Sabine Lautenschläger enters the cave of the Bavarian lions

A James Alexander post

In no other country in the euro zone, [is] the public so intensely [engaged] with each monetary policy measures of the ECB as passionately as in Germany. This applies to the Bavarian public, which is particularly known for distinct opinions and clear announcements. Nowhere rate cuts, buying programs and negative (deposit) interest rates were so criticized as in Bavaria. Since I am a friend of clear words, I would stay in the cave of the Bavarian lions to represent goals, risks and side effects of the current monetary policy of the ECB.
[a few minor edits to Google Translate]

She went to defend ECB monetary policy, but what came out of news reports didn’t look promising. She was reported to have come out against further QE because things are not so bad on the outlook and monetary policy takes time to work. Well the outlook is poor even if there are some signs that in real time the Euro Area economy is picking up.

The old “long and variable lags” are a common mistake of many macroeconomists, that elevate some campaigning remarks once made by Milton Friedman against excess money growth into some sort of universal truth. Broad money growth may correlate with economic growth over long and variable lags, but not monetary policy, and not base money growth. We now know monetary policy is the market reaction to it, the setting of the SatNav, and not the often tortuous journey itself.

However, reading the excellent Google Translate version of the German-only speech shows her giving a surprisingly balanced speech.

The start was the usual claim, that:

The independence of central banks is a relatively young, but now an undisputed achievement.

Well, maybe, maybe not. The crushing of inflation may be a success but is also the crushing of nominal growth and a double-dip recession in the Euro Area an achievement?. More people should dispute this as an “achievement”. Perhaps she meant it is a negative achievement.

Then she entered into a fairly extensive discussion of the pros and cons of lower rates and low inflation. She nodded to savers who were complaining about low rates, but replied well that there would be less savings if economic growth collapsed.

Low interest rates are [nothing] that excites me – also because of the risks and side effects associated with them. However, the low interest is currently necessary and justified. I understand the concern [of] German savers who look with little enthusiasm on the yield of their passbook – I belong there also. Higher rates would stifle economic recovery and bring permanently low inflation, sustained economic downturn and more unemployment – and this would [restrict] the ability to save still much broader.[This almost verbatim Yellen´s answer to Ralph Nader]
[a few minor edits to Google Translate]

After dismissing the short-term impacts of lower energy prices on inflation, rather thinking they might somehow be expansionary, she moved on to outline the heart of Market Monetarism, the “musical chairs” problem.

Now many citizens are not overly concerned if the inflation rate is low [for] long. Here is but sometimes overlooked that not only high, but also such a low inflation rate has costs and entails risks.
A moderate inflation acts as a lubricant of economic growth by facilitating the adjustment of relative prices and, above all, wages. Price and wage adjustments are among the most important tools that companies have to improve their competitiveness. But studies show that companies reduce their salary payments only very rarely in absolute terms, but rather on clear rounds for their workforce. This works quite well in times of normal inflation of about 2% – as Germany has demonstrated in the first decade of this millennium. But if too low inflation[,] and the contention is that wage increases do not grow to the sky[,] the adjustment process is delayed. So low inflation abducted [ie blocks] sometimes necessary adjustment of relative wages and prices. The result is a rigid wage structure, higher unemployment and lower economic growth.
[a few minor edits to Google Translate]

The rest of the speech was not so good as this. We get the usual lecture on low rates reducing pressure on sovereign countries to reform, the danger of bubbles and mythical redistribution effects. Although on the last point she fights back well, lecturing the Bavarians on the need for a healthy Euro Area economy, the destination of 50% of the regions exports.

And she finished with the usual nonsense about monetary policy having limits, the need to wait and see and the fact that current data isn’t so bad. The last point may carry some weight, even.

However, Rome wasn’t built in a day. The lecture on nominal wage rigidity was a refreshing break from the past. Whether she really believes it doesn’t matter, the fact that it was in the speech is a great thing in itself, and those Bavarian lions had to listen.

Quite a contrast to the other German on the ECB Board, Jens Weidmann:

And we need to be aware that the longer we stay in ultra-loose monetary policy mode, the less effective this policy will become and the more the attendant risks and side-effects will come into play.

“Ultra-loose”, really? If it were ultra-loose why would financial markets price government bonds of the Euro Area’s strongest economy’s at negative rates six years out. Yes, six years out! How can Weidmann, also the head of the Bundesbank, make an elementary mistake like this. It is forgiveable for journalists and financial types, but not from a senior monetary policy maker. If he really thought that monetary polices were ultra-loose and inflation about to take off he could make a killing betting against such a foolish, foolish market. To help him out, and this is not investment advice, he should buy this

Also, disappointingly, he shows no respect for the independence of the central bank. He spends 80% of his speech lecturing politicians on how to do their jobs and just 20% on monetary policy. It was the usual list of macroeconomic imbalances, product and labour market imbalances, bank leverage, fiscal policy etc, etc. It’s ironic but there seems no symmetry when it comes to central banks throwing stones, especially the ECB, especially Bundesbankers. Central bankers are perfect of course, never themselves causing any problems, and certainly never saying “sorry”, or at least until years, or even decades later. I expect he would be outraged if a politician gave a speech on the economy and spent 80% lecturing the ECB on its responsibility.

And the 20% Weidmann spent on monetary policy he got wrong. Monetary policy is not ultra-loose. He shouldn’t let himself be blinded by low-interest rates but look at nominal growth expectations, 3% is tight by any standards, even by Euro Area standards.

The early days of the Volcker Adjustment – A reply to Bob Murphy

Bob Murphy has a post, which starts with a parody:

Suppose someone asks you, “What was the stance of US monetary policy in mid-1980? Pretend you are a Market Monetarist answering.”


First thing, we would not look at interest rates; that is a totally misleading indicator. As Sumner tells us in this post, “Interest rates tell us nothing about the stance of monetary policy.” In context, he is saying that the Fed interest rate cuts in the early 1930s were still consistent with very tight policy.

Instead, let’s look at NGDP and unemployment: (and puts up a version of this chart)


And says:

Oh man, there’s a smoking gun, right? The unemployment rate skyrockets in the middle of 1980, while NGDP growth (blue line) collapses. (The blue line is the level of NGDP, so you can see that it falls way below the previous trend starting in 1980.) Think of all the employers who had signed wage contracts during the late 1970s, and all the consumers who took out home mortgages, expecting NGDP to grow at a brisk pace. The rug was pulled out from them by the tight-fisted Volcker, right around mid-1980.

I said parody, because to a market monetarist it would be: “Let´s look at NGDP growth and inflation”.

Changing the chart above to accommodate (beginning the chart in mid-1979 to coincide with Volcker becoming Fed Chairman and extending to mid-1985 that more or less defines for Volcker “mission accomplished):


We gather that monetary policy (NGDP growth) was being tightened as the US went into the 1980 recession (Jan-Jul 1980). However inflation was still rising so, in a sense, monetary policy was not “tight enough”.

Coinciding with the end of the 1980 recession monetary policy becomes “expansionary”. NGDP growth rises and inflation still increases for a while. In mid-1981, monetary policy tightens significantly, with both NGDP growth and inflation coming down. At the end of the 1981-82 recession, NGDP growth increases and inflation continues to decline, indicating monetary policy is neither “tight” nor “loose”, but “just right” to stabilize the economy.

Most people knew, when Volcker came along, that it wouldn´t be easy to conquer inflation. Over the previous 15 years of high, rising and volatile inflation, inflation expectations had become entrenched. Moreover, since the early 1960s, it was the rate of unemployment that “governed” monetary policy. Also, as clearly stated by Arthur Burns during his tenure as Fed Chairman from 1970 to 1978, inflation was not a monetary phenomenon, being the result of, depending on the circumstances, union power, oligopolies, powerful oil producing countries.

To Burns, monetary policy could only try to mitigate the effect on unemployment of those real (or supply) shocks.

So, when Volcker´s early tightening resulted in a 2-percentage point rise in unemployment, from 5.7% to 7.7% while inflation (due to lack of credibility given the go-stop style of monetary policy over the previous 15 years) continued to rise, the Fed “backtracked”. The attack on inflation one year later proved successful, although costly in terms of unemployment. Lesson: It´s not easy to break inflation expectations!

As the next chart shows, the cost was high, but temporary, because the economy regained its previous real output trend level path.


From then, until the end of Greenspan´s tenure, the economy experienced a “Great Moderation”. With the mistakes made by Bernanke, and continued with Yellen the economy has been downgraded to “Secular Stagnating”!

The Fed is “data-independent”

Otherwise, they wouldn´t be so vocal about “the time has come”. Especially given the information coming from the inflation data. With oil price high or low, inflation was falling and remains too low!

Data Independent_1

What is clear is that nominal growth has been too slow, keeping both real growth and inflation below what could be, at point a instead of point b.

Data Independent_2

Only a monetary policy dummy could make a remark that allowed the Fed to come out looking good!

Ralph Nader wrote Yellen a sexist letter complaining about low interest rates and its effects on savers and got this response:

Would savers have been better off if the Federal Reserve had not acted as forcefully(!) as it did and had maintained a higher level of short-term interest rates, including rates paid to savers? I don’t believe so.

Unemployment would have risen to even higher levels, home prices would have collapsed further, even more businesses and individuals would have faced bankruptcy and foreclosure, and the stock market would not have recovered.

True, savers could have seen higher returns on their federally-insured deposits, but these returns would hardly have offset the more dramatic declines they would have experienced in the value of their homes and retirement accounts. Many of these savers would have lost their jobs or pensions (or faced increased burdens from supporting unemployed children and grandchildren).[many did lose jobs and many faced increased burdens]

If instead Nader had asked Yellen why the Fed allowed nominal spending to fall continuously from early 2006 and then crash after mid-2008, she would be dumbstruck and at pains to give a coherent answer!


The Fed´s gone AWOL and says “Mission Accomplished”?

Tim Duy´s bottom Line:

Bottom Line:  The Fed is set to declare “Mission Accomplished” at the next FOMC meeting.

Indeed, many policymakers have already said as much. Absent a very significant change in the outlook, failure to hike rates in December would renew the barrage of criticism regarding their communications strategy that prompted them to highlight the December meeting in their last statement.

Once they have communicated their intentions for subsequent rate hikes, they will turn their attention to the issue of normalizing the balance sheet. Even though officials have not committed to a specific path, I am working with a baseline of 100bp of tightening between now and next December, or roughly 25bp every other meeting. I expect that by the second quarter of next year they will begin communicating the fate of the balance sheet.

Whether they should hike or not remains a separate issue. Over the next twelve months we will learn the extent of which the Federal Reserve can resist the global downward pull of interest rates. Other central banks have been less-than-successful in their efforts to pull off the zero bound – not exactly a hopeful precedent.

How come “Mission Accomplished” if over the past five years nothing of relevance has changed? Don´t tell me about the “low” (maybe too low for them) rate of unemployment. That´s at least two stages removed from “relevant”. They´re only grasping at the first straw that floated down.

NGDP growth is running below average (3.8%), RGDP growth is right on average (2.1%) and core inflation is below average (1.5%)


In fact, the “Mission” was accomplished five years ago when the FOMC, after pulling the economy up by it´s hairs, decided that´s the pace they wanted it to keep!

They should be careful because the beast is showing signs of fatigue again. It needs more “fuel”, not less. But find a “better grade” one!

A Good Economics Reporter! Alex Rosenberg of CNBC. When Did Ralph Nader Get Extra-Stupid?

A Benjamin Cole post

In the Market Monetarist community, there is a lot of bemoaning “the media.”

Well, meet Alex Rosenberg of CNBC.

While other reporters weigh in on inflation and the U.S. Federal Reserve Board’s ponderous decision-making, Rosenberg (correctly) points out the markets say inflation is about dead.

“The Federal Reserve now looks set to raise rates in December, partially based on expectation that inflation is set to finally rise to its 2 percent target. There’s only one potential problem. There’s actually a way that markets can see where investors think inflation will go. And they do not exactly see eye to eye with America’s central bank.”

Rosenberg adds,

“Over the next five years, annual inflation is expected to run at less than 1.3 percent. Even over the next ten, investors are looking for no more than 1.6 percent per year.”

Hot dang! Of course, Rosenberg is referring to the TIPS market, and deducing inflation expectations from inflation-protected U.S. Treasuries compared to plain-vanilla Treasury IOUs.

It gets better:

“So while the Fed continues to bang the drum on its 2 percent inflation target, and is now apparently trying to prevent inflation from rising above that in the future, it is striking to note just how quickly the bond market’s expectations of inflation have been decreasing,” writes Rosenberg.

The CNBC’er does such a good job, I will stand aside and just quote some more:

“Over the past year, almost no inflation has been seen, with prices actually falling year-over-year during some months. And while this is partially a reflection of falling oil prices, inflation has generally been declining for the past quarter of a century.”

Now that is some great reporting, econo-punditry. Where have they been hiding this guy? Well, he is “new,” as they say. His bio says he has a BA from Brown, minted 2011. He did something for NBC Universal before. CNBC calls him a “producer,” but he obviously one of the nation’s better econo-pundits already.

On The Other Hand…

From the elevated insights of Rosenberg, we descend to the befouled chambers of Ralph Nader, who a couple generations ago made his mark as a consumer activist. Nader on Oct. 30 (he should have waited a day) wrote a public letter haranguing Fed Chair Janet Yellen for keeping interest rates low, and so harming ordinary savers.

“We want to know why the Federal Reserve, funded and heavily run by the banks, is keeping interest rates so low that we receive virtually no income for our hard-earned savings while the Fed lets the big banks borrow money for virtually no interest.”

This is a blog, not a book, so I run of pixels to list all the reasons why Nader is making an ass out of himself. We could start with Rosenberg, who correctly points out inflation has been dying for decades. So interest rates come down too—duh.

Or that savers are also employees, employers and investors, and tighter money could wreck the economy, as it did in 2008. Or that higher short-term interest rates could lower long-term interest rates (by lowering growth and inflation expectations), so investors in bonds—that is, savers—would get lower yields. Or that even if yields on long-term bonds went up, then savers who bought bonds would suffer capital losses (bond values would go down).

The helmet-haired Yellen soiled herself by responding to Nader, but the Federal Reserve enjoys any discussion, however poorly premised, about why rates should go up, so she seized the opportunity.

How do we get CNBC’er Rosenberg to run the Fed?

Crimes against the economy and, by extension, against its citizens

In 1997, Bernanke (with Gertler and Watson) wrote “Systematic Monetary Policy and the Effiects of Oil Price Shocks“:

THE PRINCIPAL OBJECTIVE of this paper is to increase our understanding of the role of monetary policy in postwar U. S. business cycles. We take as our starting point two common findings in the recent monetary policy literature based on vector autoregressions (VARs).’

…Put more positively, if one takes the VAR evidence on monetary policy seriously (as we do), then any case for an important role of monetary policy in the business cycle rests on the argument that the choice of the monetary policy rule (the “reaction function”) has significant macroeconomic effects.

…The results are reasonable, with all variables exhibiting their expected qualitative behaviors. In particular, the absence of an endogenously restrictive monetary policy results in higher output and prices, as one would anticipate. Quantitatively, the effects are large, in that a nonresponsive monetary policy suffices to eliminate most of the output effect of an oil price shock, particularly after the first eight to ten months.

…The conclusion that a substantial part of the real effects of oil price shocks is due to the monetary policy response helps to explain why the effects of these shocks seems larger than can easily be explained in neoclassical (flexible price) models.

…Substantively, our results suggest that an important part of the effect of oil price shocks on the economy results not from the change in oil prices, per se, but from the resulting tightening of monetary policy. This finding may help to explain the apparently large effects of oil price changes found by Hamilton and many others.

In other words the explicit warning is: “Don´t impose a negative demand shock over a negative supply shock”.

Then I read this from Blanchard, Cerutti & Summers: Inflation and Activity – Two Explorations and their Monetary Policy Implications:

“We find that, indeed, recessions associated with either oil price increases or with financial crisis are more likely to be followed by lower output later. But we find that recessions plausibly triggered by demand shocks are also often followed by lower output or even lower output growth.”

Therefore, it appears that Bernanke (and the Fed) imposed a massive negative demand shock on a significantly negative supply shock, comprising both an oil shock and a financial crisis!

That´s the main cause of the Great Recession (which has morphed into the “New Normal” or “Secular Stagnation”). The house price boom and bust and the ensuing financial crisis, in addition to “second fidllers” in the drama, serve as the “strawmen” that exculpate the Fed and even helped turn its Chairman into Person of the Year, 2009, Hero and bestselling author!

The story is illustrated below.

We start in late 2003, when the oil shock (could call it the “China shock”) began. From then to mid-2008, the price of oil quadrupled. According to Bernanke, you shouldn´t “drink” from that fountain.


From 2003 to January 2006, it was Greenspan´s show. It appears that Greenspan followed Bernanke´s advice, and didn´t allow monetary policy (gauged by NGDP growth) to tighten. But Bernanke forgot his own counsel, and chose a monetary policy rule (strong reaction to the rise in headline inflation) with significantly negative macroeconomic effects.



As we know, that was only the beginning. Things became much worse during the next 12 months.

Let´s backtrack and ask the question: Was Greenspan lucky?

The answer to this question leads us to examine in greater depth the role of monetary policy in generating the “Great Recession”.

The Dynamic AS/AD model tells us that a negative (positive) AS (oil) shock will decrease (increase) real growth and increase (decrease) inflation.

Bernanke et al very sensible conclusion from 1997 was that monetary policy should not react to those shocks.

But how can we gauge the stance of monetary policy? As Bernanke, channeling Milton Friedman, once said:

“As emphasized by Friedman (in his eleventh proposition) and by Allan Meltzer, nominal interest rates are not good indicators of the stance of policy, as a high nominal interest rate can indicate either monetary tightness or ease, depending on the state of inflation expectations. Indeed, confusing low nominal interest rates with monetary ease was the source of major problems in the 1930s, and it has perhaps been a problem in Japan in recent years as wellThe real short-term interest rate, another candidate measure of policy stance, is also imperfect, because it mixes monetary and real influences, such as the rate of productivity growth

The absence of a clear and straightforward measure of monetary ease or tightness is a major problem in practice. How can we know, for example, whether policy is “neutral” or excessively “activist”?

Ultimately, it appears, one can check to see if an economy has a stable monetary background only by looking at macroeconomic indicators such as nominal GDP growth and inflation…”

[Note: Unfortunately, he preferred to concentrate on inflation, and worse, the headline variety, which was being buffeted by the oil and commodity price shocks! As indicated by the Dynamic AS/AD (DASAD) model, inflation is not always a good indicator of the stance of monetary policy.]

The chart below provides a view of the stance of monetary policy by looking at the NGDP gap. The NGDP gap is the deviation of NGDP from its stable trend path. Therefore, if, for example, NGDP is rising above trend, monetary policy is deemed “loose” and “loosening”. Other cases are illustrated in the chart. The unemployment rate stands as counterpart for the real effects of monetary policy.


In the second half of the 1990s, the economy experienced a positive (productivity) supply shock. According to the DASAD model, inflation falls and real growth increases (unemployment falls).

The chart above tells us that Greenspan allowed monetary policy to loosen, magnifying the growth and employment effects of the shock. When unemployment dropped below 4%, the “Phillips Curve/Slack crowd” took over and monetary policy tightened.

The Fed “overtightened” monetary policy [note: despite interest rates falling fast], as NGDP continued to fall below trend.

In mid-2003, the Fed adopted “Forward Guidance”, in effect “loosening” monetary policy, so that NGDP began to climb back to trend. If you refer to the NGDP growth chart at the beginning, you will notice that NGDP was growing at the high rate of 6.5% from late 2003 to early 2006. That´s the only way NGDP can climb back to trend, i.e. by growing for a time at a rate above the trend growth rate of around 5.4%.

Greenspan was “lucky” because, when the oil shock hit, monetary policy was on a “correction” trend, and thus minimized the negative real growth effect of the shock, with the unemployment rate even turning down.

When Bernanke took the helm, NGDP was “on trend”, i.e. NGDP growth was “just right” to provide a “stable monetary background”. But he forgot what he had known for 10 years and adopted a monetary reaction function focused on headline inflation. With the ongoing and even strengthening oil shock, monetary policy was tightened with NGDP falling below trend at a fast pace.

Now, given the fragile financial economic environment, the tightening of monetary policy only made that environment more fragile

At that point, another Great Depression was in the making, so Bernanke, faithful to his credit channel view of the propagation of the Great Depression, came quickly to the rescue of banks.

Monetary policy, however, remained tight and was only weakly loosened with the introduction of QE1 in March 2009.

NGDP and RGDP growth recovered, but for the past five years have remained at a level well below the previous trend growth rates; no wander the monikers “New Normal” and “Secular Stagnation” have become household words!


The Blanchard et all paper rationalize this state of affairs by indicating that “even recessions triggered by demand shocks are often followed by lower output or even lower output growth”.

That sort of reasoning forgets that one thing monetary policy can avoid, or at least minimize the effects of, are demand shocks! Moreover, as Bernanke told us in 1997, monetary policy can also minimize the output effects of supply shocks, particularly by not reacting to those types of shocks.

Monetary policy, however, does not participate in the discussions. In a recent paper, “Long-term damage from the Great Recession in OECD countries”, for example, Lawrence Ball writes:

“The global financial crisis of 2008-2009 triggered national recessions of varying severity. The hardest-hit economies include those in the periphery of the euro area, which experienced severe banking and debt crises. At the other extreme, Australia was almost unscathed because of factors including fiscal stimulus and strong exports to Asia.”

One did badly because of banking and debt crisis. The other did well because of fiscal stimulus!

Interestingly, the economies that didn´t experience a recession (or a financial crisis) in 2008-09, like Australia, Israel and Poland, are the ones in which monetary policy managed to keep NGDP growth close to trend! That seems to be just luck because Stanley Fischer, now Vice-Chairman of the Federal Reserve Board, at the time was head of the Bank of Israel, and from his recent utterances still has no idea why he was successful!

And when you hear someone like New York Fed president Dudley, who has a permanent vote at the FOMC, express himself so disjointedly:

“We hope that relatively soon we will become reasonably confident that inflation will return to our 2 percent objective,” he said at Hofstra University. Dudley said it was “very logical” to expect that the Fed’s inflation and employment conditions would be met “soon,” allowing policymakers to “start thinking about raising the short-term interest rates.”

You easily conclude that the economy will likely get worse!


One point emphasized by both the Blanchard et al and Larry Ball´s article, is the concept of hysteresis (and super-hysteresis), which concerns the level (and growth rate) of real output following real or nominal shocks.

The chart below casts some doubt on the idea, at least for the US.


Even the oil shocks of the 1970s or the demand shock from Volcker’s disinflation did not permanently reduce the level or growth rate of real output, which always returned to trend (the trend in the chart was formed from 1970 to 1997).

The more recent Bernanke/Yellen supply/demand shock has worked out differently, with both the level and growth rate of output forcefully reduced, i.e. denoting hysteresis/super-hysteresis!

As argued above, that comes mostly from the misconceived monetary policy adopted since Bernanke took over. That policy has drastically reduced both the target level of NGDP and its growth rate. The charts illustrate for the most recent period.


The real damage is that now the much lower level and growth rate of real output have become the “New Normal”!

The chart below well describes the inadequacy of using interest rates to gauge the stance of monetary policy. Interest rates, in fact, say that monetary policy is loosening when it is tightening, and vice-versa! That is consistent with Friedman´s saying from 1968: “low interest rates indicate that monetary policy has been tight and high interest rates that it has been easy”.


Another point often made, especially by the people at the FOMC, is that the unemployment rate is down to levels that indicate the economy is running out of slack (so policy must be “tightened”).

I find it wrong to reason from an unemployment change when unemployment at present means something possibly very different from what it meant in previous decades. The chart illustrates that at present, both unemployment and labor force participation rates are falling. In previous periods, a fall in unemployment went together with increasing or high labor force participation.


The tight coincidence between the fall in participation rates and the deep drop of NGDP below trend also make me skeptical to attribute any significant share of the drop in participation to structural/demographic factors.

Here also, most of the damage to the labor market lies in the hands of the misguided monetary policy adopted by the Bernanke/Yellen Fed! They feel that “the time has come to “tighten” monetary policy”. By misunderstanding monetary policy, they ignore that for the past year monetary policy has been tightening, with implications for the dollar and oil prices!

The charts illustrate:


And, being clueless, they think the low inflation is something temporary that is due to the oil and exchange rate effect. In other words, monetary policy is even absent from direct discussions of inflation!

ECB Chief Economist Peter Praet talks about “nominal growth”, wow!

A James Alexander post

Frances Coppola rightly drew attention to this section of a speech by Peter Praet, ECB Board Member and its Chief Economist, actually the opening paragraph:

The euro area economy is gradually emerging from a deep and protracted downturn. However, despite improvements over the last year, real GDP is still below the level of the first quarter of 2008. The picture is more striking still if one looks at where nominal growth would be now if pre-crisis trends had been maintained.

A chart in the pack, that could accompany this statement, seems to be from the Marcus Nunes school of little stories. But it is unclear whether it is Nominal or Real GDP, probably real and it does not appear in the start of the published presentation or specifically linked to the comment quoted above. It actually originates from a Spring 2015 internal EU working party and was used back in May 2015 by Mario Draghi.

JA Praet_1

Since September it appears that Praet has also been using the following chart that nods to the importance of GDP expectations. And of course it is represents a terrible tragedy.

JA Praet_2

When the opening paragraph and the two charts are allied to the often cited charts looking at Inflation Expectations, one could get the feeling that the ECB is actually looking at NGDP expectations. The ECB is to be congratulated for looking at market-based expectations, and even confirming their usefulness vs the Fed that appears to have contempt for them.

JA Praet_3

Very sadly, the bulk of the speech is made up of a strong rear guard defence of the Philips Curve which rather spoiled my excitement. E.g.:

There are two key structural conditions that matter for the central bank to meet its objective. First, the financial transmission channel must remain intact, so that monetary policy is able to maintain sufficient traction over the economy and economic slack remains controllable. Second, a structural connection between economic slack, inflation expectations and inflation needs to exist, with the Phillips curve providing the traditional framework to account for this relationship. How the crisis has affected both conditions has been a persistent source of uncertainty for monetary policy – and remains so, to some extent, today.

The process of monetary transmission has clearly become less regular during the crisis. 

Actually, the first assumption could be challenged. ECB monetary policy has twice caused recessions in the Euro Area by tightening monetary policy when it was already tight (2008 and 2011) and until very recently the inflation ceiling message has dominated almost all discourse. The monetary transmission mechanism has worked perfectly, just to the massive detriment of the Euro Area economy. There is no puzzle, no less regular working.

And a paper from a German research institute presented at an ECB conference on the output gap poured enormous scorn on the notion that economic slack, or NAIRU could be calculated, using either the traditional or New Keynesian Philips Curve. The ECB’s NAIRU for Spain, for instance, was shown to more or less just follow the actual unemployment rate. The ECB (and the other leading central banks) should give up on the voodoo Philips Curve/slack theory of macro.

JA Praet_4

But, hey, Euro base money growth is rising, Draghi’s speech last week also showed some signs of positive monetary thinking. That things are looking up for the Euro Area are confirmed by some strong recent Eurozone  PMI data. Just stop calling out for those “close to but less than 2%” evil spirits.

Calling Arthur Burns

A Benjamin Cole post

Where is Arthur Burns when you need him? Burns was the mousy U.S. Federal Reserve Board Chairman from 1970 to 1978, the last man in America to part his hair in the middle, and the central banker who infamously presided over double-digit inflation. Burns actually posed for official portraits with a pipe thoughtfully in hand. For you youngsters, that is a smoking pipe; he wasn’t a plumber.

At any rate, back in the disco-1970s Burns held that the powerful market players of the day—unions, the Big 3 automakers, Big Steel, Big Retail, etc., would cut output but not prices, if monetary policy was tightened.  Other industries were rate-regulated, including transportation, telecommunications and banking. Even stockbroker commissions (very fat!) were regulated by law, and there was little international trade or competition.

Burns was successful in many regards; recovering from the 1973-75 recession, U.S. real output expanded by 20% in just four years. You read that right—20% real growth. That is a grand slam.

But, as measured by the CPI, inflation hit 13.3% in 1979.

Subsequently, Burns’ reputation was all but ruined by Chairman Paul Volcker (1979-1987), who raised interest rates sharply and crushed inflation back to under 5% in a few years, and then declared victory (yes, anything under 5% inflation was fine in those days. BTW, the NeoFisherians need to ponder Volcker).

Burns thereafter was inducted into the Economics Hall of Shame.


Today the economy is far less inflation-prone than in the 1970s, what with unions dead, and the Big 3 and Big Steel desperately fighting for market share, a web-infested retail sector, and globalized economy. How much has the world changed? New motor vehicle prices have not changed in 20 years.

Burns could have a field day!

But there is a fly in the ointment. Today the housing market has emerged as a sector immune to inflation fighting. As blogger Kevin Erdmann has pointed out, the U.S. is a nation with ubiquitous property zoning, and consequent artificial housing scarcity. Politically, this is a dead end. First, zoning is local, so there is nothing the Fed or Congress can do about it. Secondly, powerful homeowner groups crave retail-free single-family detached housing districts, and highest-and-best-use be damned to hell. Thirdly, many urban neighborhoods have character, a feel that has attracted residents, who have slavishly gentrified entire districts. Soviet-style apartment blocs might solve the urban housing problem, but few want such fixes—in their neighborhood.

Burns would have recognized that housing, now 40% of the PCE deflator, is immune to tight money—and thus he would print more money, and tolerated some inflation. Today, would Burns be right?

Probably. After all, PCE core inflation is running at 1.3% and falling. Unit labor costs have hardly budged since 2008. Forget computer prices. Copper is selling for the same as 10 years ago.  The rest of the developed world is fighting deflation, not inflation.

It is time for a rehabilitation of Arthur Burns.

Yes, I still prefer nominal NGDPLT. Or even an IT band of 2.5% to 3.5%. But I would take Burns over today’s FOMC in a heartbeat.

PS Forgotten today is that Arthur Burns was one of two professors that Rutgers student Milton Friedman said inspired him to be an economist. Later, Friedman followed Burns to the NBER, and after tutelage by Burns, Friedman wrote his classic work A Monetary History of the United States, 1867–1960. After his stint at the Fed, Burns went on to hang his hat at the right-wing redoubt, the American Enterprise Institute. Surely, Burns can be rehabilitated, and his policies brought to bear in modern-day America.