An obvious solution

This WSJ piece shows clearly the “divisions” within the Fed:

 If economic growth doesn’t pick up in the third quarter, Federal Reserve Bank of Chicago President Charles Evans said he would push for expanding the Fed’s already unprecedented stimulative policies.

“It’s obvious the third quarter has to show improvement,” Evans said.

The Fed, said Evans, can’t keep pushing back projections for economic growth without considering taking additional action. Evans’ comments, made during a briefing with reporters, reveal contrasting views at the Fed.

But than there´s Plosser:

On Wednesday, Federal Reserve Bank of Philadelphia President Charles Plosser suggested, in an interview with Reuters, that the Fed might have to raise the short-term federal-funds rate later this year if the economy strengthens as he expects.

The end result is a string of “on and off” actions – QE1, QE2,.. – that do very little to get the economy out of the “hole” it fell into 3 years ago due, you guessed, to a major MP blunder. The time is ripe for a new “recipe”. Target NGDP!

Joke of the century

Southern Methodist University in Texas is hosting a seminar. The “call for papers” reads:

Dynamic stochastic general equilibrium (DSGE) models have become an established framework of reference in empirical macroeconomics. Because DSGE models combine micro- and macroeconomic theory with formal econometric modeling and inference, they are now widely used in policy analysis and academic discourse to address questions in monetary economics and business cycle research, and to inform policy interventions. The continued success of DSGE models will rest on a sustained ability to meet key challenges and improve upon the main modeling paradigm both in terms of its theoretical foundations and its econometric implementation.

All very true!

Fire temporarily under control, but cinders still smolder

A nice take from Ryan Avent at the Economist:

This plan has averted a near-term disaster. But the biggest risk to the euro zone is that its leaders will begin thinking that they’ve solved the problem. As growth figures worsen in coming months, markets will once again become antsy. Euro-zone officials had better be preparing for a way to convince them anew that they want this thing to work.

Crisis and the non-recovery: the common element

In a recent post, Scott Sumner writes:

To summarize, the severe financial crisis could not have caused the great GDP collapse, because monthly GDP estimates show it was half over before the post-Lehman crisis even began.  But even if this view is wrong, there is not a shred of theoretical or empirical evidence linking the current 9.2% unemployment with the 2008 financial crisis.  Theory suggests that if a central bank inflation targets, it drives NGDP.  The Fed says it has the economy where it wants it (in nominal terms), and doesn’t think we need more inflation.  When it did think we needed more inflation mid-2010 (when the core rate had fallen to 0.6%) it did QE2, which raised core inflation back up to roughly where the Fed wanted it.  Of course (just as in mid-2008) commodity price inflation is distorting Fed policy, but that’s a problem attributable to the Fed, not the financial crisis.

The “conventional” causal link runs from the crash of the house bubble to the financial fall-out to the great economic collapse and high unemployment. The first thing to note is that the “bubble” argument lacks “punch”. After all, the price movements in different regions were significantly different, especially if the “cause” of the “bubble” is, as usual, attributed to the Fed keeping “rates too low for too long”.

The Austrian argument – that too many houses were built – in which case the resulting slump (correction) has led to high unemployment also lacks “conviction”.

The panel below provides interesting information.

As indicated in the second graph of the panel, in the late 1980´s population growth “jumped”. From an average of 1% growth in 1966-1989, it went to 1.2% during 1990-00. This is associated with strong immigration.

The first graph shows that population has remained above the 1965-1989 trend. The last graph is interesting because it indicates that towards the end of the 1980´s the House-Population ratio (H/P) reached a “steady-state” (SS). From there, looking at the third graph, we can understand the persistent rise in house construction (house starts) after 1990. In 1998-2000 construction stayed flat and with population growing robustly the H/P dropped below the SS-level, giving rise to renewed house construction in the 2001-05 years to get the ratio back to the SS-level.

The second graph also shows that after 2005 population growth dropped considerably, from an average of 1.2% in 1990-00 to 0.92% in 2005-10, noting that since 2008 population growth has fallen below 0.9%. No mystery that house starts have also fallen dramatically with the high unemployment causing “doubling-up”, especially among people in their 20´s, helping explain the rise in the vacancy rate, which went from an average of 11.9% in 1994-05 to 14.4% in 2008-10.

The next graph shows that while employment in residential construction peaked in early 2006, nonresidential construction employment only “dived” when NGDP “crashed” after mid 2008.

Most likely, monetary policy bears the brunt of the responsibility for turning a “regular” recession into a “great” one (more likely, given the time span, a “little depression”).

This month marks 2 years since the NBER declared the “recovery” began. Since what´s transpired so far bears little resemblance to what people perceive as “recovery”, just like before there was intense search for the “causal chain” behind the crisis now there is an intense search for the “cause(s)” behind the “absence” of recovery.

Recently, this piece by David Leonhardt has spawned a lot of discussion:

There is no shortage of explanations for the economy’s maddening inability to leave behind the Great Recession and start adding large numbers of jobs…

But the real culprit—or at least the main one—has been hiding in plain sight. We are living through a tremendous bust. It isn’t simply a housing bust. It’s a fizzling of the great consumer bubble that was decades in the making…

If you’re looking for one overarching explanation for the still-terrible job market, it is this great consumer bust.

In David Altig´s comment there is an interesting argument:

First, some perspective on the pace of the current recovery. Though we have grown used to thinking of the rebound from the most recent recession as being spectacularly substandard, that impression (which I share) is driven more by the depth of the downturn than the actual speed of the recovery.

Gives the impression that the “depth” of the recession is just a minor detail that obfuscates the almost “standard” pace of the recent recovery. Once it is perceived that the “depth” of the downturn is the “anomalous” fact, and that it was due to monetary policy errors, the “cause” of the absence of recovery becomes crystal clear. Ryan Avent at the Economist, in his take on Leonhardt´s piece has said it best:

The government’s ability to affect real growth is constrained, but real growth is highly correlated with nominal growth, and the government’s ability to influence nominal growth is absolute. The Federal Reserve could commit to faster nominal GDP growth and begin using the tools available to get there. Some portion of the growth in nominal GDP (and I’m willing to bet the lion’s share) would represent a real increase in output. The outlook for investment would look better, employment conditions—and expected incomes—would improve, asset values would rise, and deleveraging would quickly (almost as if by magic) seem like less of a problem.

An update on inflation

Every month, coinciding with the CPI release the Atlanta Fed Inflation Project announces the “inflation expectations curve”. The figure shows that while during the life of QE1 inflation expectations were rising over time, since then, despite QE2 the slope has “inverted”. I really cannot fathom the “hawks” view that there is imminent danger of inflation becoming unhinged!

Let´s take a look at actual inflation, considering both headline and alternative measures of core.

All measures begin to trend up with the announcement of QE2 in early November. But the “cause” of this rise in all inflation measures seems to be oil & commodity prices.

Those are spot prices that react quickly to new information. Notice that the “up trend” begins as soon as QE2 is hinted and the slope increases with the actual implementation of the program in early November. Notice also how the trend reverses (flattens in the case of the PPI all commodities) as soon as the scheduled end of QE2 is confirmed in April!

The perception must have been that “quantitative easing” would spur economic activity in the US, which would add to emerging market “robustness”. Commodity and oil prices increase with spillover effects into prices generally. But that´s now in the past. Maybe more decisive hints of QE3 will change things again. Or maybe Bernanke´s stated view that “I worry only about deflation”, will weaken future reactions to monetary “easing”.

“The power of words”

Recently, Scott Sumner and David Glasner had posts on the market impact of Bernanke´s (and Fisher´s) “manifestations”. “News of objective facts” get priced-in very quickly (emotional based reactions get priced-out rapidly). “Words” from “authorities” can be a different matter. The picture below provides an illustration. Between January 1961 and December 1963 I show 4 major “events”, only one of which had a prolonged impact on the market. Intuitively, many would think the “missile crisis” would mark the occasion. Or even President Kennedy´s assassination. No, it was the “apparently” least likely candidate – Kennedy´s speech chastising in very harsh words the Steel industry for having raised prices.

Why would that be so? While objective facts can be promptly evaluated, even the effect of having a president assassinated could be appraised based on the constitution, the impact of Kennedy´s “words” against the Steel industry had no clear “benchmark”. Going forward, would the Executive be involved in price determination? The lingering or persistent reaction of the market becomes understandable.

Link to Video of speech


Parsing Bernanke

David Beckworth has this very pointed contrast between Governor (actually academic) Bernanke and Chairman Bernanke. In answering a Japanese reporter´s question:

AKIHIRO OKADA.  Mr. Chairman, I am Akihiro Okada with Yomiuri Shimbun, a Japanese newspaper.  During the Japanese lost decade in the 1990s, you strongly criticized Japan’s lack of policies.  Recently Larry Summers suggested in his column that the U.S. is in the middle of its own lost decade.  Based on those points with QE2 ending, what do you think of Japan’s experience and the reality facing the U.S.?  Are there any historical lessons that we should be reminded about?  Thank you.

Bernanke answers:

Well, I’m a little bit more sympathetic to central bankers now than I was 10 years ago.  I think it’s very important to understand that in my comments—both in my comment in the published comment a decade ago as well as in my speech in 2002 about deflation—my main point was that a determined central bank can always do something about deflation.  After all, inflation is a monetary phenomenon, a central bank can always create money, and so on.  I also argued—and I think it’s well understood that deflation, persistent deflation can be a very debilitating factor in growth and employment in an economy.  So we acted on that advice here in the United States, as I just described, in August, September of last year.  We could infer from, say, TIPS prices—inflation index bond prices—that investors saw something on the order of a one-third chance of outright deflation going forward.  So there was a significant risk there.  The securities purchases that we did were intended, in part, to end that risk of deflation.  And I think it’s widely agreed that we succeeded in ending that deflation risk.  I think also that our policies were constructive on the employment side.  This, I realize, is a bit more controversial.  And we’ve been consistent with that—with that approach.  But we did take actions as needed, even though we were at the zero lower bound of interest rates, to address deflation.  So that was the thrust of my remarks 10 years ago.  And we’ve been consistent with that approach.

Amazing. The word deflation shows up 8 times – that´s 3.1% of the 261 words paragraph! Inflation shows up only once. I think this kind of corroborates the views I expressed in a recent post:

He´s an inflation targeter through and through! And an inflation targeter wants, at all costs, to avoid deflation! That´s all folks! He has no understanding of the benefits from stabilizing nominal spending growth along a target path. He only thinks in terms of inflation/deflation.

Japanese monetary authorities have shown a “revealed preference” for zero (albeit tiny deflation). Back in the 00´s, their QE attempt was stopped as soon as inflation returned to zero. It seems that despite all his criticisms of Japanese MP years ago, Bernanke is repeating the same “errors”. QE´s are ignited once their is the risk of deflation and “switched-off” as soon as the risk abates. For all other matters – nominal spending level, unemployment – he shows no concern whatsoever!

Is “bribery” the way to go?

From the WSJ: Ben Bernanke may have shot debt-ceiling negotiations in the foot Wednesday.

Instead, the complacency being exhibited by investors underlines the consensus view that legislators will pull a deal out of the hat at the 11th hour. The sentiment repeated across Wall Street is that the politicians just couldn’t be so stupid as to let the U.S. default.

But what if they could be? In that case, markets may be setting themselves up for an even worse fall than would otherwise be the case should the unthinkable occur and the U.S. undergoes some kind of default or needs to prioritize payments. The latter could cut off things such as Social Security checks, adding another problem for already sputtering economic growth.

In that sense, silence from Mr. Bernanke on the chance for further quantitative easing would have put pressure on Congress. Instead, he again offered reassurance that the Fed stands ready to backstop markets.

Fear that the “Bernanke put” might not be there would have rattled investors. And that might be just what is needed to get politicians to do some hard bargaining.

What a way to go!

A replay of Jackson Hole August 27 2010?


In particular, the Committee is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly. The issue at this stage is not whether we have the tools to help support economic activity and guard against disinflation. We do. As I will discuss next, the issue is instead whether, at any given juncture, the benefits of each tool, in terms of additional stimulus, outweigh the associated costs or risks of using the tool.

Today at the Congressional Hearing:

“The possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might reemerge, implying a need for additional policy support,” he said.

Yes, as is his “style”, he mostly worries about deflation!

But, according to the script, and given the markets desperate wish for something, anything, that “brightens” the horizon, stocks (worldwide) are up, long term rates are up, and the dollar is down.

A divided nation

The government is divided, analysts are divided, and the Fed is divided!

Today and tomorrow Bernanke appears before Congress to deliver his semiannual report on monetary policy. According to the WSJ, in a divided Congress he´ll likely be criticized for doing either too little or too much!

According to the WSJ:

The reality is that the Fed simply doesn’t at this point seem to have the right set of tools to fix what ails the U.S. economy. Even though interest rates have been pushed to historically low levels, demand for loans remains tepid. Other measures, such as lowering the 0.25% rate the Fed pays banks on their excess reserves, aren’t likely to spur much activity.

And then suggests:

Perhaps the Fed chairman should turn the tables on members of Congress this week and ask what they are going to do about it.

But this will only incite more divisions.

The basic reason for all the “divisions” and “confrontations” is that for maybe 99% of the people alive today, the economic situation is novel. 80 years ago, while the Great Depression was in full bloom, the divisions were the same.

In the “Original QE Debate” – The Goldsborough Bill of 1932 – in an exchange between Rep Goldsborough and Fed Governor Harrison, Goldsborough argued that “an articulated, explicit policy would render monetary policy potent through its constructive influence on expectations”.

At that time the proposal was to set a price level target (PLT) – defined as the average price level obtained in the 1920´s – which one year later FDR adopted, reversing the dismal trend.

For the situation today, David Beckworth has a succinct proposal:

The question then is how to change the dreary economic outlook that is causing households, firms, and financial institutions to hold relatively large shares of money and money-like assets.  The best way to do it would be for the Fed to adopt a level target, such as a nominal GDP level target.  It would go a long ways in appropriately shaping nominal expectations and in bringing aggregate demand back to a more robust level.   Finally, ignore all those naysayers who say it cannot be done in a balance sheet recession or who say there is no magic lever that can revive the economy.  They don’t know their history.  It worked for FDR in 1933-1936 and could work now too.

You can bet that as the “hole” the economy is in “closes”, the divisions and confrontations will fade.