While they bicker the Zone flounders

Travis links to a piece that would make the deviousness of Frank Underwood (of House of Cards fame) look like child´s play!:

In early October, European Central Bank board member Benoit Coeure paid a discreet visit to the Chancellery in Berlin to express concerns about rising criticism of the bank from German politicians.

The Frenchman, one of ECB President Mario Draghi’s closest allies in Frankfurt, hoped for reassurances that the bank bashing, led by Finance minister Wolfgang Schaeuble, would stop.

But the message from Chancellor Angela Merkel’s advisers was not entirely comforting, according to one official familiar with the discussion.

Merkel would continue to refrain from questioning the ECB’s policies in public. But the broader backlash would be difficult to contain, especially if Draghi pressed ahead with unconventional measures to bolster the European economy, for example buying mass quantities of government bonds.

“Then you would see a real debate,” a top German official told Reuters on condition of anonymity. “Public criticism in Germany would take off.”

At the end:

Earlier this month, Hans Michelbach of the Bavarian Christian Social Union (CSU), the top conservative in the Bundestag’s finance committee, went so far as to label Draghi’s appointment to the top ECB post a “mistake”.

Meanwhile, the real people in the real world weep!

Drag it down

HT Becky Hargrove

With incredible headlines like these, who can believe inflation is the “proper” target?

It´s from The Economist over a span of 17 years!

In 2014: Politicians and central bankers are not providing the world with the inflation it needs; some economies face damaging deflation instead

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.

In 1997: “America’s inflation rate is low and stable. This has rekindled an old debate over the benefits of price stability

But how low should inflation go? Many economists argue that a small amount of it may not be a bad thing and could even be beneficial. One of the first was James Tobin of Yale University, who suggested in 1972 that a bit of inflation helps “grease the wheels” of the economy. In today’s world of low inflation, the validity of his argument is increasingly important for policy-makers. If it is correct, then the pursuit of extremely low levels of inflation may be misguided—not only because of the short-term rise in unemployment that can result from cutting inflation, but also because zero inflation might cause permanently and unnecessarily higher levels of unemployment. This is why the concept of inflation as economic grease has become the focus of controversy anew.

The charts indicate very clearly that the problem does not reside with the level of inflation but with the level of nominal spending, even if at present you “pull-down” both the level and growth rate of nominal spending. A large gap is still present!

Incredible headlines_0

Incredible headlines

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.


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.


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:


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!


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