Frustrating

The Jackson Hole 2016 gathering just started. The Conference Title is Designing Resilient Monetary Policy Frameworks for the Future.

However, the session directly linked to the Conference Title – Evaluating Alternative Monetary Frameworks – is a letdown of massive proportions.

 

10:55 a.m. Evaluating Alternative Monetary Frameworks 
   
Author: Ulrich Bindseil 
  Head of Directorate General Market Operations
  European Central Bank
 
Discussants: Jean-Pierre Danthine
  President
  Paris School of Economics
 
  Simon Potter 
  Executive Vice President, Markets Group Federal Reserve Bank of New York

Ulrich Bindseil: 12 years ago he wrote…ending:

If the Fed would have been fully independent from the US Government at least directly after WW1, it would probably have had far less incentives to deny the validity of well established central bank technique, namely that short term interest rates are the operational target of monetary policy.”

Jean Pierre is a Finance person and Simon Potter is an econometrician (time series) and forecaster.

Hope I get pie in the face!

While they discuss about economy “overheating”, the economy is “overcooling”

Stan Fischer:

The Federal Reserve’s governors are debating what is going on in the U.S. economy and how to set policy, the Fed’s No. 2 official said on Thursday.

“The issue of overheating of the economy is being discussed within the Fed board,” Fed Vice Chair Stanley Fischer told a room of labor activists who met with Fed officials to press them not to raise interest rates.

“Everything that’s being argued here is being argued in the board as well,” said Fischer.

But reality “stinks”!

Fischer-Overheating

If 2% is not enough, don´t double it

According to the Economist:

…How might these problems be fixed? One possibility is simply to raise the inflation target to, say, 4%. Credibly enacted, that ought to alleviate the risk of impotence. If investors and consumers believe inflation will reach 4%, nominal interest rates should eventually rise to 5% or so even if real rates stay low. But rich-world central banks have undershot their targets for so long they may struggle to persuade the public to expect higher inflation. And a higher target would still leave central banks with a dilemma when economic growth and inflation diverge. Neither would it make up for big misses.

A more radical option is to move away from targeting inflation altogether. Many economists (and this newspaper) see advantages in targeting the level of nominal GDP, the total amount of spending in the economy before adjusting for inflation. A nominal-GDP target would allow for temporary variations in inflation. Downturns would be tempered by an expectation of protracted stimulus later on to make up lost ground. In better times, a rise in real GDP would provide the lion’s share of the required nominal-GDP growth and inflation could drift lower.

Tyler Cowen and Fiat-Money Independent Central Banks

A Benjamin Cole post

The globe’s major fiat-money central banks are considered “independent,” those being the Bank of Japan, the U.S. Federal Reserve and the European Central Bank.

The ostensible reason for the independent status is so that central bankers can “do the right thing” and not cave in to political or popular demands, almost invariably described as “printing money.”

But if inflation everywhere and always is a monetary phenomenon, then so too must be disinflation and deflation. After obtaining the former in the 1980-1990, the major central banks have obtained the latter in the late 2000s over much of the globe, and the U.S. is but one recession away from deflation also.

Tyler Cowen

Tyler Cowen, the brilliant blogging polymath from George Mason, recently posited it is politics and the labor class that is pushing the Fed to chronic tight-money, in his recent and welcome endorsement of nominal GDP level targeting by central banks, or NGDPLT.

By Cowen’s reckoning, the central banks are independent, except they are cowed by a working class that does not want to see wage cuts through inflation.

Does the AFL-CIO stand athwart of Fed desires for NGDPLT, and the attendant moderate rates of inflation?

Rather…

I rather suspect it is strident right-wing academia, think-tankers, punditry and bloggers, and related party politics that have contorted an eagerly compliant Fed into a supine posture now conducive to a deflationary perma-recession.

It is rare to see true happiness in this world, but the beam on a central banker’s face when announcing a rate-hike is the best place to look.

The Fed has leaned to deflation for decades, and is on the doorstep now. It is benighted, second-rate mythology that the Fed has been “easy” or “held rates low.” If the Fed has been easy, how to explain the 35-year decline in inflation and interest rates?

Conclusion

Glad we are to accept a Tyler Cowen into the NGDPLT camp. Maybe for politesse, Cowen must identify the anti-inflation zealots as laborites. So be it.

There is still a real danger to American prosperity, even if the Fed adopts NGDPLT, and that is the Fedsters will select a straitjacket tight version of NGDPLT, or chronically miss LT on the low side, as they do with the IT (inflation targeting).

The idea of an independent fiat-money central bank may be proving a bad one. In the modern-era, such institutions generally asphyxiate economic growth.

If interest rates “disappear”, Central Banks lose their relevance!

In Central Bankers’ Main Challenge: Staying Relevant – Decline in the natural interest rate gives authorities less ammunition to counteract economic shocks, Grep Ip writes:

When central bankers gather this week in Jackson Hole, Wyo., they will be consumed not with some pressing crisis in the global economy but by an existential threat to their relevance.

The threat stems from the realization that the sluggish economic growth that has prevailed since 2009 may be here to stay. If so, then so are today’s low interest rates.

For more than 8 years they´ve been shooting themselves in the foot, refusing to abandon their inflation target framework and the associated interest rate targeting (which now they desperately want to “normalize”).

Charming!

Contra Nick Xenophon´s idea

The Conversation is critical, but for the wrong reasons:

In the revolving door of economic ideas, the old can be suddenly new again. Independent Senator Nick Xenophon resurrected one such idea this week. He said the Reserve Bank of Australia should replace its inflation target of 2-3% per annum with a target of nominal GDP growth of around 5.5% per annum.

………………………………………………………………………………………..

One big problem with Xenophon’s idea is that the theory does not fit the times. It is not the right policy for today.

Energy prices are not going up; they have been falling and are now flat. Yes, electricity prices have been going through the roof in South Australia and to a lesser extent elsewhere. But oil prices have been falling or flat over recent years, and this has a more pervasive effect than government bungling of the electricity market.

So output growth and inflation are not moving in opposite directions – both have fallen in recent years. Inflation is now below the bottom of the RBA’s target zone of 2-3% on any of the alternative measures.

The RBA, along with most central banks of advanced countries, would actually like to see more inflation, not less. Annual output growth is struggling to reach 3%, which is below the long run average of 3.5%. Hence nominal GDP growth is below the 5.5% long-run average that Xenophon would target. So whether the RBA targets inflation or nominal GDP growth doesn’t matter – the policy would be the same – that is, stimulate spending by lowering interest rates, which is exactly what it has been doing.

Why does The Conversation think NGDP targeting is only useful when (real) growth and inflation are moving in opposite directions? That is, when the economy is buffeted by a supply shock. Inflation targeting entices the wrong policy from the central bank, “instructing” it to tighten. NGDP targeting “instructs” the central bank to “ignore it” – good move.

But, more generally, NGDP targeting (in fact NGDP LEVEL Targeting) is the appropriate framework for “all seasons”. In addition to keeping the central bank from mishandling supply shocks, it keeps the central bank from generating demand shocks, which throws both inflation and real growth in the same direction, up as during the “Great Inflation” and down as in the “Great Recession”.

The last highlighted sentence from The Conversation is just confirmation that what is required is a LEVEL target. For example, if the central bank adopted a Price Level Target it would not be in the “low inflation-low real growth” it is in today. The downside of PLT is that just as in the case of IT, the central bank would be tricked into taking the wrong action when the economy is hit by supply shocks.

Another wrong take (among others) of The Conversation is this:

Another downside is that although nominal GDP growth would be more stable, inflation would tend to be more volatile. Inflation could jump up and down, but as long as output growth moved in the opposite direction the RBA would do nothing to dampen the volatility in inflation. Volatile inflation increases the uncertainty about future prices, which inhibits investment spending by firms and households.

As the “experience” of many countries (US,UK, Australia, for example) with implicit NGDP Level Targeting showed, what NGDP-LT provides is Nominal Stability. As Nick Xenophon puts in his “comments on critics” (see comment here):

How does someone who starts a business – taking out a loan and hiring staff – in expectation of 7 per cent a year growth in nominal spending deal with a sudden drop in spending to 2 per cent? Not well, I reckon.

The Fed Is Artificially Budging Rates—But Higher Not Lower Does Fiat-Money Central Banking Lead to Deflation?

A Benjamin Cole post

At the always interesting Alt-M website is a post by highly regarded monetary scholar Gerald P. O’Driscoll, pondering if the Fed can raise rates even if it wants to, whether Fed presently is artificially pumping up short-term rates.

O’Driscoll notes that today 20 central banks globally have negative interest rates in place.  Were now an activist Fed to jack-up the Fed funds rate and the interest on excess reserves (IOER) by another 25 basis points, the spread between U.S. rates and global rates would widen even more.

O’Driscoll points out such an action will attract capital to the U.S., thus raising the exchange rate of the U.S. dollar, slowing domestic business activity when the economy barely growing anyway.

Moreover, the Fed appears to be struggling to even keep short-term rates as high as they are. As O’Driscoll notes, in December 2015 the Fed raised interest on excess reserves from 25 to 50 basis points and also posted an offering rate of 25 basis points on reverse repurchase agreements. The Fed’s mysterious reverse-repo program has expanded to $321 billion at recent count, as it tries to sop up enough cash to prevent even lower rates.

But the Fed is battling the tide. O’Driscoll notes interest rates on short-term treasury bills (4 weeks) have recently traded down close to or even below 25 basis points.

Of course, long-term rates are primarily set by market forces, and 10-year Treasuries have been yielding near record-lows, now offering about 1.50% interest.

“There are real questions as to whether further hikes in what are administered (not market) interest rates will move market interest rates as desired. We have no experience on which to base such a forecast,” intones O’Driscoll.

There is much to admire in O’Driscoll’s blogging, but perhaps I quibble with his non-conclusion, which is that, “Fed policymakers are still mostly stuck in closed economy thinking. But, so, too, are most advocates of monetary reform. New thinking is needed all around.”

Well, bring it on, I say. Like what?

The Alt-M Outlook

In the past O’Driscoll has called for free banking, or a gold standard, and noted that modern-day central banks are aligned with nationalist malignancies of financing wars, empire-building, welfare-ism, oppressive state seizure of private assets and inflation.

Maybe all true in the past, but what about inflation since 1982 or so?

In the last 35 years the direction of interest rates and inflation internationally has been down, under globalist central-bank management. Indeed, much of the planet is now in deflation, and the U.S. but one recession away from joining the world. As Milton Friedman noted, you don’t get to chronically low interest rates through chronically easy money. For 30 years we have heard doom from inflation-mongers, and now we have global deflation.

If central banks have an inflationist agenda, they are even more incompetent than we suspect. The admirable Alt-M team still discusses fiat-money central banking as having statist-inflationary agenda. Yet the Alt-M perspective appears out of date, by a few decades.

Conclusion

Maybe free banking or a gold standard will work better than globalist central banking.

But unlike O’Driscoll, I think the problem is globalist fiat-money central bankers are obsessed with inflation and not economic growth. The ECB, for example, appears intent on crushing nations, not promoting statism.

Indeed, for now it would be better if a modern-day Korekiyo Takahashi (Japan’s central banker who ended the Great Depression on the islands) seized the Fed and sent in the helicopters. Darken the skies, and don’t stop until we see robust real growth and inflation north of 4%.

Of course, Market Monetarists contend the practical path forward is central-bank NGDPLT. It may actually happen.

The Alt-M crowd offers plenty of food for thought, but perhaps some updating is needed.

Someone has been listening

And that someone is in far-away Australia, a country that has avoided recession for a quarter century. Things started going wrong for the past few years, when it ignored its NGDP level target and started worrying about home prices.

Read this: The new RBA governor should target [nominal] growth, not inflation:

If you had told Australians 10 years ago that official interest rates would fall to 1.5 per cent, many would have jumped for joy.

Aside from homeowners, Australians are not feeling much joy these days. This is despite the lowest interest rates in 70 years, low inflation, economic growth close to normal and the unemployment rate – though not ideal – still lower than it was during the Sydney Olympics.

So why are we feeling so miserable? The reason is that most Australians’ incomes are going nowhere.

Wages are growing at recessionary levels, profits for small and medium-sized businesses are flat and the budget deficit constrains government spending.

Overall, Australia’s “nominal” growth rate –  the growth in actual money in our pockets – has fallen from 7 per cent per annum in the decade before the GFC to only 2 per cent today.

A large part of it is also due to the out-of-date inflation target that the Reserve Bank of Australia has been tasked with hitting.

A better option would be for the RBA to target a reasonable rate of growth in Australia’s nominal GDP.

In other words, we should replace the RBA’s existing inflation target with a nominal GDP target.

Stronger growth in nominal GDP would provide workers and businesses with greater means to pay their debts, hire more staff and invest in new plant and equipment.

Amen

HT Virgílio

Is Growth Moderate or mediocre?

A James Alexander post

No wonder the Federal Reserve has challenges with its communication these days. They say they are data-dependent but when the data comes in they still can’t agree on what it represents.

Data point: 2Q 2016 RGDP growth of 1.2% QoQ annualised and 1.2% YoY, coincidentally.

Minutes of the Federal Open Market Committee July 26–27, 2016:

“Staff Review of the Economic Situation: The information reviewed for the July 26–27 meeting indicated that labor market conditions generally improved in June and that growth in real gross domestic product (GDP) was moderate in the second quarter.”

Vice Chairman Stanley Fischer, at the “Program on the World Economy” a conference sponsored by The Aspen Institute, Aspen, Colorado, August 21, 2016, Remarks on the U.S. Economy :

“Output growth has been much less impressive. Over the four quarters ending this spring, real GDP is now estimated to have increased only 1-1/4 percent. This pace likely understates the underlying momentum in aggregate demand, in part because of a sizable inventory correction that began early last year; even so, GDP growth has been mediocre at best.”

It’s no surprise that the Fed is confused when Fischer goes on to say stuff like “the frustratingly slow pace of real wage gains seen during the recent expansion likely partly reflects the slow growth in productivity”. But immediately caveats with a footnote that says the exact opposite: “An alternative explanation is that productivity growth has been slow because wage growth has been slow; that is, faced with only tepid rises in labor costs, firms have had less incentive to invest in labor-saving technologies.”

Of course, we favour the latter explanation, and it is moderately encouraging to see Fischer or someone important reading his speech has inserted the caveat.

The bulk of Fischer’s speech is very traditional central-banker speak passing the buck for their poor nominal growth management to politicians. So they call on politicians to engage in greater fiscal activism and structural reform to counter the RGDP slowdown, just like we often hear in Europe or Japan. The unspoken assumption is that if the politicians do engage in fiscal activism such that it (inevitably) raises inflation expectations the central bankers will offset it.

Central bankers who cannot escape from Inflation Target ceilings, and politicians who don’t assist them are doomed to be trapped by them. Inflation will never reach the targets and nominal growth will be squeezed no matter how low interest rates go or how big is the QE. This fatal mistake is repeated by many outside central banks in mainstream macro. The call to use Helicopter Money is another variant. HM will not be used while Inflation Target ceilings are in place.

It seems so obvious that if you move the Inflation Target to a higher plane, to a Level Target or an NGDP LT, then interest rates will naturally move higher as the expectations channel that drives down inflation works in the opposite direction, rendering QE or HM unnecessary.

Inflation Target ceilings will cause growth to remain moderate to mediocre for some time unless the Fed can figure out some alternative targets that allow greater nominal growth – even if it means temporarily busting current inflation targets.

How not to propose NGDP Targeting

Stephen King (not the popular author) but HSBC’s senior economic adviser, elaborates on Larry Summers´ comments on San Francisco Fed president John Williams´ letter. King´s conclusion, however, in effect disparages the idea of NGDP Targeting. Maybe he doesn´t understand the concept:

In these circumstances, the entire monetary policy framework is up for grabs. Shibboleths will have to be dispensed with. At zero rates, central banks may have to work increasingly closely with finance ministries, prioritising the need for co-ordinated action over the desire for independence. Inflation targeting may have to be ditched, perhaps replaced by nominal gross domestic product targeting: a slowdown in real growth would then be countered by a commitment to higher inflation, boosting nominal GDP and limiting the risk of ever more indigestible debt.

Yet nominal GDP targeting will work only if central banks can credibly demonstrate not just their desire for higher inflation but also their ability to deliver it. To date, they have not been particularly successful. And if productivity growth is permanently lower, expectations of a life of ever-rising prosperity will have to be abandoned. If the economics are already difficult, the politics will be considerably harder.

Characterizing NGDP Targeting as a framework in which a slowdown in real growth has to be countered by a commitment to higher inflation is a confused idea. A real growth slowdown may be the result of a negative demand shock or of a negative supply shock. In the former situation, inflation will also fall. In the latter it will rise.

If the central bank is focused on delivering Nominal Stability (which NGDP Targeting, level targeting does provide), drops in real growth resulting from monetary shocks will be avoided, while supply shocks will be “ignored”. Actually, the fact that the Bernanke Fed was so focused on the inflation from the rise in oil/commodity prices was its downfall. In that sense, you could say the Fed is flexible in allowing the (temporary) rise in inflation following a supply shock, but to say it has to be “committed” to it is pure nonsense.

The charts provide a visual history of the economy´s nominal and real growth and inflation.

How not to propose NGDP Targeting

The first thing to notice is that an inflation process (1970s) is characterized by increases in both headline and core measures. This was true in the 1970s and it was made possible by the up trending NGDP growth.

Instances of oil shocks (red dots) are associated with increases in inflation (both Headline & Core) and recessions in the 1970s, but in the 2003-05 and 2007-08 oil shocks, only headline inflation shows a modest increase. The reason for the very different outcomes can be found in the contrasting behavior of monetary policy: very expansionary in the 1970s (up trending NGDP growth) and “stable” in the 2000s.

Volcker´s first attempt at reducing inflation in early 1980 was unsuccessful. His second attempt in late 1981, characterized by a strong monetary contraction (steep drop in NGDP growth) was a success. The important thing to note is the healthy bounce back in real output growth after the deep 1981/82 recession while inflation kept falling.

As soon as he took the Fed´s helm in early 2006, Bernanke showed concern with inflation. With the second leg of the oil price rise in 2007, the concern became an obsession. Monetary policy (NGDP growth) began to tighten and in mid-2008 the brakes were pressed hard. The aftermath, which shows a complete absence of real output bounce back, has kept the economy depressed (or in a state of “Great Stagnation”).

The “Great Moderation” is strong evidence of the benefit of having nominal stability, a situation where the central bank is successful in keeping NGDP growth on a stable (stationary) path. That is the result of the CB offsetting changes in velocity by opposite changes in the money supply.

Note that, by not explicitly targeting NGDP, in 2001-2003, the Fed inadvertently tightened monetary policy. After mid-2003 this error was corrected, with NGDP growth moving back to the stationary path. The Bernanke Fed quickly changed the (effective) monetary policy framework to one first effectively and then explicitly based on inflation targeting. Lately, with inflation persistently below target and “zero” policy rate, the monetary policy framework has become one geared to policy (rate) “normalization”. The manifest failure of this framework has lately been a topic of discussion at the Fed, with John Williams letter being one example.

However, if you pay attention to NGDP growth, you immediately conclude that both the lackluster recovery and low inflation are the natural consequence of excessively tight monetary policy, or too low NGDP growth. This could be “cured” by the adoption of an explicit NGDP Level Target monetary policy framework.

PS The resistance in abandoning the IT framework is strong. This piece by Greg Ip “The Case for Raising the Fed’s Inflation Target”  attests.