the result is a massive AD (NGDP) negative shock, something that David Beckworth argues does not mesh at all well with an inflation targeting regime.

But at Forbes, there´s also the “bad cop“!

What the election result in Brazil means?

Disclosure: I´m not registered with any party and don´t much like politics.

But danger lurks for Brazil. After three unsuccessful bids for the presidency, in 2002, at the last minute, the Workers Party (PT) but on “sheep´s clothes” and got elected. That was the first stage of their three-stage program.

The second stage involved “financing”, so corruption grew exponentially over the last 12 years. Now the coffers are full and, having won Sunday´s election (no matter the narrow margin) they are ready to begin the third and final stage for their perpetuation in power and the ‘unmaking’ of Brazil.

Corruption will be drastically toned down (after all the money is in and public opinion is wary). This stage will be defined by a sequence of plebiscites, each one geared to concentrate power in the hands of the Executive, bypassing tortuous Congressional proceedings and trampling over individual liberties.

For several years now, for example, they have tried to gag the press by introducing what is euphemistically called “Social Control of the Media”. This will likely be discussed more forcefully now and in the near future we can expect “society will be called to manifest its opinion”. Other plebiscites will follow. When people realize what´s really going on, it will be too late!

That´s the “democratic” route to Dictatorship; it has happened in Venezuela, Bolivia and is in full bloom in Argentina (once again).

Central Banks that make the same mistake are ‘rewarded’ with similar outcomes

While the Riksbank can focus exclusively on Sweden, the ECB has a more complicated task, having to ‘oversee’ a bunch of countries.

Both central banks have an exclusive mandate: “Price stability”. While in Sweden that is understood as 2% inflation, in the EZ it is something slightly lower.

Nevertheless, the two ‘countries’ central banks acted in tandem, tightening as a reaction to higher than target inflation due to oil price shocks. Not surprisingly, they ended up in the same “alley”, but the EZ side of the “alley” is a bit “darker” because of its more diffuse clientele.

Common Mistake_1

Common Mistake_2

Common Mistake_3

This is certainly more evidence against inflation targeting. It´s a “guide dog” that can easily lead you astray!

PS The US turned out different because, although it fell into the “first trap”, it didn´t repeat the mistake. Instead it did QE. Australia did even better because it didn´t fall even into the first trap, keeping NGDP evolving close to trend!

The Riksbank thinks inflation is a “price phenomenon”

The Riksbank´s “Monetary Policy Report” asks the question: “Why is inflation low” and this is a summary of the answer:

Inflation has been low in Sweden in recent years and fell further in the latter part of 2013, mainly because the rate of price increase for services slowed down. This article points to the existence of several different factors that have contributed to this low inflation at different points in time. Demand has been weak for many years, which has contributed to cost increases being moderate and price mark-ups low. Energy prices have also developed weakly over the past few years. A stronger exchange rate contributed to lower inflation in 2011–2012, but probably to a lesser degree since 2013. Food prices have increased more slowly since the end of last year.

The only reason that makes sense is “Demand has been weak” (the others fall under “reasoning from a price change”), but they never ask why! Maybe the Riksbank does not like to say “my fault”, as is clearly shown in the chart below.


The next charts clearly demonstrate the danger of monetary policy reacting to price (oil) shocks. It did it in mid-2008 and then again in late 2010. In the second round of tightening the “justification” was “exuberance in the real estate market”.