UK NGDP takes a dive

A James Alexander post

In the current absence of the excellent Britmouse we shall have to start covering UK NGDP here at this site. He was getting a bit overoptimistic anyway. And it is not good news this week.

The first estimate release of GVA (a cut down version of NGDP) last month had warned of a sharp slowdown in NGDP in the UK during 2Q. This was confirmed. Money is tight in the UK and yet we have the same “normalization” charade from our own MPC that we see at the Fed.


It is not surprising that we have a slowdown in the UK given the fiscal tightening, seen very visibly in the sharp rise in tax revenues with more to come, allied to the strangulation effect of the 2% inflation ceiling. (Note to Keynesians: fiscal policy can be conducted via taxes too.)

The “inflation” that the MPC should be worried about is worryingly low and going lower as shown in the Implied GDP deflator.


For sure there has finally been some modest pick-up private sector wage growth, as in the US. But, as in the US, too, the capitalist classes seem to want to stop prosperity spreading to the masses by active monetary tightening. These hawks should be careful of what they wish for … Syriza, Podemos, Jermey Corbyn and Trump/Sanders mania.

I wonder whether Governor Carney will be reflecting the “normalization” mania or looking at the (real) nominal data this morning in his Jackson Hole party piece?

The Fed Paints Itself Into A Smaller And Smaller Corner Jackson Hole Could Spell Bad News

A Benjamin Cole post

The Fed entrapment of itself began with ex-Chairman Ben Bernanke, who slated the tapering down of quantitative easing before leaving office. Bernanke did not reduce QE to, say, “a low and variable level,” that would leave open the door for increasing QE as needed, as a mere policy adjustment.

By closing off QE as an option in 2014, Bernanke left his successor, Janet Yellen, without QE as tool. To use QE again, Yellen would have to engage in a “flip-flop” or policy reversal, considered a cardinal sin in Washington, D.C. talking-head circles.  Worse, Yellen faces a vociferous gaggle of tight-money ideologues and extremists, eager to pounce on any Fed policy they can denounce as “activist,” “hyperinflationary” or ineffective.

Not content with having closed off one door, Yellen grabbed the paint brush herself and kept backstepping and improving the floor around her, reminding everyone everywhere that the Fed would likely raise rates in 2015.

So now we are bearing down on 2016, and the Fed still has not raised rates, leading to rising, acute and evidently hysterical discomfort among the prominent herds of “interest-rate crackheads.”  For months, the only topic in the FOMC room, and tight-money circles, has been hiking interest rates.


Global trade H1 was down year-over-year. Singapore is in a deflationary recession, Hong Kong’s stock market off YOY. China is wobbly, and Europe in deflation. The Atlanta Fed says Q3 GDP in the U.S. is penciling out flat.

Wages in the United States are dead, and inflation below the Fed’s IT target—and the market expects inflation in the next five years to run at less than 1% on the PCE, or at about one-half of the Fed’s putative “average” target.

Worst of all, the U.S. RGDP is perhaps 10% below where it should or could be, had mediocre economic growth rates been obtained since 2008.  I know of no industry straining to meet demand—indeed, most industry denizens still speak of weak demand, and certainly aggregate demand is weak.

But the Fed is trapped. Global central bankers and the other usual tight-money fanatics are now convening at the Fed’ annual Jackson Hole confab, to gird each other up for even tighter money ahead.

Jackson Hole is not a conclave of venture capitalists, real estate developers, business operators or even labor groups and truckdrivers or dockworkers.

People in the real economy are not invited to Jackson Hole.

At one time, the economics profession embraced “independent” central banks as a good idea. Is anyone so sure anymore?

“Central bankers aren’t sure they understand how inflation works anymore”

JACKSON HOLE, Wyo.—Central bankers aren’t sure they understand how inflation works anymore:

Inflation didn’t fall as much as many expected during the financial crisis, when the economy faltered and unemployment soared. It hasn’t bounced back as they predicted when the economy recovered and unemployment fell.

The conundrum challenges much of what central bankers thought they understood about the world, as well as their ability to do their job. How will they know when to raise or lower interest rates if they’re unsure what causes consumer prices to rise and fall?

“There is definitely less confidence, a lot less confidence” about how inflation works,James Bullard, President of the Federal Reserve Bank of St. Louis, said in an interview here Friday.

The economy’s performance has “really challenged” the notion of a strong link between unemployment and inflation, Mr. Bullard said on the sidelines of the conference. The existence of such a link was also challenged in the 1970s, an era of high inflation and high unemployment.

Today’s uncertainty is a turnabout in a community that gave itself credit for figuring out and taming inflation after bringing it down sharply from double-digit rates in the 1970s.

The Fed’s thinking about inflation forces has changed before. For a while in the 1980s the central bank focused on managing the growth of the supply of money in the banking system. One view was that the purchasing power of dollars was closely connected to the supply of dollars in the economy. The Fed gave up on this approach in the 1990s when links between measures of money supply and measured consumer prices seemed disconnected

Since then, central banks moved toward setting inflation targets and trying to reach them by adjusting interest rates, often in response to the amount of slack in the economy, as shown in unemployment rates and other measures…

Maybe they never did understand! Let me help them with a hint.

Hint: The inflation dynamics is closely tied to the Fed´s success in obtaining NOMINAL STABILITY!

The charts illustrate. Immediately after WWII and extending to the mid-1960s, inflation was “low” (average=2%) but volatile (St Dev=2). Average NGDP growth was 6.3% with St. Dev. of 4.5. That compares with “low” (average=2.5%) and stable inflation (St Dev=1). Meanwhile, NGDP growth averaged 5.7% but it´s standard deviation (1.4) was just one-third the standard deviation of the 1948-65 period.

Inflation Dynamics_1

What have we had for the past 9 years, since Bernanke (followed by Yellen) took over the Fed?

The chart shows that inflation has been a little “too low” (average 1.8%) and stable (St Dev=1.1), while NGDP growth has also been “too low” (average=3.2%) and only relatively stable (St Dev=2.3).

Inflation Dynamics_2

You could say that there has been nominal stability. Unfortunately, the stable LEVEL path is “too low”!

The market monetarist conclusion is: Target a level path for Nominal Spending (NGDP). Inflation will remain “low” and stable, but the rest of the economy will feel much better!

To cap it up, the next chart allows you to get a feel for the “dynamics of inflation” when NGDP growth rides on a rising trend and when inflation is “spiked” by a couple of “strong” oil shocks!

Inflation Dynamics_3

The NGDL level target story is certainly much “cleaner” than the Phillips Curve (growth/low unemployment) drives inflation story.

Jackson Hole

Tomorrow, Fed Vice-Chair Stanley Fischer will speak on Global Inflation Dynamics. At the opening dinner last night he told reporters:

The Federal Reserve’s No. 2 official said Friday the central bank hasn’t settled on whether to raise interest rates next month, and the option remains on the table.

“I think it’s early to tell” what will happen at the Fed meeting, Federal Reserve Vice Chairman Stanley Fischer told CNBC, citing the market turbulence of the past weeks.

Until recently, “there was a pretty strong case” to raise the Fed’s benchmark short-term interest rate from near zero at the central bank’s policy meeting Sept. 16-17, Mr. Fischer said. “It was not a conclusion yet; it was a case.”

But recent events—worries over China’s growth outlook, its currency devaluation and volatile global markets—suggest Fed officials need to step back and mull incoming data before deciding what action to take, he said.

“The change in circumstances which began with the Chinese devaluation are still relatively new, and we are still watching how it unfolds. So I wouldn’t want to go ahead and decide right now what the case is, compelling or less compelling” for rate rises.

It seems markets have concluded that the “case is less compelling”!

Rate Hike

Phillips Curve, the FOMC´s Lullaby

Just two days ago, I had something to say on the Fed and the Phillips Curve. Today, Tim Duy concludes, after a lengthy discussion of all the wrong arguments for a rate rise in September:

But if they take that risk, it won’t be because they want to send the markets a message that they are in charge, or that the “Greenspan put” needs to be put to rest, or that they can’t been seen as cowering to the markets, or that they need to stay the course because they already signaled a rate hike, or because foreign central bankers are demanding the Fed hike rates, or because they need to build ammo for the next crisis, or any other reason that comes from barstool moralizing after one too many. If they hike rates it will be for one simple reason: The recent market turmoil does little to shake their faith in the Phillips Curve. That would be the heart of their argument. And if you are arguing for September, that should be the heart of your argument as well.

Phillips Curve LullabyNo matter all the evidence against “Phillips Curvism” that has accumulated over the decades, the FOMC still finds “comfort” in it!

Get me out of my misery: just “pull the trigger”!

JACKSON HOLE, Wyo.—After months of forewarning by Federal Reserve officials that they are preparing to raise short-term interest rates, some international officials attending the Fed’s annual retreat here this week have a message: Get on with it already.

“If you delay something that you were planning to do, then you leave the impression that your compass is different than what you led markets to believe,” Jacob Frenkel, chairman of J.P. Morgan Chase International and former head of the Bank of Israel, said in an interview Thursday. Market drama is increased by delay, he added.

Interestingly, in 2013, when Jacob Frenkel was appointed to replace Stanley Fischer as head of the Bank of Israel (although that didn´t pan out), he said:

At the conference, Frenkel had an enlightening conversation with Axel Weber, today the chairman of the Swiss banking group UBS and formerly the leader of Deutsche Bundesbank, the German central bank.

“We were both formerly central bankers and I personally can say I wouldn’t want to be a central banker today, with interest rates at rock bottom, because there’s almost nothing that can be done,” Frenkel observed. Every central banker knows that keeping interest rates that low isn’t sustainable, he added: “That doesn’t mean it’s a bad policy, but that’s not a place anybody would want to be.”

2 cheers for ECB’s Praet, 0 for NYFed’s Dudley

A James Alexander post

Two interviews on 26th August showed up a chasm between the ECB and
the NY Fed, reflecting very badly on the Fed. What a difference a few
years makes. Draghi will be popping over to Yellen to tell her what to
do soon.

Peter Praet, ECB Board Member and Chief Economist said:

“There should be no ambiguity on the willingness and ability of the
governing council to act if needed … . The [asset-buying programme]
provides sufficient flexibility to do so in terms of size, composition
and length of the programme.”

NY Fed Governor and member of the Federal Open Market Committee William Dudley said:

“At this moment, the decision to begin the normalization process at
the September FOMC meeting seems less compelling to me than it was a
few weeks ago, [but an initial rate hike] could become more compelling
by the time of the meeting as we get additional information on how the
U.S. economy is performing and (on) international financial market
developments, all of which are important to shaping the U.S. economic

Dudley was only in damage limitation mode after the FOMC had actively, if only “slightly” in their eyes, tightened monetary policy with this comment in the minutes release on 19th August :

“To further reflect the Committee’s assessment that economic conditions had continued to progress toward its objectives, the Committee slightly altered its characterization of when it anticipates that it will be appropriate to begin the process of policy normalization.”

What is normal? Normal is a healthy economy growing well. Sure,
tighten policy when the economy is growing too fast, when expected
NGDP growth is 7% of something (ideally having made up for past below
trend misses). FWIW the average of the two volatile numbers for 1q and
2q 2015 is a very dull 3.7%. Tightening before excessive growth is not
normal, and will send that 3.7% lower. Dangerously low.

These central banks are too inflexible. At least the ECB is
inflexible in a good way at the moment, atoning for mulitple past
sins. The Fed is now insanely focused on “normality” rather than
prosperity. Until the Fed drops this weird obsession, the current
turmoil will not end well. I’m backing Europe.

“Off the table” (again)!

As I “forecast” in June, Tim Duy would “downgrade” September!

Bottom Line: The Fed has long argued that the timing of the first rate hike does not matter. I had thought so as well, but that is clearly no longer the case. A rate hike during a period of substantial financial market turmoil would matter a great deal. It looks like the Fed’s plans to raise rate will once again be overtaken by events.

A mindset cast in bronze

Back in April 1997, while still a ‘freshman’ Fed Board member, Laurence Meyer gave a milestone speech at the Forecasters Club of New York. For the first time, I think, a board member provided a detailed account of his decision process framework.

One month earlier, the FOMC had changed (raised) interest rates for the first time since having reduced it in February 1996.

Meyer writes:

I am going to offer some interpretations of the outlook as a context for the recent policy action by the Federal Reserve and explain how I view this action as part of a prudent and systematic strategy for monetary policy. The Forecasters Club of New York is an ideal forum for me to offer this commentary because, in my view, the recent policy action must be understood not in terms of where the economy has been recently, but rather in terms of the change in the forecast, a change in expectations about where the economy likely would be in six or twelve months in the absence of a policy change.


Despite the sharpness and force of the Phillips Curve/NAIRU model, it can be difficult to implement in practice. Still, this relationship was about the most stable tool in the macroeconomists’ tool kit for most of the past 20 years; those who were willing to depend on it were likely to be very successful forecasters of inflation, and the record speaks for itself on this score. Nevertheless, the combination of the 7-year low in the unemployment rate and 30-year low in inflation was a surprise to those using this framework. The challenge is to understand why we have been so fortunate…

So, what was going on and what did come about? The charts illustrate.

Inflation had been stable while unemployment was trending down. Almost immediately following the speech, the fall in unemployment increased and inflation ‘shot down’!


The more convincing story behind this fact was the productivity increase that was taking place (helped out by the steep drop in oil prices following the Asia crisis, although this did not have much effect on core prices). Anyway, such positive supply shocks reduce inflation and increase growth (reduce unemployment).

In short, contrary to Meyers (and most in the FOMC) view, there was no ‘dangerous’ increase in resource utilization.

The rate increase was of the “one and done” kind. Much later, following the Russia/LTCM event in August 1998, rates were reduced.


The next chart indicates that NGDP was evolving close to trend, growing close to 5.5%. When Russia/LTCM happened, the growth in AD was increased. This turned out to be excessive. We know that because it ignited a cycle to nominal spending that first went too high and later was brought down too low, only being stabilized again towards the end of Greenspan´s tenure in early 2006!


The “too much nominal growth” leg is seen in the next chart, which indicates that money growth more than offset the fall in velocity, especially following Russia/LTCM.


Jumping to the present, apparently nothing has changed because now we read:

Federal Reserve officials might raise interest rates soon because they have a theory: Falling unemployment pushes up prices and wages, requiring tighter credit to keep inflation in check.

David Altig, research director at the Atlanta Fed is quoted:

We haven’t lost faith in the framework described by Mr. Phillips and his successors, that a tight labor market generates higher inflation, said David Altig, research director at the Atlanta Fed. But the numbers that you would plug into that framework and the exact levels at which the pressures begin to emerge, we’re not so clear on those.

In economics, it´s interesting to observe how some things, especially those that require “estimation”, become “gospel” and, despite their suspicious origins, never go away, being endlessly “reestimated”.

When Modigliani and Papademos (yes, the same one who later became head of the Central Bank of Greece and then its Prime Minister)  “invented” NAIRU (NIRU at the time) in a BPEA paper in 1975, their clear aim was to downplay “monetarism” and argue for monetary expansion expansion based on the fact that NAIRU/NIRU was above its “non accelerating rate”:

At this point the analysis confronts a widely held concern, encouraged by at least some monetarists, that such a rapid rate of growth and sudden acceleration of the money supply , would unfavorably influence prices and inevitably set off a new round of inflation.

Our analysis indicates that such concerns are unfounded; it implies that inflation systematically accelerates only when unemployment falls below NIRU, and the M1 growth that we expect will be needed as component of a policy package aimed at approaching NIRU from above over the next two years.

We all know how that turned out!

Today, New York Fed chief Dudley apparently moved markets by saying:

From my perspective, at this moment, the decision to begin the normalization process at the September FOMC meeting seems less compelling to me than it was a few weeks ago,” he said.

But he also said:

Responding to a question about whether a Fed move will come in a subsequent 2015 FOMC meeting, Dudley said he “really” hopes to raise rates this year, but “let’s see how the data unfold before we make any statements about exactly when that might occur.”

And I say: I really hope a large rock will fall on my head this year!