Soon to be forgotten

Kocherlakota “bows out”. Unfortunately there´s a nice stock of “substitutes”, with next year voting president Lacker already having shown his “Stooge” credentials.

 This from Kocherlakota:

While a cooling in inflation joined with a rise in the unemployment rate “would be an argument for further accommodation,” Federal Reserve Bank of Minneapolis President Narayana Kocherlakota noted the tradeoff between price pressures and long-term unemployment “might well cost us too much” if further easing were put in place.

So don´t complain, “we´re getting it cheap” as is!

HT Patricia Stefani

Market Monetarism in France – English version

This article by Nicolas Goetzmann was sent by the author to Scott Sumner, who translated the ending. The full translation follows.

The anti-inflation obsession of the ECB brought under the limelight by the American monetarists

The recession cycle towards which Europe tends seems to have been triggered by the rate decisions taken by the ECB in the spring and summer of this year. Why is there such European blindness to the risks to growth brought forth by those decisions while in the US, those professing the same monetarist ideology, start to give equal weight to the fight against inflation and to upholding demand and thus employment?

During the month of April 2011, the European Central Bank, through the bias of its president Jean-Claude Trichet, raised the target rate by 25 basis points. That rate hike, small as it was, sent a clear message to the markets: monetary policy will not tolerate an increase in inflation and feels it is obliged to constrain aggregate demand. It cannot be attributed to chance the fact that that message dated April 2011 correlates perfectly with the increase in unemployment and the contraction of economic activity.

The rate decisions by the ECB were without doubt the starting point of the recession.

 The double rate hike decisions of April 7th and July 7th, through the bias towards further rate hikes they imparted , thus decreasing aggregate demand, was the starting point for the reduction in the forecasts for growth and inflation and for the increase in the unemployment rate forecast in France and in Europe.

 Those decisions also renewed uncertainty over the levels of public debt since lower growth forecasts would worsen the national accounts. The fear engendered by the orthodoxy of monetary policy had considerable influence over the marked deceleration in economic activity beginning last summer.

Aggregate demand – which is the sum of all demands for goods and services in an economy – is traditionally the focus of monetary policy. The ongoing talk giving rein to fears of inflation as justification to all the actions taken by the ECB conveniently forgets that monetary policy directly influences aggregate demand and not the inflation rate. We tend to forget that step. In this context, the ECB´s decision in April sounded like an advertisement: the feeble demand would weaken further.

The increase in unemployment after April is certainly not surprising; it was deliberate. The mistakes, identical to those committed in 2008, did not teach anything about the effects of a monetary policy geared to price stability. It has become blatantly clear at present that mastering inflation is no more the way to generate an environment amicable to economic development. The ECB under Jean-Claude Trichet has turned price stability into an end in itself, completely oblivious to the ultimate goal of all economic policy: growth.

The ECB is not responsible for the debt levels of States, but the signal sent out to the markets was akin to throwing a lit match on hay. At the end of his tenure, Jean-Claude Trichet congratulated himself on his accomplishments, saying he had done even better than the Bundesbank in its time, having kept inflation below 2%. The fact that unemployment in Europe is above 10% is of secondary importance.

Mario Draghi´s intervention of December 8th takes a similar route, notwithstanding the double rate decrease since his arrival. The Bundesbank doctrine remains the backbone of European monetary thought, in spite of present evidence of its utter failure.

 In the US, in contrast to the ECB, the monetarists have given up taking the fight against inflation as the sole objective of economic policy.

 It should be noted that at present the debate introduced by the “market monetarists” is very vibrant in the US over the very nature of the Central Bank´s mandate. The number of supporters for a policy based on demand, more precisely nominal GDP (i.e. including inflation), is visibly increasing.

 It is not about putting in place an inflationary policy, but rather a policy that takes into consideration, with equal weight, both price stability and the level of demand, and thus employment. The remarkable job done by Scott Sumner, economics professor at Bentley University, on Nominal GDP Targeting is gaining considerable traction in the US. The subject is now being discussed within the Federal Reserve, following the appearance of articles on the topic by Christina Romer, former  Head of President Obama Counsel of Economic Advisors, in the Op-Ed page of the New York Times; Paul Krugman, Nobel Prize recipient, in his New York Times blog and Jan Hatzius, Chief-Economist at Goldman Sachs. Such major academic contributions to an understanding of the monetary nature of the crisis is still absent from the European debate.

Bits & Pieces

“I’m hard pressed to see the rationale for further monetary stimulus,” Lacker told reporters after a speech.”

To which Benjamin Cole commented:

Yeah, he is hard-pressed. I am reminded of a guy in a Three Stooges clip who has his head “pressed” by a garment-pressing contraption. Lacker is that guy.

“Earlier, a modest rally in stocks evaporated after European Central Bank President Mario Draghi made cautious comments on the state of Europe’s economy. Mr. Draghi said the region’s economic outlook was subject to “high uncertainty” and that substantial risks remained. He added that the central bank was trying “to do its best” to avoid a credit crunch stemming from the lack of funding banks are facing in the euro zone.”

Yes, he´s doing his best but in another direction altogether:

Draghi Draghing Down the Market

“Mario Draghi has learned much from the Germans, as he is proving by once again spraying cold water on everybody’s hopes for an immediate cash bonanza from the ECB.”

“Draghi, talking to the European Parliamentary Commission this morning, has produced the following series of Dow Jones Newswires headlines, which do not exactly ring with the sound of soaring Money Helicopters:”

Draghi: Monetary Policy Can’t Do Everything

Draghi: Losing ECB’s Credibility Wouldn’t Help Mkt Confidence

Draghi: EU Treaty Forbids Monetary Financing

Draghi: We Want To Act Within The Treaty

Draghi: Any Move Breaching Treaty Would Hurt ECB Credibility

Draghi: ECB Must Boost Financial Stability Without Weakening Its Credibility

Here’s the most glowing praise he can muster:

Draghi: Latest EU Summit Package Isn’t Negative

You hear that? It isn’t negative. Break out the champagne.

Update: More Bits&Pieces:

FRANKFURT—The existence of the euro zone is “irreversible” and speculation about its breakup is “morbid,” European Central Bank President Mario Draghi said Monday.

I have no doubt whatsoever about the strength of the euro, about its permanence and its irreversibility. The one currency is irreversible,” Mr. Draghi said at his first hearing of the European Parliament’s Committee on Economic and Monetary Affairs since he took the helm of the ECB Nov. 1. A break-up of the currency union would have extraordinary costs, he added.

The ECB welcomes the latest decisions by European Union heads of states and governments for sound and transparent fiscal rules, as the “new fiscal compact is an essential signal, showing a clear trajectory for the future evolution of the euro area,” Mr. Draghi said.

Now, that´s being MORBID!

A tale of two monetary policies

Christina Romer is back with her monthly opinion piece at the NYT:

RECESSIONS after financial crises are long and severe, and the subsequent recoveries are protracted. That is the bold conclusion of “This Time Is Different,” the book by Carmen Reinhart and Kenneth Rogoff, and it has become conventional wisdom.

Their title is meant to be ironic. “This time is different” is what policy makers always say before a bubble bursts. Yet each time, according to the authors, the results are fundamentally the same.

But while there are strong patterns in the authors’ mountains of data, this simple summary misses an important fact: There’s dramatic variation in the aftermaths of crises, and much of it is caused by how policy makers respond. This history has important implications today.

Oh yes, how policymakers respond makes a whole world of difference. After all why, if not for responding to “disturbances”, do we have “policymakers”?

And the response to the ongoing crisis has been dismal. Yes, the big banks were saved, so you didn´t experience a “bank fallout” like the one in the early 1930´s, which was certainly an important factor behind the depth and breadth of the GD. But even then, as Chris Romer reminds us:

There was even huge variation within the United States during this period. The Friedman-Schwartz study found four distinct waves of banking panics in the early 1930s. After the first three, output plummeted. But after the last one, in early 1933, output skyrocketed, with industrial production rising nearly 60 percent from March to July. That time was very different.

In the post WWII period, this time around is unique in the sense that it was the only time aggregate nominal spending (NGDP) was allowed to turn negative. I say “allowed” because that most encompassing nominal aggregate is controllable by the Fed.

In a recent comment in Scott Sumner´s post, Luis Arroyo (responsible for the Spanish Blog Illusíon Monetaria) says:

Simply, I see that assets prices change at much more velocity than goods prices, and the influence goes from assets markets toward goods markets, and not the opposite.

To which SS responds:

We are closer than you think. I see the connection as follows:

1. Future expected monetary policy determines future expected NGDP.

2. Future expected NGDP determines future expected asset prices.

3. Future expected asset prices determines current asset prices.

4. Both future expected NGDP and current asset prices determine current NGDP, current AD.

Point 4 is similar to your argument.

And the biggest fall in NGDP since the Great Depression most certainly could cause a large fall in asset prices.

It could be interesting, in this context, to take a look at the big drop in stock prices (the largest proportional one day fall in history) and the impact it had on NGDP, if any.

The charts below put the 87-89 period side by side with the 07 – 09 period for ease of comparison.

Luis is correct about the speed with which asset prices can change, but as we can attest, nominal aggregate spending can change very quickly too! And that´s related, according to SS´s four points, to how quickly expectations of future monetary policy changes.

For example, in March 09 the Fed announced QE1. Asset (stock) prices immediately reversed, before the same move could be detected in NGDP, but consistent with a change in expectations of future MP.

In 1987 stock prices plunged (the reasons for that are still hotly debated), but note that NGDP kept growing, so future expected asset prices did not change much, inducing a reversal in current stock prices. We get the same “shape” in 2009, but we know, even in 2011, that there is much doubt about future expected NGDP, given that the Fed seems content in keeping the economy “crawling inside the hole”!

If Richard Fischer didn´t exist he would have to be invented!

The WSJ reports (my bolds):

Dallas Fed President Richard Fisher, in a speech in Austin, Texas, said “on the foreign front, we are innocent bystanders.” His observations came in a speech that represented a broadside against leaders across the globe.

Just as we had come to see the light of an evolving domestic recovery, one senses Europe, and possibly the emerging economies, sneaking up behind us, Wodehousean pipe in hand, poised to knock us off course,” Fisher said, in reference to humor writer P.G. Wodehouse. He said the European Union gathering last week failed to resolve that region’s government debt crisis, leaving efforts at stemming the crisis incomplete.

Fisher also pointed his fire across the Pacific. “The Chinese have not provided convincing proof that they will be able to contain the pricking of their real estate bubble or the shadow banking industry that enabled it,” he said. The official also said he was “sickened” by U.S. leaders’ inability to put the American government’s fiscal house in order.

No Mr. Fischer, the US is never an “innocent bystander”, especially when it concerns monetary policy! And you have to change your glass prescription. We haven´t seen any “light of recovery”, being still “deep inside the hole you helped dig”!

Why this time was a little bit different?

At Macroblog Dave Altig  revisits the topic of “why we didn´t get it”:

“Unfortunately, even seemingly compelling historical evidence is not always so clear cut. An illustration of this, relevant to the failure to forecast the Great Recession, was provided in a paper by Enrique Mendoza and Marco Terrones (from the University of Maryland and the International Monetary Fund, respectively), presented last month at a Central Bank of Chile conference, “Capital Mobility and Monetary Policy.” What the paper puts forward is described by Mendoza and Terrones as follows”:

… in Mendoza and Terrones (2008) we proposed a new methodology for measuring and identifying credit booms and showed that it was successful in identifying credit boom events with a clear cyclical pattern in both macro and micro data.

“The method we proposed is a ‘thresholds method.’ This method works by first splitting real credit per capita in each country into its cyclical and trend components, and then identifying a credit boom as an episode in which credit exceeds its long-run trend by more than a given ‘boom’ threshold, defined in terms of a tail probability event… The key defining feature of this method is that the thresholds are proportional to each country’s standard deviation of credit over the business cycle. Hence, credit booms reflect ‘unusually large’ cyclical credit expansions.

“And here is what they find”:

In this paper, we apply this method to data for 61 countries (21 industrialized countries, ICs, and 40 emerging market economies, EMs), over the 1960-2010 period. We found a total of 70 credit booms, 35 in ICs and 35 in EMs, including 16 credit booms that peaked in the critical period surrounding the recent financial crisis between 2007 and 2010 (again with about half of these recent booms in ICs and EMs each)…

The results show that credit booms are associated with periods of economic expansion, rising equity and housing prices, real appreciation and widening external deficits in the upswing of the booms, followed by the opposite dynamics in the downswing.

“That certainly sounds familiar, and supports the “we should have known” meme. But the full facts are a little trickier. Mendoza and Terrones continue”:

A major deviation in the evidence reported here relative to our previous findings in Mendoza and Terrones (2008) is that adding the data from the recent credit booms and crisis we find that in fact credit booms in ICs and EMs are more similar than different. In contrast, in our earlier work we found differences in the magnitudes of credit booms, the size of the macroeconomic fluctuations associated with credit booms, and the likelihood that they are followed by banking or currency crises.

… while not all credit booms end in crisis, the peaks of credit booms are often followed by banking crises, currency crises of Sudden Stops, and the frequency with which this happens is about the same for EMs and ICs (20 to 25 percent for banking and currency for banking crisis, 14 percent for Sudden Stops).

“Their notion still supports the case of the “we should have known” camp, but here’s the rub (emphasis mine)”:

This is a critical change from our previous findings, because lacking substantial evidence from all the recent booms and crises, we had found only 9 percent frequency of banking crises after credit booms for EMs and zero for ICs, and 14 percent frequency of currency crises after credit booms for EMs v. 31 percent for ICs.

“In other words, based on this particular evidence, we should have been looking for a run on the dollar, not a banking crisis. What we got, of course, was pretty much the opposite.”

Maybe the fact that for the first time since 1938, in 2008 the Fed allowed NGDP to crash had something to do with making “this time a little bit different” (actually, according to Altig, pretty much the opposite)?

On this see Scott Sumner´s post on “Wittgenstein as a macroeconomist”:

Wittgenstein:  Tell me, why do people always say it’s natural to assume the Great Recession was caused by the financial crisis of 2008?

Friend:  Well, obviously because it looks as though the Great Recession was caused by the financial crisis of 2008.

Wittgenstein:  Well, what would it have looked like if it had been caused by Fed policy errors, which allowed nominal GDP to fall at the sharpest rate since 1938, especially during a time when banks were already stressed by the subprime fiasco, and when the resources for repaying nominal debts come from nominal income?

Uau! How low can expectations fall?

This was not worth the ink used to print:

WASHINGTON — Senate leaders said on Friday night that they had reached a deal that would extend a payroll tax cut for two months — falling far short of the year-long extension they had been seeking.

And politicians are master “straw grabbers”:

A senior administration officials said that the deal announced Friday night meets the test that President Obama had set out: that Congress would not go home without preventing a tax increase on 160 million Americans.

“Merry Xmas everyone”!

Who´s afraid of INFLATION?

It´s been hard to even remember it was “inflation day” in the economic calendar. It has been a non-event altogether. If you haven´t been following it closely, or if you only listen to the likes of Ron Paul or Peter Schiff, you may be interested in this chart.

It shows expected inflation from 1 to 10 years ahead calculated every month by the diligent people at the Atlanta Cleveland Fed. The Dec 07 line, for example, indicates the “expected inflation curve” captured after the release of the November 07 CPI, and so on.

Over the first year of the “Great Recession” inflation expectations, mirroring NGDP dropped like a stone. It backed up in 09 but fell again afterwards so that today´s medium to long term inflation expectations is even lower than at the “deep end” of the recession in 2008!

“Winds of depression”

From the FT:

The managing director of the International Monetary Fund has warned that the global economy faces the prospect of “economic retraction, rising protectionism, isolation and . . . what happened in the 30s [Depression]”, as European tensions again flared over suggestions in Paris that the UK’s credit rating should be downgraded before France’s.

“There is no economy in the world, whether low-income countries, emerging markets, middle-income countries or super-advanced economies that will be immune to the crisis that we see not only unfolding but escalating,” Christine Lagarde said in a speech at the US state department in Washington. “It is not a crisis that will be resolved by one group of countries taking action. It is going to be hopefully resolved by all countries, all regions, all categories of countries actually taking action.”

 We now know that the 1930´s Great Depression was a consequence of contractionary monetary policies all over the developed world, with France (isn´t she always in the “limelight”) and the US all out on a “gold accumulating spree”.

At present there´s much hesitation in recognizing the monetary character of the present “depression” (yes, sir, it´s more than a “Great Recession”).

Nowadays the “politically correct” says that “everyone has to be involved in the process”, otherwise it´s considered “discrimination”. Maybe that´s why Christine Lagarde says things only have a chance to be resolved if every country and then some (all categories of countries) actually taking action!

That´s just not doable. There always must be a leader to point the way. In the EU the natural leader, Germany, is making a “mess of things”. Instead of promoting “unity” she´s dead set on promoting “rupture”. Her second lieutenant, France, does the same, only in a more subtle, less Teutonic, way. I think the Economist has it right:

For another insight into Mr Sarkozy’s thinking about Europe, one should listen to an interview he gave a few days earlier, at the end of the marathon-summitry in Brussels at the end of October:

 I don’t think there is enough economic integration in the euro zone, the 17, and too much integration in the European Union at 27.

The reason being:

France, or Mr Sarkozy at any rate, does not appear to have got over its resentment of the EU’s enlargement. At 27 nations-strong, the European Union is too big for France to lord it over the rest and is too liberal in economic terms for Frances protectionist leanings. Hence Mr Sarkozy’s yearning for a smaller, cosier, “federalist” euro zone.

Apparently, trying to alienate Britain fits “naturally”.into that strategy.

So, could the US successfully, on its own, lead a “charge of the light brigade”?

David Beckworth is a staunch believer in the Fed being a “monetary superpower” (see here, for example). If that´s true, the Fed could go a long way in leading a worldwide recovery.

The charts below are interesting. I chart US industrial production and trade and emerging markets industrial production and trade. Note that all through the 1990´s the US “dictated the rhythm”, noticeably helping emerging markets recover after the Asia crisis of 1997. In the early 2000s the “baton” was transferred to the emerging markets – read China after it joined the WTO. But the production and trade weight of the US (around 20% in both categories) is very significant, so if it could somehow “recover” from its “depression”, it would have a significant impact on world economic activity, maybe even helping the EU “get its act together”.

That´s, implicitly, what Benjamin Cole, a staunch believer in NGDP targeting, is saying in his guest post at Lars Christensen´s blog. And he´s someone from outside the profession, so has no “ax to grind”:

 There are times in history when caution is not rewarded, and for the crafters of monetary policy, this is one of those times.  What appears prudent by old shibboleths is in fact precarious by today’s realities.   Feeble inaction, and stilted moralizing about inflation are not substitutes for transparent resolve to reinvigorate the United States economy.

Market Monetarism is an idea whose time has come.  It offers a way to prosperity without crushing federal deficits, and offers regime stability to the American business class.

The only question is why Bernanke instead chooses the pathway cleared by the Bank of Japan.

To the last sentence I would add: given that at one time he was very critical of that chosen path!

Bernanke in the “crosshairs”

The other day Jon Hilsenrath sketched an “epitaph” for Bernanke. Now he notes that “getting him fired” as “promised” by Newt Gingrich will not be easy or even feasible. And that´s not something “new”. As I noted here, firing Bernanke was also Earl Thompson´s advice to Obama early in 2009.

Reading the American Spectator article linked by Hilsenrath, I learned that William McChesney Martin was “disliked” by both sides of the political spectrum. In the early 1960´s liberal James Tobin (from Kennedy´s CEA) advocated his dismissal and later conservative Richard Nixon also tried. In the end he was the longest office holder, beating Greenspan´s tenure by a few months.

Why, I wonder, Arthur Burns who presided over the Fed all through the “Great Inflation” (1970-77) was never in the “crosshairs” the way Bernanke is? I think a possible answer can be found comparing the charts below.

Yes, inflation was pretty high and variable under Burns, be it the headline or core measure. But regarding inflation, you can always “blame it” on something or someone, and Burns was pretty good at the “blame game”. Alternatively it was “foreign powers” through oil prices, domestic oligopolies or domestic trade unions.

With inflation remaining close to “target” under Bernanke, why should he be so vilified? The point is that Burns, in contrast to Bernanke left no “hole unfilled”. The NGDP “hole” “dug” by Bernanke´s monetary errors (despite the conventional wisdom that says he “saved the country from a second Great Depression”) is responsible for the subsidiary “employment hole”, which some argue is due to “structural factors”. Only this time the “blame game” doesn´t work!