What should be the “expiration date” for monetary policy actions?

Greg Ip paints an interesting image:

Final thought: by extending the expiration date of the programme to December 31st, the Fed accentuates the stimulus withdrawal syndrome scheduled to begin on that date. The Bush tax cuts and payroll-tax cut expire then, and the sequester of automatic spending cuts takes effect on January 2nd. Should we add a monetary off-ramp to the fiscal cliff?

Only the “expiration date” for monetary policy should not be a date at all, but a preannounced LEVEL of nominal spending (NGDP). And the way things are moving we´re only distancing ourselves from that level.

Last chance?

From the WSJ:

NEW YORK—Speculation that U.S. central bankers are set to unveil additional stimulus measures lifted the Standard & Poor’s 500-stock index for the fourth session in a row, as tensions eased across Europe’s financial markets.

Speculation that U.S. central bankers are set to unveil additional stimulus measures put the Dow industrials on course for another triple-digit gain. Tomi Kilgore has details on The News Hub. Photo: AP.

The S&P 500 rose 13.20 points, or 1%, to 1357.98 on Tuesday, giving the benchmark its longest winning streak since May.

Unfortunately, there´s a limit to the number of times you cry ‘wolf’ and someone (the markets) comes out to help!

Scott Sumner sums it well:

The Fed has adopted an extremely reckless and risky policy.  But here’s the great irony; 99% of economists think that solving the problem, going back to faster NGDP growth, would be a risky decision for the Fed.   “Oh dear  . . . they might have to buy so much stuff.”   It’s all about fear of the unknown.  I’m here to tell you that 5% NGDP growth is the known.  What we have today is the unknown.  This applies doubly to Europe.  Remember those who said the euro would bring ‘stability,” that it would eliminate the instability of exchange rate fluctuations?

Update: This post from VoxEu has a different take, but the end result is the same. They think the economy is like Rocky Balboa:

Every Sylvester Stallone fan knows that Rocky Balboa never gives up, or rather: “it ain’t about how hard ya hit. It’s about how hard you can get it and keep moving forward.” (Stallone 2006). However many times Rocky gets hit, he keeps on coming. Even after Apollo Creed floors him with a vicious hammer punch, Rocky jumps up for more punishment.

We fear the US recovery, like Rocky, will be down on canvas again, pummelled by another round of policy uncertainty. If that happens, will the US economy spring back again, like Rocky? Perhaps, but even the most resilient fighters suffer long-term damage from repeated heavy blows.

Maybe it´s not that farfetched

From Floyd Norris at the NYT:

Imagine for a moment that two decades ago, a newly unified Germany set out to take over the European Continent, as the previous unified Germany had tried and failed to do half a century earlier. This time it would use money, not guns, to accomplish the goal.

There is, let me hasten to note, no evidence of any such conspiracy. But if there had been, things might have played out more or less as they have.

But how about this from seven months ago:

Forget what the response on the panel was. It was unremarkable. What’s interesting is what happened later, during a coffee break, when I got into a discussion with two senior German executives attending the meeting.

The nature of these meetings is that the hallway chatter is always more interesting that the formal program. Part of the reason why is that, particularly when talking to journalists, the businesspeople or politicians tend to regard those conversations as off the record. So I’ll abide by that here. One of the German execs was a consultant, and the other headed what I’ll call a quasi-official German organization.

They were slightly irritated by the pessimism I’d expressed earlier in the day. “Don’t you realize,” one of them said, “that the cost to us (Germany) of bailing out Greece is far less than it cost us to reintegrate East Germany after the wall came down in 1989?”

I almost choked on my croissant. Yes, I replied, I am aware of that. I lived and worked in Berlin as a journalist in the mid 1990s, when that very painful (economically speaking) process was taking place in Germany. But doesn’t that, I said politely, rather beg the question: Germany integrating their brethren, who’d been isolated and impoverished during the cold war, was a dream come true, whatever the cost. Germans, on the other hand paying to bail out Greece is, to average German, rather the opposite of a dream come true, is it not?

He waved me off. No no, he said, it will be taken care of. The Germans, he said, understood how beneficial to them membership in the euro zone has been. Without it, the gentleman said, the value of the Deutschemark would be 50% or 75% higher than it is under the euro. “German industry would be wiped off the map.”

And to cap it off:

Here was my ‘choking on my croissant’ moment number two. Most economists would agree with what my friend at the meeting had said; but he seemed either oblivious (not likely) or simply unconcerned (more likely) with the flip side of what he had just uttered. Italy, to take the third-largest economy in Europe, one with a sizeable and modern industrial base, is stuck with a currency — the euro — which is stronger than the old lira would be under current circumstances. But membership in the euro zone means Italy can’t devalue to bring some relief to its exporters.

I pushed back politely. Look, I said, it’s not Greece I’m worried about. It’s Italy. Third-biggest bond market in the world. Bond spreads this morning again heading over 7% (before the ECB intervened this to push them back down again.) Too big to fail, too big to save. Is the government, even one under a new Prime Minister, going to push through sufficient austerity to avoid a default?

Now the consultant perked up, speaking what he too believes to be the unvarnished truth. They have to, he said, because “to be blunt about it, we have them [both the Greeks and the Italians] by the balls.”

And now they´ve added Spain!

Brazil & Mexico: Not much to show off!

While Mexico is hosting the G-20 meetings in the resort town of Los Cabos, Brazil is hosting the Rio+20, the UN Conference on Sustainable Development in Rio. Appropriately, the NYT has a comparative feature on Mexico and Brazil:

Mexicans looked on with envy in recent years as Brazilians won a reputation as Latin America’s chosen people. With a surging economy and a prominent place on the world stage, Brazilwas the country poised for greatness while Mexico remained mired in bloodshed and destitution.

But just as momentum can change suddenly in a match at the World Cup or an event at the Olympics — both competitions that Brazil will host in the next four years — so can the dynamics between nations.

Last year, Mexico’s economy grew faster than Brazil’s, and it looks set to outpace its larger Latin rival again in 2012.

Brazil and Mexico probably have more in common than their supposed rivalry would suggest. Each has stabilized its economy after decades of veering from crisis to crisis and improved the well-being of many of its citizens.

In Brazil, “the dividends of what it did in the 1990s paid off with a political transition dovetailing with commodity prices,” said Lisa M. Schineller, a Latin America analyst for Standard & Poor’s. “It all came together.”

Now the two countries also face many of the same problems: inadequate schools, creaky infrastructure, bureaucracy and corruption.

As the charts show, for more than 60 years Mexico and Brazil have followed a parallel path, almost as if they were “linked” together. More recently Brazil´s RGDP per capita benefited from the “China pull”, much like in the second half of the 1990s Mexico benefited from the “Nafta pull”.

But when you compare both to China, it´s clear that their performance has been pretty mediocre!

Debunking a cherished myth: The 1970´s was not the “stagflationary decade”.

In a recent post provocatively entitled “In praise of stagflation” Scott Sumner writes:

In one of yesterday’s posts I pointed out that we can’t trust any of the economic history that we learned in school–citing the 1929 stock market crash (which actually had no impact on the economy.)  Another example is that “decade of stagflation;” the 1970s.  The only problem with this commonly held view is that the 1970s were not a decade of stagflation; rather we saw an extraordinary surge in aggregate demand:

NGDP growth averaged:  10.4%

RGDP growth averaged:   3.2%

Growth was normal, and inflation was very high.  Rapid growth in AD explains roughly 100% of the inflation during the 1970s.  There was no stagflation, just inflation.

Now a purist can find a few individual years of stagflation, such as 1974.  This occurred for two reasons.  OPEC sharply cut oil output in late 1973, which was a severe real shock to the economy.  And price controls were being phased out, meaning that part of the measured inflation of 1974 actually occurred in 1972-73, but was covered up to facilitate Richard Nixon’s re-election.  (Actually that’s not quite fair—in those days many of the best and the brightest progressive economists supported wage-price controls.)

So the “stagflationary 1970s” is a big myth.

That myth springs from the popular view that it was the rise in oil prices that caused the rise in inflation. Quite likely it was not so. The chart shows that while inflation had picked up from the mid-1960s, oil prices were “stuck” at about $3 to $3.50 a barrel. Naturally, oil producers were a bit peeved about the reduction in their real incomes and decided to do something about it. In addition, as Scott claims, part of the steep rise in inflation was due to the undoing of price controls.

But it was a supply shock anyway. And the economy reacted as indicated by a regular AS-AD model. The chart below shows that aggregate demand (AD) was on a rising trend over the decade, while real output growth averaged about 3.2% a year. The fact that turned the 1970´s into the “inflation decade” was the systematic increase in nominal spending to compensate for the negative effects of the shocks on unemployment and RGDP growth.

A longer term view brings out clearly what went on with real output growth and inflation during the different nominal spending growth “regimes”. It clearly indicates the advantages of stabilizing nominal spending – or aggregate demand – growth along a defined level path.

Panics galore

Wikipedia lists quite a few panics:

I picked a few and charted NGDP and RGDP for the periods. Some panics were founded on the bursting of a “railway bubble” (1847, 1873, 1893) while others were the result of financial crises or market corrections (1837, 1907). Some did no harm to real output. Others were “merciless”. The different outcomes of the panics rest with what happened to NGDP: If NGDP crashed output suffered commensurately. The Great Depression is on a league – or dimension – by itself.

 

What does a “downloaded” economy look like? An Update

Back in March I published this post:

As the nominal spending charts below show the economy´s “download” was sudden, fast and furious. It certainly wasn´t achieved through a dial-up connection. Must have shot down through a band so wide it could only have been the work of the “monetary engineers”!

And the real magnitudes followed suit.

And the word is being spread that the best thing to do is “keep it down”, lest inflation blossoms!

Some of my MM friends look at the recent movements of the long bond and the S&P index and get excited. I still believe it´s just another “Indian summer”.

Update: My view that it was an “Indian Summer” has been proved correct. The charts show the long bond and S&P following my friend´s optimistic takes. As soon as they wrote things drastically reversed.

The last chart indicates that Fiscal Stimulus (Government Spending) was “switched” on and off in 2008-10. Did nothing to “upload” the economy and caused a lot of trouble.

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Inflation Expectations: From bad to worse

With the monthly release of the CPI the Cleveland Fed publishes it´s measure of inflation expectations. As the chart shows, over the past two years and even over the last six months inflation expectations are “shrinking”. And that´s very bad news!

For a discussion on the Cleveland Fed measure of inflation expectations see here.