How long is “too long”?

Diana Furchtgott-Roth writes “Why the Fed Should Raise Rates”

Practically no one believes that the Fed will raise interest rates after its July meeting this week, but some Federal Reserve officials, such as Atlanta Fed President Dennis Lockhart and Dallas Fed President Robert Kaplan, are suggesting that rates could go up in September.

With Fed Chair Janet Yellen constantly putting off rate increases, no one can be sure what will happen in the fall — even if the jobs reports for July and August are as rosy as the 287,000 June jobs increase.

The unemployment rate stands at 4.9 percent, and the latest inflation data show that the Consumer Price Index rose by more than 2 percent over the past year.

The Fed should not depend on employment data, which will be revised several times, to decide when to raise rates. Rates have been too low for too long, and it is time for them to rise — regardless of what the jobs report shows.


The longer the Fed leaves rates low, the greater the danger of inflation. Levels of inflation depend not only on interest rates set by the Fed, but on the willingness of banks to lend. It is difficult for the Fed to forecast a precise level of inflation and stick to it because its models are imprecise across a multitude of economic measures. The Fed and the IMF regularly overpredict GDP growth, and in 2007 their models did not forecast the recession.

Western economies’ experience of inflation in the 1970s and 1980s showed that eliminating inflation is no easy feat. The world does not need another bout of stagflation.

Interestingly, to a New Fisherian such as Steven Williamson, the danger of rates too low for too long is deflation!

We know that, for almost eight years, while interest rates have been extremely low, inflation has been locked inside the 1%-2% range, and shows no sign of “escaping”, either to the “north” or to the “south”!


What´s behind the low inflation AND low real growth is the low LEVEL and low growth of NGDP!


The Fed has more than just “some explaining” to do

Narayana Kocherlakota writes “The Fed Has Some Explaining to Do”:

My forecast is that the Fed will remain reluctant to raise rates until inflationary pressures are much stronger, at which point it will feel compelled to move at a faster pace than four times per year. This is similar to Chicago Fed President Charles Evans’s suggestion that the central bank should wait to raise rates until core inflation reaches 2 percent. If prices start rising at that rate, the Fed will be right to put a lot more weight on inflationary concerns than on downside risks.

Charles Evans’ suggestion has been practiced in the past.

Back in mid-2003, when inflation was far below 2%, the Fed adopted forward guidance (“FG”). In the Minutes of the August 2003 meeting we read:

The Committee judges that, on balance, the risk of inflation becoming undesirably low is likely to be the predominant concern for the foreseeable future. In these circumstances, the Committee believes that policy accommodation can be maintained for a considerable period.

In January 2004, the message changed to:

With inflation quite low and resource use slack, the Committee believes that it can be patient in removing its policy accommodation.

In May 2004, in the meeting before the first rate hike, the message became:

With underlying inflation still expected to be relatively low, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured.

The chart illustrates the period:


The FF Target rate started moving up when core inflation reached 2%, just like Charles Evans suggests at present.

However, note that at the time, NGDP was somewhat below the trend level path. The chart indicates that forward guidance was sufficient to take it back to trend, with core inflation at 2%


Unfortunately, at present, the environment is very different. Today, NGDP is way below the original trend level, in which case, even if (big if) inflation is brought closer to 2%, the level of nominal spending will still remain far below any reasonable trend path.


To “ignite” the economy, and lift it from the depressed state it´s in, the best alternative is not to keep “fiddling” with interest rates, but to change the target to an NGDP Level target.


Unwittingly, Conor Sen demolishes inflation targeting

Conor Sen discusses inflation:

Those who argue that the U.S. Federal Reserve should keep interest rates low typically point to the same piece of evidence: The central bank’s preferred measure of inflation remains below its 2 percent target, suggesting that the economy still needs stimulus.

What they ignore is that during the dot-com and housing booms of the 1990s and 2000s, this logic would have led to bigger bubbles — and bigger busts.

Stop right there.

That´s the best argument against inflation targeting!

In the late 1990s and early 2000s, the economy was buffeted by (positive) productivity shocks. That increases RGDP growth and reduces inflation. If the fall in inflation induces the Fed to adopt a more expansionary monetary policy, the result will be nominal instability.

But those were not straightforward times. Other relevant shocks were taking place. There was the Russia/LTCM shock of 1998, the oil shock of 1999 and Y2K (1999), terrorist attack (9/11/2001), the Eron et al also in 2001. In 2003-08 there were also back to back significant negative oil shocks.

Instead of gauging the stance of monetary policy by the up´s and down´s of the Fed Funds rate, you should look at the behavior of NGDP relative to trend.

The chart puts the NGDP Gap (the behavior of NGDP relative to its trend path) and PCE Core inflation.

C Sen_1

It seems that in its reactions to those shocks, the Fed initially “oversupplied” money between 1998 and 2000 and then, “undersupplied” money between 2001 and 2003. During most of that period, inflation remained below “target” because the positive supply shock was preponderant.

Then Conor Sen writes:

The bursting of the subprime bubble was particularly disastrous, forcing the Fed and Congress to take extraordinary measures to keep the financial system afloat and contain the economic damage. One can only wonder how much worse the episode would have been — and whether Congress would have found the political will to pay for even bigger bailouts — if the Fed had further fueled the boom by conducting even looser monetary policy. We should be glad the bubble got no bigger than it did.

He couldn´t be more wrong. What happened is that with the end of the productivity boom and the reemergence of a strong negative supply (oil) shock, core inflation ticked above the then implicit inflation target between 2005 and 2007.

But that was enough to bring on the inflation paranoia, which is quite evident in the 2008 FOMC Transcripts.

The result was that in 2008 monetary policy was severely tightened, with NGDP taking a deep and prolonged dive.

Now, you could ask: Why didn’t inflation become deflation? It certainly was on the way to that, but in 2009 the Fed reversed course and put NGDP growth back into positive territory. The chart illustrates.

C Sen_2

Something interesting to note: Since the crisis, core inflation has not behaved differently from what it did during 1997-2004, remaining mostly below target.

The difference is that now, instead of a productivity boom, we´re having a productivity slump. Inflation should be higher. It isn´t because NGDP growth has remained on a much lower path than before.

However, likely because the NGDP level path has been so much lower, opportunities for productivity enhancement investments have been rare. This has important feed-back effects and may be the main reason for the appearance of “feelings” of “Great Stagnation”.

At the end, Conor Sen confirms “inflation” as the proper target. But one that should be complemented by other indicators

Of course the Fed has to focus on inflation in making its monetary policy decisions. But officials should keep in mind that core PCE is not the only measure, and factor in other indicators such as employment and the behavior of asset markets. If they do so, the case for removing stimulus in the near future will look a lot stronger.

Life for the Fed and for the market would be much simpler if, instead of an elusive “inflation target”, the Fed targeted a trend level path for NGDP, much like it implicitly did from 1987 to 2007.

HT David Beckworth

Hot potatoes? Encouraging news from Euro land

A James Alexander post

It’s been lonely blogging that the Euro Area economy was not nearly as bad as consensus reckons, even consensus amongst our fellow Market Monetarists. But the data has consistently shown Euro Area NGDP growth doing better, and at least as good as the long-term average.

The long-term avearge is dragged by the twin recessions and growth is still way below trend but it is far from hopeless. The Euro Area PMIs for July out today are quite good in themselves and especially good given they were taken after the Brexit shock and incorporate the impact of the growing Italian bank crisis and the terrorist tragedies in France. The Composite Index may be at 18 month lows but it was expected to be much worse that the still positive 52.9 reading.


Monetary policy is just about as easy as it could be given it is operating with the handbrake firmly on. The ECB balance sheet is roaring up and taking Euro Base Money with it. Draghi has said that he will keep the policy of QE for as long as it takes.

There is constant worrying chatter about the challenges of finding appropriate stuff for the ECB to buy – and this is great news. It is the “Chuck Norris” effect in action as it demonstrates the ECB’s commitment to QE on top of the actual financial asset buying it is undertaking. It will make economic actors begin to believe nominal growth really will accelerate even if the ECB doesn´t take further concrete steps (or “steppes”). The hot potato monster  may be stalking the land again.

German and Spanish NGDP growth rates are a great cause for hope. Draghi must know Italy desperately needs stronger NGDP growth to help solve its bad debt problem as our friend Lars Christensen has shown in a “one graph”  version. If Italy doesn’t get it then the EU may soon suffer another exit.

Releasing the handbrake represented by the foolishly self-defeating 2% inflation ceiling would mean that none of this money growth is actually necessary but, hey-ho, that is the way of the world with inflation ceilings or inflation targets that morph into ceilings.

“Tug of War”

From the IMF:

MUSCAT, Oman—Painting a dark outlook for the global economy, the International Monetary Fund on Thursday issued an “urgent” call for the world’s largest economies to roll out more growth-boosting policies.

The IMF said central banks need to maintain their easy-money policies and the Group of 20 largest economies must prepare contingency plans should a stagnating outlook turn into a downturn.

About the Fed:

Federal Reserve officials are looking more confidently toward an interest-rate increase before the end of the year, possibly as soon as September, as financial markets have stabilized after Britain’s vote to leave the European Union and the economy shows signs of picking up.

The Fedborg pushes for rate rises but, instead, will send them down

A James Alexander post

Jon Hilsenrath at the Wall Street Journal is an excellent journalist. He often scoops his peers by getting people to talk to him off the record. His main line is into anonymous Fed staffers in Washington – aka the Fedborg.

The Fedborg is the consensus of backoffice staff who have tirelessly argued for “normalization” of monetary policy, i.e. raising rates to historical norms despite massive evidence that inflation and nominal growth are miles below healthy historical norms. The Fedborg seems to believe that preservation of financial stability is more important than prosperity. The fact that time and again this elevation of financial stability over prosperity leads to financial instability seems to keep eluding them.

Hilsenrath’s story “Fed Officials Gain Confidence They Can Raise Rates This Year  in today’s WSJ probably moved markets. The yield curve shifted up a handful of basis points and the USD rose too – the index rose 30bps from 96.70 to 97.00

A rate increase could come as early as September if economic data hold firm

… Officials are almost certain to leave rates unchanged when they meet July 26-27, according to their public comments and interviews with officials. But the message in their post meeting policy statement could be that the economy is on a more solid footing than appeared to be the case when they last gathered in June, setting the stage for raising rates if the data hold up in the months ahead …

Such a message would get the attention of traders in futures markets, who see low chances for the Fed moving as early as September. In early June, traders on the Chicago Mercantile Exchange placed a probability of greater than 60% that the Fed would raise short-term rates by at least a quarter percentage point by its September policy meeting, according to the CME. The probability dropped sharply after a weak May jobs report and the June 23 Brexit vote and was just 12% on Monday.

As Hilsenrath weaves into his story, public comments by various hawkish regional governors have been again trying to talk up more rate rises than the market expects. But the chatter has had very little impact.

New news

So the un-named “officials” have given Hilsenrath his scoop. The officials have upped the ante and tried to get the market to take the regional governors more seriously.

The Fedborg is not at all happy that it keeps getting overruled by more sensible regional governors in alliance with more sensible permanent Fed members like Lael Brainard. So, the Fedborg stoops to spin pressuring markets and the sensible governors alike. We hope that the they will fail again, but what really needs to happen is a Kocherlakota “house cleaning” of these back office experts and their replacement with more rounded, sensible, evidence-based, pro-prosperity types. Or they could just recognise their errors and stop pushing financial stability that results in financial instability.

Although in the short term the Fed can often influence rates in the way they wish ultimately it depends on the market. The market ultimately will send rates down if the Fed tries to raise them now.

What happens when you let NGDP Drop below the trend level target?

You go the “(un)conventional” way:

The Reserve Bank of Australia has drafted an emergency playbook to follow the world’s major central banks in embracing extreme monetary policy as global interest rates stumble to historic lows and the Australian dollar stays stubbornly high.

Until mid-2014, Australia was doing nicely. In the past two years, however, it began worrying about asset bubbles:

Addressing members of the Committee for Economic Development of Australia (CEDA) lunch in Adelaide, he said monetary policy aimed at encouraging business investment and generating employment amid global economic weakness was in danger of creating a housing bubble in Australia.

And continued to do so one year on:

The Reserve Bank of Australia’s surprise decision to defer its widely anticipated April rate cut for at least another month might have been influenced by the increasingly pricey housing market, which it regards as posing a real “dilemma”.

According to UBS, in March the ratio of Australian dwelling prices-to-disposable household incomes equalled – and is presently surpassing – the previous record of 5.3 times set back in September 2003. And they predict it will climb further.

The policy interest rate has been lowered significantly. So what? That only means that monetary policy has been tight, something easily gleaned from the behavior of NGDP growth and inflation.




What Australia should do is try to get NGDP back on trend, which has served it well.


What a healthy US labor market looks like

A James Alexander post

Tim Duy provides an excellent summary  of the state of play in the US economy from last week’s data releases. While Duy lands on the side of caution in terms of rate rises he is still unsure about what the Fed is actually targeting. I don’t think Duy is cautious enough because the Fed should drop all ideas of rate rises in the future, and not just talk about delaying them. A neutral stance rather than their current stop-start tightening bias is most appropriate.

One of his charts shows wage growth over the last 20 years. I think it shows just how far the US has yet to go in terms of achieving a healthy economy that needs any monetary tightening. Back in the 1990s hourly wage growth was running at around a nominal 4%. The Atlanta Fed wage growth showing wage growth for those in work for at least 12m was running at 5% – the difference being that those in temporary or part-time employment often see less wage growth.

JA Healthy Lab Market_1

Looking at just the Atlanta Fed data itself,  there is a fascinating breakdown between different categories of employed workers. Particularly job stayers vs job switchers. A healthy labor market, from the point of view of labor, is one where there is a good degree of job switching. It is also healthy from the point of view of the economy in that it allows good nominal growth to do its magic.

JA Healthy Lab Market_2

A healthy labor market, a healthy economy

  • One where workers who perform less well (are less productive) than average or in firms of industries doing less well than average, see their nominal pay rise but by less than those doing better (more productive) than average or in firms or industries doing better than average.
  • In real terms those doing less well than average or in firms or industries doing less well than average will see smaller rises or even possibly small falls.
  • This is an excellent result as it allows relative winners and losers to emerge yet without compulsory job losses.
  • Productivity rises as those workers more productive than average or in firms and industries more productive than average do better. The result is real economic growth for all.

In the 1997-2001 period job switchers (those who were recognised as being more productive) did significantly better than average – and there was a productivity boom. Between 2002-2006 the weak recovery did not see this pattern repeated, although it was emerging by 2006 just as the Fed began to apply the monetary brakes. The story post 2008 is dreadful. Monetary tightness has prevented not only any significant nominal wage growth but also any healthy differentiation – and any productivity growth to boot. It is only in the last few quarters that there has been any signs of healthy wage growth and again the beginnings of some healthy differentiation – differentiation in wage growth between job-stayers and job-switchers that leads to productivity growth.

A potential tragedy versus a potentially healthy labor market

Yet what do we see? A Fed already intent on repeating its historic 2007-2008 mistake of tightening monetary policy when on the cusp of a healthy labor market. What a tragedy! No wonder economic populism came close to winning the Democratic nomination, has won the Republican nomination and may yet win the Presidential election. Elites reap what they have sown (see Brexit). Neglect nominal GDP growth at your peril.

Three ideas for new UK Chancellor Hammond

A James Alexander post

The UK has a new Chancellor of the Exchequer this weekend, Philip Hammond. Encouragingly he has studied at least some economics having read the infamous PPE course at Oxford, more than could be said for George Osborne who just read Modern History. Although Hammond was awarded a 1st we don’t know (yet) whether he specialised in the Politics bit (hopefully, little), the Philosophy bit (OK’ish) or the Economics bit (hopefully a lot).

The fact that he has been in business and especially property development is reasonably encouraging. He should recognise the need for nominal growth across the economy, as economic actors live in the (real) nominal world and not in artificial constructs like inflation and Real GDP.

Here are three ideas he should be considering this weekend:

  1. Commission his UK Treasury to update the 2013 Review of the monetary policy framework. The strict inflation targeting was more or less reaffirmed but has failed to get inflation up to, let alone averaging, 2%. The grand line-up of public and private sector economists who criticised NGDP targeting should all be asked back to justify the failure of IT to deliver.

2. Downgrade the essentially arbitrary inflation target of 2% as secondary to a target of 5% growth in underlying          nominal GDP. This growth rate of 5% is about right for nominal wage or income growth such that an economy has flexibility to cope with shocks and not lead to involuntary unemployment and recessions. This level will also allow much greater relative real wage and income flexibility, which in turn will allow for relatively more productive individuals and firms to be rewarded by real rises in wages and incomes, and for less productive ones to be let down gently in real terms but still grow (more or less) in nominal terms. Productivity will rise, people will be happier and you will be more popular.

2.1. If this is  too much change in one step, move to a properly assessed dual target of inflation in a range of 1-3% with the flexibility coming from reference to real growth in GDP. It is imperative to stop the 2% target becoming, as it may already have done, a 2% ceiling to projections two years out.

3. Issue some government bonds tied to a 24 month moving average of NGDP or, better still, sponsor an NGDP Growth Futures market and target NGDP growth one or two years ahead. Do not target current or historic NGDP as there is always noise in that data that needs to settle down as estimates become actuals and errors corrected. CPI is an unwise target as it is an economic and politically-sensitive index that cannot be corrected for its inevitable errors – except when the whole framework is revised like with the switch from RPI.


Brexit devaluation: Reasoning from a price change?

A James Alexander post

One of Scott Sumner’s great contributions to economics (blogging) has been his oft-repeated mantra of “not reasoning from a price change”. Probably its most familiar usage  is related to the oil price, although there are many, many more.

The oil price case

The 2014 collapse in oil prices was heralded by many financial types and economists as a great boon to wealth creation, a sort of hidden tax cut. What Scott tirelessly pointed out is that if the oil price drop was as a result of a drop in demand then the cut in price would not herald a rise in wealth, but was more a consequence of a fall in wealth.

While many thought the fall in price was related to supply it did also coincide with the great monetary tightening that followed on from the end of QE3 and the rise and rise of the USD further confirmed this thesis. There were no wild consumer celebrations of the oil price fall, things carried on pretty much as usual: the dull, low growth environment.

Similarly, earlier rises in the price of oil, often dramatic ones, should not have heralded real economy shocks as they are most often associated with an increase in demand. Real economy shocks have only been the consequence of oil price shocks when central banks have mistakenly decided that the short term CPI impacts are long term inflationary impacts – which they never are and never can be unless they are a trigger for excessive monetary tightening by those same central banks.

Sometimes the OPEC oil cartel has managed to raise prices dramatically, but economic crashes following such actions should only occur if monetary policy overreacts.

All in all, positive and negative oil price shocks are really just another instance of central banks being the real shockers, and not real shocks, just like Brexit. Bernanke himself wrote a paper in 1997 which concludes:

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.

Currency devaluation not like any commodity price move

On Brexit I have been criticised for reasoning from a price change when celebrating the fall in the value of the pound. Surely it has fallen because of Brexit, and thus cannot also ameliorate the impact of Brexit?

Macroeconomists have struggled to make clear exactly the nature of the potential Brexit shock. Is it an Aggregate Supply or an Aggregate Demand shock? Or both?

Supply shock offset partly by devaluation

A “supply shock” is one that shifts the Aggregate Supply curve to the left, less is supplied at each and every price level along the curve. Such a shock would be inflationary as less output is available for the same amount of money around.

JA Brexit AS-AD Shocks_1

The tricky wrinkle is that the shock is, potentially, to the supplying of overseas markets only, not UK ones. Brexit is firstly a threat to UK exports. This would be expected to impact the currency not the UK economy per se. This shock would mean less GBP demand and the consequent drop in the currency.

The drop in the currency would then partially offset the impact as cheaper UK production would tempt other foreigners, even EU ones, to buy UK goods and services, shifting the AD curve to the right. How much so depends on the elasticity of overseas demand, an unknown, especially in advance.

JA Brexit AS-AD Shocks_2

The potential supply shock from Brexit will also depend on the deal with the EU and the deals with the RoW now negotiated independently of the EU. These are huge uncertainties but uncertainty is normal. Businesses live with it all the time.

The theory that the EU will want to “punish” the UK is interesting but self-interest will win out.  Assuming the worst case seems like scaremongering. This piece “Long Day’s Journey Into Night” by the Centre for European Reform being typical:

Economic developments in Britain since the referendum suggest that a recession is coming. And the politics of the negotiation with the EU suggest the country will suffer a prolonged period of weak economic growth … It is clearly in the EU’s interest to be inflexible. The EU wants the UK to understand the trade-off between single market access and free movement, and to come to a decision about what is more important to Britain. If people elsewhere in Europe see mounting economic problems in Britain, they might be less likely to support anti-EU parties, for example in France.

Many countries thrive outside the EU, why not the UK? Many countries inside the EU are in dire straits.The almost wide-eyed optimism that the EU is the best for the UK, or even many countries left in it, is sadly unimaginative.

This optimism could be envisaged as the AS curve shifting right in the short-term. In the longer run the AS curve is usually considered more vertical, so Brexit may not really alter the level of RGDP but would have raised the price level. Insofar as the EU was holding back UK productivity the AS curve may indeed shift to the right, lowering the price level and increasing RGDP.

JA Brexit AS-AD Shocks_3

Demand shock may occur too, entirely offset’able by monetary policy

The “pure” shock of Brexit was on UK politics. Spending decisions may well be put off. A surprise change in leadership of government is undoubtedly unsettling. Especially to non-Brits used to British stability. Part of the UK devaluation was this pure negative shock. And insofar as it was pure shock the impact will dissipate as politics settles down again, and the GBP will rally – as it has partly been doing so already.

It is even possible UK political economy will improve, and thus turn into a positive demand shock. Cameron was an average PM, more style than substance. More importantly, Osborne was over-focused on the deficit and under-focused on NGDP growth – even if he did recognise the worsening of the problem he did nothing about it. And the Labour Party may implode, which is usually good for UK economic confidence – though not always. The Blair years with Brown at the Treasury were mostly good ones for the UK economy.

The furious ignorance about monetary policy in this piece from the UK’s Centre for Policy Studies is quite encouraging – in that they fear a loosening of monetary policy from the new government:

Plans to relax the UK’s deficit reduction programme open up the risk of monetary policy

being used to deal with UK debt by inflation.

  • The UK has already been through unprecedentedly loose monetary policy with record low

interest rates for 83 consecutive months and a £375bn QE programme.

  • Risks of persistent loose monetary policy are clear. Asset price inflation, increasing

consumer debt, rising inflation and sustaining zombie firms are major risks.

  • Government borrowing costs have fallen since Brexit, but counter-intuitively costs to insure

against government defaults have increased. Additional risk of investor flight if holders of

0.38 per cent yielding debt may soon face a 2.5 to 3 per cent inflation environment (as

currently forecasted).

  • Abandonment of deficit targets, political instability and inappropriate monetary policy

response could lead to potential recession risk.

It is hard to know where to start putting these people right except to point out that low rates are a sign of tight monetary policy not loose or even ultra-loose, that 2.5-3.0% inflation is absolutely nothing to fear, and that only strong nominal growth can deal with “excessive” debt.


Sometimes it feels like the UK is sailing between the Scylla of EU wrath for requesting a divorce and the Charybdis of tight monetary policy. I expect that like with most divorce proceedings, even the sometimes bloody ones, life moves on sooner rather than later. And I hope that now Osborne has left the Treasury the blockages to a more flexible monetary policy will dissolve.