The monetary view of the Great Recession

It´s nice every month to get the e-mail from the Center for Financial Stability announcing the update of the Divisia broad money series.

Here I use it to explain events surrounding the great recession and the slow recovery.

The charts indicate that with both broad money growth and velocity “dropping down the chute”, nominal spending (NGDP) can´t do anything except dutifully follow!

Monetary View of GR_1

Monetary View of GR_2

And over the last few years, while velocity has basically regained its pre-crisis level, broad money growth has remained much lower. The implication is that nominal spending is growing at a significantly lower pace, keeping the economy “trapped in a depressed state”.

In a criminal investigation, often the good strategy is phrased as “follow the money”. Many economists, in trying to “explain” the slow growth prefer to search for “residual seasonality“!

Update: Rereading this 15-month old post, I think it gives support to the arguments made here fo the “monetary view” of the GR:

Bottom line: The oil shock of 07-08 was a trigger for the Fed´s actions. And these actions were inimical to the health of the economy, already weakened by the fall-out of the house price bust. It is clear from the statements, minutes and now transcripts for 2008 that the Fed´s focus was on headline inflation, and since that was being significantly impacted by oil prices, the “public” anticipated monetary policy tightening (a rise in rates). No wonder NGDP dropped significantly (plunging after July 08).

One good paragraph and two awful ones!

In his conclusion to “The Idolatry of Interest Rates Part I: Chasing Will-o’-the-Wisp”, James Montier writes:

This paper has sought to tackle two forms of idolatry surrounding interest rates. First is the idolatry of the “equilibrium/natural/neutral” rate of interest displayed by central bankers around the world. This is a make-believe concept with no foundation in the way our financial world really works. It is scary to think that this is the topic that central bankers are debating. Talk about a massive exercise in navel gazing!

The second idolatry I’ve sought to tackle is the modern-day belief in the world’s greatest con: that monetary policy matters. There is precious little evidence that monetary policy matters for the major components of demand (investment and consumption look pretty immune to the shifts in interest rates over time).

Perhaps it is time to recall that we have another tool in our economic kit: fiscal policy. This is a political pariah of a policy, but offers a potential way out of the low growth we find ourselves facing.

The first paragraph is perfect. “Talk about a massive exercise in navel gazing”, indeed!

(Update) Picture of “navel gazing”:

Navel Gazing

But Montier loses it badly thereafter. If he only went and asked FDR, or Paul Volcker, or Kuroda, to name only a few “operatives”. In 1933, despite the large depreciation of the dollar, the trade balance went into deficit, the same happening when Kuroda got a huge yen depreciation in 2013. Volcker whacked inflation with? You guessed, monetary policy.

He´s right that “there´s precious little evidence that monetary policy matters for the components of demand. That´s the implication of the “never reason from a GDP component change” principle! What matters is AD (NGDP).

And fiscal policy, without an adequate monetary policy, certainly does not offer a way out!

More than most, Terrorists understand the importance of economic history

Lars e-mailed this news:

Bin Laden´s reading list

Materials Regarding France   (19 items)
  • Call for Submissions to French Culture, Politics, and Society Journal
  • Did France Cause the Great Depression?” by Douglas Irwin, National Bureau of Economic Research
  • Economic and Social Conditions in France during the 18th Century by Henri See (2004)
  • “Economic Survey of France 2009”
  • “France Country Report,” European Network and Information Security Agency (Jan 2010)

As Lars notes: “maybe he realized that the worst form of terrorism is monetary policy failure”

The Japan Story

A Benjamin Cole post

If you don’t like quantitative easing, then consider this: The Nikkei 225, a broad measure of Japan’s stock market, is up 45.9% in the last 52 weeks.

On May 20, official Japan reported that Q1 GDP was up 2.4% YOY.

This is good news for Japan, a nation nearly moribund from 1992 through 2012, when so encrusted in deflation it managed but scant growth of 1 percent annually. In that pair of lost decades, the Japan stock market lost about 80% of its nominal value, as did property values. The nation became deeply indebted, as it tried fiscal stimulus to revive. The yen soared in value against the U.S. dollar.

The twenty years after 1992 were a debacle for Japan, a long real-world experiment that savages the folly that deflation and a strong currency are economic cure-alls.

Congratulations are in order to the current Bank of Japan, led by the courageous Governor Haruhiko Kuroda, who has shown resolve, so unlike the indecisive, feeble troupe who gaggle together at the Federal Open Market Committee, the lugubrious policy-making board of the U.S. Federal Reserve.

In contrast to the stop-and-go FOMC, BoJ’er Kuroda has been buying $80 billion in bonds a month since 2013, and has said he would do more if necessary to hit his 2% inflation target.

And yes, ordinary Japanese are benefitting too: “Wage growth is now positive, ending years of wage deflation,” Christopher Mahon, of Baring Asset Management recently told Barron’s. Mahon says buy Japan.

If I have criticism for the BoJ, it is that they should have a nominal GDP target, not an IT—more on that later.

QE in the U.S.

When finally the Fed did try to right kind of QE—QE3, which was open ended, results dependent—QE worked in the United States too. After peek-a-boo with QE 1 and QE2, the Fed in September of 2012 said it would buy $40 billion a month, and later upped that to $85 billion a month, until conditions improved. That policy roughly worked (although note that BoJ is buying $80 billion of bonds a month in an economy half the size of the U.S. economy).

Yet unlike the BoJ stalwarts, the FOMC folded up their QE tents when inflation was still below target, ending QE3 in October, 2014. Thus, the FOMC sent a signal to Wall Street and markets everywhere: seeking robust economic growth is not worth risking inflation even close to 2%.

Since the Fed quit QE, the DJIA has drifted sideways for fleeting gains, while the first half 2015 may be flat in terms of GDP growth, with just a little bad luck.

The U.S. is in the same “stall speed” that defined Japan for two decades.

And For What?

The Fed is obsessed with a nominal index of prices, the PCE deflator.

But as Martin Feldstein pointed out recently in the The Wall Street Journal, government indices of inflation are imprecise, and may read a few percent high. The Fed may have the nation in Japan-style deflation now.

Feldstein then lectured that government policies should be growth-oriented, more so than today.

Amen—I hope the Fed is listening. And watching. Watching Japan, that is.

And the IT? Well, Marcus Nunes is right, as he recently blogged: The Fed should actually target nominal GDP. But if they would even have the resolve to hit the IT they have, or preferably one a bit higher, that would be an improvement.

The Only U.S. Macroeconomics Graph You Need

A Benjamin Cole post

That the United States economy today is far less inflation-prone than the 1970s is hardly in dispute. But for some reason—ideology, or generational perhaps—we have now a Fed that is monomaniacally obsessed with inflation, and thus overly timid of promoting robust growth. Or even of trying.

B Cole_Only graph

Since the 1970s, we have seen international trade balloon in the U.S., with the attendant global supply lines. We have seen the destruction of Big Labor, Big Auto, Big Steel, Big Aluminum, big anything. Who has market power today?

Meanwhile, retailing has been transformed by the incredible global sourcing and efficient distribution of a Wal-Mart, Target or the ubiquitous dollar stores—not to mention now-robust informal retail markets courtesy of Craigslist and the Internet.

Moreover, since the 1970s whole industries, such as transportation or finance, have had price shackles thrown off. Remember regulated airline, train and trucking fares? How about fixed stockbroker commissions? Passbook rates?

Top federal marginal tax rates have been cut from 90% in the 1960s to under 40% today—capital is abundant, or even glutted. No good idea in business today goes unfunded. This is different from a couple decades back, when many complained that one “had to have connections” to get bank or VC funding.


The proof is in the pudding. The last time the U.S. saw double-digit inflation was in the 1980s, and early at that. The last time the U.S. had a reported annual CPI rate above even briefly above 5% was…twenty-five years ago.

Today, if there is demand for something in the U.S—cars, say—it is not only the Big 3 who answer the call. It is Honda, Toyota, Mazda, Nissan, Hyundai, Kia, Volkswagen, BMW, a few others and what is left of the Big 3, those being GM, Ford and Fiat-Chrysler.

The Upshot

The Fed and the inflation-fixated are fighting the last war. The game now is to keep demand growing and robust. Prices will take care of themselves. That is called competition, and we have never had so much competition before in the U.S.

Print more money.

Surprise! Martin Feldstein, unwittingly, makes the case for nominal stability

In the WSJ, MF writes “The U.S. Underestimates Growth”:

…This is why we shouldn’t place much weight on the official measures of real GDP growth. It is relatively easy to add up the total dollars that are spent in the economy—the amount labeled nominal GDP. Calculating the growth of real GDP requires comparing the increase of nominal GDP to the increase in the price level. That is impossibly difficult.

But John Cochrane gives a “convenient” interpretation of MF in “Feldstein on Inflation“:

The basic idea is that inflation may be overstated, because it doesn’t do a good job of handling new products. As a result, real output growth may be a bit stronger than measured.  Marty runs through a lot of sensible conclusions.

He doesn’t talk about monetary policy, but that’s interesting too. So what if inflation really is (say) 3% lower than we think it is, and therefore real output growth is 3% larger than it really is?
That would mean we are a lot closer to “normal” of course.

It´s not Friedman´s Chicago any longer!

Note: Nominal Stability a.k.a. NGDP Level Targeting

The ECB will not change strategy, even if that means marching towards and falling-off the precipice!

The European Central Bank can’t change the fundamental goal of its monetary policy, even in times that call for extraordinary measures, said European Central Bank Executive Board member Yves Mersch in remarks published Monday.

“What anchors trust in the central bank is that our objective and strategy stay constant–and this is even more important when monetary policy becomes more unconventional,” he said. “For this reason, innovative ideas to change our strategy, such as targeting a price level, would in fact be counterproductive in the current environment.

The ECB´s target is an inflation rate close to but slightly below 2%. From 1999 to 2007 they did an almost perfect job, with inflation averaging 2%. Over the last few years, however, inflation has been on a downtrend and has recently even become negative!

The chart shows what happens under the IT and PLT alternatives. Given that the price level has fallen significantly below the 2% trend line from 1999, if, as Mr Mersch prefers, the ECB keeps to its IT strategy, the price level will be permanently lower. This means that the ECB will not be ‘penalized’ for having missed the inflation target for a long time. It´s sufficient that from now on it hits it!


Adopting a price level target, on the other hand, would force the ECB to offset its previous error. Temporarily, inflation would be higher than 2%, which, in any case, is exactly what´s needed!

It would be even better if, instead of a price level target the ECB adopted an NGDP level target, but that would be asking too much from such a conservative body.

“Secular Stagnation! Larry Summers is wrong”

Roger Farmer posts: “Secular Stagnation! Larry Summers is right

Larry Summers has once again been advancing the secular stagnation hypothesis. David Andolfatto responds with this tweet which plots GDP per person in the United States since the late nineteenth century. I’m with Larry on this one.

Why does this matter and what does it have to do with secular stagnation? Those who would deny the secular stagnation hypothesis want you to believe that the economy has a very strong tendency to revert to a mean growth path which is independent of shocks. Leave the economy to itself, and the recuperative powers of the market will restore us to the social optimum. The secular stagnationists, and I am one of them, disagree.

We believe that, in the absence of corrective policies by the central bank or the treasury, the economy will never recover after a shock. The unemployment rate will not revert to its social optimum and, associated with that fact, the economy will never revert to its optimum growth path. After a shock, the data do not revert to the same trend that they followed before the shock hit.

GDP per person has a unit root. That is accepted by everyone who has studied these data. The interesting question is why?

If, as Robert Gordon believes, it is caused by random technology shifts then there is not much that monetary policy or macro prudential policies can do about it. If, as I believe, it is caused by random movements from one inefficient equilibrium to another, we should be thinking very hard about how to design a monetary/macro-prudential policy that keeps the economic train on the tracks.

I´m closer to Andolfatto. Furthermore, Farmer´s allegation that “a unit root in GDP per person is accepted by everyone is false! He links to a Cochrane 1988 paper. These two links (here and here) indicate “everyone” is not really everyone!

The chart below takes the post WWII years. I estimate the trend from 1950 to 1994 and project for the next 20 years. GDP per person remains on trend up to 2007, after which it drops AND stays down.

Farmer SS_1

During the late 1960s and throughout the 1970s, the economy was buffeted by significant demand (fiscal) and real (oil) shocks. Monetary policy was lousy (the reason behind the period getting named “Great Inflation”). Nevertheless, the chart indicates that real GDP per person always reverted to trend, contrary to what Farmer presumes.

During the “Great Moderation”, output per person hugged very closely to the trend, with little oscillation. That was broken in 2008 and for the past 7 years GDP per person has evolved far below trend. It´s not really a “Great Stagnation”, but a “depression” (even if it´s not “Great”).

I agree with Farmer that we should “thinking very hard about how to design a monetary policy that keeps the economic train on the tracks”. Market Monetarist´s suggestion is that monetary policy should strive to obtain nominal stability, in other words, keep NGDP evolving close to a level trend path.

The NGDP growth chart illustrates

Farmer SS_2

Update: Jérémie Cohen Setton at Bruegel has a take:

What’s at stake: The question of whether capitalist economies are self-correcting and will eventually revert to mean growth has received renewed interest given the underperformance of most economies six years after the onset of the Great Recessions. While the idea of persistent high unemployment was central to Keynes’ General Theory, it was quickly abandoned by the neoclassical synthesis.

Tyler Cowen writes that the most crucial issue is whether economies will return to normal conditions of steady growth, or whether we are witnessing a fundamental transformation, unveiled in bits and pieces. One relatively optimistic view is that observed deficiencies — like slow growth in real wages and the overall economy, persistently low interest rates and low levels of labor participation — are merely temporary.  Another commonly heard view is that we made the mistake of letting the last recession linger too long, allowing some of its features to become entrenched.



Reasoning from GDP component changes – A media macro favorite

In “The U.S. Economy Just Had Its Worst Month Since the Recession”, the WSJ reports on Macroeconomic Advisers explanation, or better “hand waving”, of “potholes” in the way of the economic recovery:

Macroeconomic Advisers on Thursday said its monthly estimate showed GDP fell an inflation-adjusted 1% in March, the largest drop since December 2008, “when the U.S. economy was in the throes of recession,” the firm said. Monthly GDP had climbed 0.3% in February and ticked up 0.1% in January after falling 0.4% in December, the firm said (and shows a version of this chart).

Macro Advisers Media Macro_1

The key reason not to worry too much: The contraction reflected a drop in net exports related to the resolution of a labor dispute at West Coast ports, the firm said.

“Because the decline in monthly GDP was driven by a surge in imports that was probably unrelated to current production, we are suspicious of it and believe it overstates the underlying weakness in the economy,” Macroeconomic Advisers said in a note to clients.

Note on the chart above the presence of multiple “potholes” of similar size. I bet that for each there was a convenient “explanation”. I don´t recall their “explanation” for the “jumps”, but maybe it went along the lines “the economy has finally found its ‘foothold’”.

But when you go beyond the noisy high frequency data, and look at accumulated growth which gives a better feeling for the underlying trend, what you see is the picture of a “brain at rest”, and that´s because of the “low level stable stimulus” being provided by nominal spending (NGDP) growth!

Macro Advisers Media Macro_2

Thinking About The Unthinkable: On Nuking Unemployment

A Benjamin Cole post

In 1962, Herman Kahn, the American author of On Thermonuclear War, followed up with his tome Thinking About The Unthinkable, about a nuclear war with the Soviet Union.

Some were appalled at Kahn’s parsing the life after coast-to-coast atomic blasts.

But today’s macroeconomists would be equally aghast at the suggestion the United States should seek zero unemployment.

But should they be?


Cross-country economic comparisons are notably treacherous due to differences in the definitions and quality of data compilation.

Yet Thailand has had just about no unemployment for years, and modest inflation rates. For example, the latest issue of The Economist reports Thailand has an unemployment rate of 1% and a deflation rate of 1%. Thailand’s latest quarter reported annual growth rate 7.1%, and 3.9% YOY. I can tell you that in rural Thailand work goes undone for lack of laborers.

My anecdotal take is this employment picture is great for the Thais. Almost any Thai has a sense of value, a sense the economy works for them, if they work.

Thailand, run by populists, royalists and now a junta is able to do better than the United States?

Is this creditable?

The Phillips Phlat-Line

Is the U.S. so different? We have seen since the 1990s in the U.S. that inflation barely budges, even as unemployment drops. The Phillips Curve is dead. Indeed, the U.S. has had steady drops in the reported national unemployment rate since 2008, and the problem is still potential deflation, not inflation. The latest PPI, of course, was down YOY.

B Cole_Unthinkable

Thinking The Unthinkable

Surely, some structural impediments could be removed in the U.S. economy, such as the overly generous Social Security and Veterans Administration disability programs, upon which 12 million Americans now draw monthly checks—in a nation in which most jobs do not involve physical labor. Extending unemployment insurance is a bad idea too. Even the minimum wage is a bad idea—although I am uneasy about suffocating the economy through tight money and then stomping the minimum wage, though some might take malicious glee in that, and have proposed as much.


Would it be such a bad thing for our macroeconomic policy to target much lower rates of unemployment?

Why not try, and see what happens?

If moderate inflation results, could we live with it? Why not? The U.S. prospered for decades with inflation in the 3% range. If in the worst cast scenario, inflation rose too high, and the Fed hit the brakes a little—how bad would that be?

When did sub-2% inflation take precedence over robust growth?