Still Trapped

In “Why isn´t inflation lower” James Hamilton comments a recent research paper:

With so much slack in the economy and so many Americans still looking for jobs, why hasn’t inflation been falling further? University of Texas Professor Olivier Coibion and Berkeley Professor Yuriy Gorodnichenko propose an answer in an interesting new research paper.


The diagram below, taken from Coibion and Gorodnichenko (2013), updates the above analysis. Here the blue circles summarize data over 1960:Q1-2007:Q3, with the inflation surprise again the variable on the vertical axis as in the previous figure. The expectations-adjusted Phillips Curve seemed to do a reasonable job of capturing an important feature of the data over the half century that followed publication of Phillips’ original article.

Still Traped

But as one can see from the red circles in the graph above, the expectations-adjusted Phillips Curve again seems to be missing over the last 5 years, with the observed inflation rate higher than predicted. Coibion and Gorodnichenko (2013) explore a number of possible explanations for this, including structural instability and changes in the labor market. They suggest that the best explanation is a divergence of different measures of the “expected inflation” that serves as a shift factor for the Phillips Curve. Using either the last-year’s average adjustment used in the above figures, or looking at expectations of inflation implied by the yields on Treasury Inflation Protected Securities, or expectations from the Survey of Professional Forecasters, one always finds recent inflation to have been higher than predicted by the historical Phillips Curve. But Coibion and Gorodnichenko note that these measures of expected inflation have recently diverged from the answers given by those households who are sampled in the University of Michigan’s survey of consumers. Those respondents have been consistently saying that they expect a higher inflation rate than the value implied by TIPS or professional inflation forecasters.

If one uses the Michigan survey expected inflation numbers, the recent observations seem to track the historical expectations-adjusted Phillips Curve pretty well.

Coibion and Gorodnichenko also have a hypothesis about why many consumers have a different assessment from financial markets and professional forecasters: regular consumers seem to be paying more attention to what’s been happening to oil prices. Perhpas this is because most Americans see gasoline prices prominently posted on a daily basis, and many of us experience its direct effects on our purchasing power immediately after any change in the price.

And the bottom line:

The phenomenon identified by Coibion and Gorodnichenko would undermine the Fed’s ability to stimulate the economy in a number of important respects. First, it makes it much more difficult for the Fed to try to justify its actions to the public on the grounds that inflation is currently too low. Second, if makes it harder for the Fed to stimulate the economy without raising inflation, particularly if one byproduct of stimulus efforts is an increase in the relative price of oil. Third, it implies that ex ante real interest rates, if we base that concept on the perceptions of large numbers of economically important decision makers, are extremely negative at the moment, casting doubt on the claim that a primary policy objective should be to make them even more negative.

The “inflation trap” is so strong that it is even no use “talking” about inflation or how different segments develop expectations of inflation!


PS I don´t think Coibion & Gorodnichenko hypothesis about the difference in inflation expectations between ‘consumers’ expectations and ‘market based’ inflation expectations is convincing. The chart below indicates that at the start of the crisis the divergence between the two sets of (1 year) inflation expectations in fact increased.

Still Traped_01

The next two charts include the year on year increase in oil prices and the level of oil prices (C&G´s measure). In the top chart while the pre 2008 difference in inflation expectations before the crisis averaged 0.7 percentage points, the rise in oil prices averaged 24%, these averages for the post crisis period were 1.6 pp and 13%.

In the bottom chart we see that although the level of oil prices has been relatively stable for the past two and a half years, the divergence in inflation expectations bounces about like a ‘cat in hot water’.

Still Traped_1


One thing MMs have been saying for a long time is “stop talking about inflation”. But everyone else insists on doing so and now they are trapped. Binyamin Appelbaum writes:

Inflation is widely reviled as a kind of tax on modern life, but as Federal Reserve policy makers prepare to meet this week, there is growing concern inside and outside the Fed that inflation is not rising fast enough.

The Fed has worked for decades to suppress inflation, but economists, including Janet Yellen, President Obama’s nominee to lead the Fed starting next year, have long argued that a little inflation is particularly valuable when the economy is weak. Rising prices help companies increase profits; rising wages help borrowers repay debts. Inflation also encourages people and businesses to borrow money and spend it more quickly.

Weighed against the political, social and economic risks of continued slow growth after a once-in-a-century financial crisis, a sustained burst of moderate inflation is not something to worry about,” Kenneth S. Rogoff, a Harvard economist, wrote recently. “It should be embraced.”

The Fed, in a break from its historic focus on suppressing inflation, has tried since the financial crisis to keep prices rising about 2 percent a year. Some Fed officials cite the slower pace of inflation as a reason, alongside reducing unemployment, to continue the central bank’s stimulus campaign.

Critics, including Professor Rogoff, say the Fed is being much too meek. He says that inflation should be pushed as high as 6 percent a year for a few years, a rate not seen since the early 1980s. And he compared the Fed’s caution to not swinging hard enough at a golf ball in a sand trap. “You need to hit it more firmly to get it up onto the grass,” he said. “As long as you’re in the sand trap, tapping it around is not enough.”

Recently I showed that during the “Great Moderation” all the usual “targets” – “IT”, PLT” or “NGDPLT” were observationally equivalent. But since the crisis erupted we received the “information” that the “mother of all targets” is “NGDPLT”.

In that post I wrote:

In the case of the Fed, the same ‘doubts’ are true, even more so because, differently from the BoC, the Fed had no explicit target. The illustration below gives you a good idea about the ‘dangers’ associated with either inflation or price level targeting, and how NGDP targeting looks like a much better proposition.

Targeting Regimes_2

Maybe soon it will be realized by the powers that be that “talking about inflation is a dead end”!

Hong Kong & Singapore – forever “bubbly”?

Scott Sumner links to The Economist:

Over time Hong Kong has adapted to some of the peg’s constraints. Its exchange rate may be rigid, but its other prices and wages are remarkably flexible. During the financial crisis, even senior civil servants took a pay cut. This flexibility allows the economy to adjust quickly to cyclical ups and downs without the help of an independent monetary policy.

Prices, particularly for property, do sometimes take on a life of their own. But a more flexible exchange rate is not enough by itself to prevent asset-price booms: Singapore’s house prices have also soared despite its strengthening currency. And in some cases the currency itself can be the asset that takes off. The Swiss franc, for example, strengthened dramatically during the euro crisis, prompting its central bank to intervene. As nearby countries like India and Indonesia fret about capital outflows and plunging currencies, the stability offered by Hong Kong’s peg looks as good on its 30th birthday as it ever has.

Scott asks:

Can we learn anything from these examples?  I’d say nothing definitive, but they do add a couple data points to several interesting questions:

1.  Are the New Keynesians right that wage flexibility makes depressions worse?

2.  Are the Austrians right that easy money leads to asset prices bubbles.

My view before reading the article was no and no.  After reading the article I hold the same view, but with an epsilon more confidence.

The charts paint a picture that both NK´s and Austrians, for different reasons, would find ‘disturbing’!


As for the ‘high inflation’: Last year HK had 3.8%, this year it´s up to 4.2% (to September). Singapore had 4.7% inflation last year and is down to less than 2% this year.

Will the new conventional monetary policy ‘target’ imbalances or bubbles?

Things seem to be sliding in that general direction.

From Japan Times:

U.K. economy grows at fastest rate in over three years, sparking bubble fears

The news comes as many economists are beginning to worry that the U.K. economy is starting to show some of the symptoms that have caused it problems in the past. The main concern is centered on the housing market.

Over recent months, house prices have accelerated, particularly in the southeast and London, fueling worries that another boom is in the cards that will eventually require the Bank of England to increase interest rates.

From Nick Rowe:

Reading Bank of Canada Monetary Policy Reports doesn’t normally annoy me, but reading this latest one did. Specifically, this bit:

“Although the Bank considers the risks around its projected inflation path to be balanced, the fact that inflation has been persistently below target means that downside risks to inflation assume increasing importance. However, the Bank must also take into consideration the risk of exacerbating already-elevated household imbalances.” (my bold)

Translation: “We would maybe like to cut interest rates to prevent inflation staying below target, but we are scared of doing this because it might cause some people to borrow too much, so we are just crossing our fingers and hoping something will turn up so we don’t need to cut interest rates.”

Long ago, in the 90s, more growth meant (through Phillips Curve reasoning) more inflation. Central Banks had to increase rates. Now, more growth spells bubbles and imbalances. Central Banks cannot reduce rates (despite below target inflation)

The HPI pictures are very different, but in both “bubbles” are ‘identified’!

Bubble Mania

St Louis Fed: U.S. National Debt Can Be Wiped Out in a Few Years By QE, and Inflation Reduced.

Study Echoes Earlier NY Fed Finding

Guest Post by Benjamin Cole

QE may be an acronym for Quantitative Easing, but the Fed says QE really translates into a monetary El Dorado, Fat City and Manna From Heaven. We have hit the jackpot and can slay the national debt dragon—but don’t take my word for it.

I may sound crazy, but am only repeating what Fed economists have essentially said, although they appear curiously indifferent to the ultimate ramifications of their findings.

They say Fed “large-scale asset purchases”—LSAP, or QE by another name—will have little or even minuscule effect on output or prices. Even very large scale LSAP, like quadruple current efforts, will but dent matters. And the Fed now has about $3.7 trillion in bonds under roof, accumulated from LSAP. Do the math, four times $3.7 trillion is $14.8 trillion.

So…the upshot is, we (U.S. citizens anyway, sorry Marcus) can just about pay off our $17 national debt, with a Mt. Everest of fresh Benjamin Franklins. Taxpayers get a nearly $17 trillion dollar “Get Out Debt Jail” card free. About $57k in deleted federal debt per citizen, btw. I like it.

“Wait!” you, the reader says. “If QE-manna is true, where are the screaming headlines, the frothing radio hosts, the emphatic blog posts?” I mean, this is Big News, no? As in XXXXL?

True, these landmark Fed studies appear to have escaped the media’s attention—but to be fair to the “news” industry, Fed PR departments do not appear to be staffed with fireballs. And we know that central banker economists speak a language that could make illicit noontime sex sound dull.

Not Dull

Certainly not dull is Yi Wen, an economist at the St. Louis Fed, and an assistant vice president there. His photo on the St. Louis Fed website is the very essence of intelligence, equanimity and probity. You wouldn’t think Wen has boldly thrust forward the instrument for a heroic and rapine savaging of the national debt.

But he did. Wen just published a paper entitled, “Evaluating Unconventional Monetary Policies—Why Aren’t They More Effective? 

In some regards, this is the strangest paper ever published in the history of man, unless that honor goes to a similar paper released by the New York Fed last year.

It is as if federal Bureau of Land Management officials hit the Mother Lode gold mine of all time by a factor of 100, but reported, New Drill Bits Prove Only Moderately Effective in Test Tunnel. In a footnote, the BLM boys tell you that a gold seam extending for miles, nearly pure and 20 feet thick, was unearthed during the test tunneling.

Why do I say that?

Buried in Wen’s Fed econospeak-ese and calculus are these incredible findings:

“Thus, based on our model the Federal Reserve’́s total asset purchases must be more than quadrupled and remain active for several more years if the Fed intends to eliminate the 10% output gap caused by the financial crisis.”

Umm, like about $17 trillion worth of QE, right? That is our outstanding national debt, btw.

“Wait a minute,” you the reader says. “Inflation? As in Weimar Republic, here we come, minus the sauerkraut?”

No!—QE/LSAP is actually anti-inflationary, calmly asserts Wen:

“Our model provides an alternative explanation for the low inflation level. The Federal Reserve’s LSAP alone can depress inflation near the liquidity trap: Once the real interest rate of financial assets is low enough, QE induces flight to liquidity because portfolio investors opt to switch from interest-bearing assets to money. Hence, the aggregate price level must fall to accommodate the increased demand for real money balances for any given target level of long-run money growth…”

BTW, the QE can be permanent, no matter, says Wen.

But Wen, it turns out, is no lone wolf madman prowling the halls in the Federal Reserve. He is part of a pack! His hipster brethren in cosmopolitan Gotham City, that is to say staff economists at the New York Fed, are saying much the same thing.

In a paper published last year, thrillingly entitled The Macroeconomic Effects of Large-Scale Asset Purchase Programs (authored by a trio, Han Chen, Vasco Cúrdia, and Andrea Ferrero), the NY Fed reported, “We consider several robustness exercises and find that the effects (of large-scale asset purchases, or QE) on GDP growth are not very likely to exceed half a percentage point. The inflationary consequences of asset purchase programs are even smaller.”

Incredible Ramifications

This upshot of these studies is simply dumbfounding: The Federal Reserve says we can crush the national debt and suffer but trifling inflation as a consequence. Moreover, the Fed knows this but thinks that other topics are far more interesting. As in, “QE is only mildly effective.”

By many lights, disappearing the national debt is not of middling concern. Recognized economists, such as John Cochrane, University of Chicago, have spent professional lifetimes sounding klaxons on the perils of excessive national indebtedness. I assume Cochrane is taking a keen, and perhaps euphoric or even climactic interest in these Fed studies.

Right now, net interest on outstanding national debt runs about $223 billion a year, and the future of federal budgets looks like a Fukushima of red ink. So, paying down debt through QE/LSAP is jackpot-time, just when needed. Pour the QE on all night long, dudes, this is Fat City. Print, baby, print.

The Morning After

As much as I want to believe in QE-manna, something tells me there is limit to this strategy, despite what Fed economists aver.

My instincts tell me a sadder story, and that is that institutional agendas have created a patient and resilient anti-QE culture, inside the Fed. At the heart of the matter is that central bankers do not like easy money and hate to hell the idea of monetizing debt by the easy trillions, measured in multiples. Think cardinal sin.

It strikes me that Fed staffers are struggling to say something negative about QE (along with the entire contingent of anti-QE barkers in blogland). But the QE-naysayers cannot claim that LSAP are hyper-inflationary, or even inflationary much at all, as that manifestly has not happened (and did not happen in Japan, 2002-6, when they did QE the first go-round).

The anti-QE’ers can’t claim LSAP deepens recessions, as that has not happened either. In fact, the 2002-6 QE in Japan was associated with that nation’s only post 1990 recovery.  

So what can the anti-QE’ers say? They are flummoxed—but can say QE doesn’t work, or barely, or might work but only at levels that would frighten Superman.

Of course, by taking this stance, the Fed anti-QE’ers have awkwardly backed into the position that the United States has a rare shot a radically slashing the national debt, without recessionary or inflationary consequences, without tax hikes or heartless spending cuts. In fact, ceteris paribus, LSAP will allow tax cuts even while we take a chainsaw to Uncle Sam’s IOUs.

But, like I said, my sixth sense says it ain’t so.

Mr. Econo-Gut tells me QE works, and we can “get away” with monetizing a few trillion in U.S. Treasuries now, stuck in zero lower bound recession-slow-growth-land, as we are, or nearly.

QE now offers a rare cost-free opportunity to slice national debt some, and stimulate the economy, and the U.S. should take it. But there is a limit. Sooner or later, the fresh cash gets spent, into circulation, or invested in other assets, like stocks and property. When things are humming and hot, the Fed will have to stop QE, maybe even sell some bonds.

If the Fed, that is, ever summons enough nerve to do QE hard enough to get us running on “hot” again, maybe in concert with cutting interest on excess reserves. But that, my readers, is a whole ‘nother column.

In real life, I think we will have to settle for steady prosperity of the kind we work for, of the type promised possible under Market Monetarism.

And we will have to find a way to pay down or limit the national debt, through federal spending cuts.

Now, that is a dull story. One the Fed should like to tell. 

A good layman´s guide to “processing” criticism of economics

Chris Auld writes:

Every mainstream science which touches on political or religious ideology attracts more than its fair share of deniers: the anti-vaccine crowd v mainstream medicine, GMO fearmongers v geneticists, creationists v biologists, global warming deniers v climatologists. Economics is no different, but economics cranks differ in that they typically make false claims about the content of economics itself, as opposed, or as a prelude, to false claims about the way the world works. That target sometimes making it hard for non-economists to differentiate crankery from solid criticism.

Here, then, are some symptoms of bad critiques of economics [sample of 2/18]:

  1. Uses “neoclassical” as if it refers to a political philosophy, set of policy prescriptions, or actual economies. Bonus: spells it “neo-classical” or “Neo-classical.”

  1. Uses the word “neoliberal” for any reason. [Not long ago I was a “victim” of this label]

“Animal Spirits” react to monetary policy

Greenspan has an article in the Nov/Dec issue of Foreign Affairs entitled: “Never Saw It Coming-Why the Financial Crisis Took Economists By Surprise

He´s become a fan of “animal spirits”:

What went wrong? Why was virtually every economist and policymaker of note so blind to the coming calamity? How did so many experts, including me, fail to see it approaching? I have come to see that an important part of the answers to those questions is a very old idea: “animal spirits,” the term Keynes famously coined in 1936 to refer to “a spontaneous urge to action rather than inaction.” Keynes was talking about an impulse that compels economic activity, but economists now use the term “animal spirits” to also refer to fears that stifle action.

Later on:

What explains the failure of the large array of fail-safe buffers that were supposed to counter developing crises? Investors and economists believed that a sophisticated global system of financial risk management could contain market breakdowns. The risk-management paradigm that had its genesis in the work of such Nobel Prize–winning economists as Harry Markowitz, Robert Merton, and Myron Scholes was so thoroughly embraced by academia, central banks, and regulators that by 2006 it had become the core of the global bank regulatory standards known as Basel II. Global banks were authorized, within limits, to apply their own company-specific risk-based models to judge their capital requirements. Most of those models produced parameters based only on the last quarter century of observations. But even a sophisticated number-crunching model that covered the last five decades would not have anticipated the crisis that loomed.

And why not? The simple answer is that no one (or any model) would have imagined the Fed would make the sort of mistake it had last made in 1938 to wit, allow nominal spending (NGDP) to crash!

The illustrations help understand why “animal spirits” went wild. Imagine if monetary policy had not lost its bearings and had “righted itself” one year earlier (March 2008)?

Animal Spirits_1

Animal Spirits_2

Update: To calm “animal spirits” Scott Sumner suggests giving them a larger dose of “MOAR“!

“Screw your courage to the sticking plate”

According to Giles Wilkes: “Implicit in Ambrose E-P: Nominal GDP growth is what matters. All else is secondary”:

As ever, it is the ECB flouting the rulebook for political reasons. You could say it has a chronic German bias. It stoked double-digit money growth to nurse Germany through the slump in the early EMU years, accomodating a dovish Bundesbank, and dooming over-heated Club Med to its fate. This time the Bundesbank is in a hawkish mood, fretting that house prices in Berlin, Stuttgart and Munich are overvalued by as much as 20pc. Perhaps they are, but average rises across Germany have been 2.8pc annually over the past three years, with no signs of a blow-off. Even if there were, Germany could cap rises by clamping down on mortgages.

In any case, Germany’s own HICP inflation (at constant taxes) has been almost flat since March. The anti-inflation taskmaster may soon be on the cusp of deflation itself, the ultimate irony, but no less dangerous for that.

As readers know, I have long argued that France, Italy, Spain and Club Med allies should gang up in the ECB’s governing council and dictate terms, forcing through the reflation policy that the region so desperately needs. They have the votes. They have the legal and treaty authority to do so. Most monetary theorists around the world would egg them on. Yet they seem paralysed, terrified that Germany will storm off and revert to the D-Mark. They should screw their courage to the sticking plate and call Berlin’s bluff. Should Germany indeed walk out – and inflict crippling loses on its own banks and insurers in the process – this would at least be a solution of sorts. By lancing the boil, it would open the way for a return to growth.

Instead Europe seems to have abdicated leadership, praying for another decade of global growth to lift them off the reefs. This may happen but it is far from assured, and it is not a grown-up policy for the world’s second biggest economy. The cycle committee of the Centre for Economic Policy Research still refuses to rule that Euroland is out of recession. Industrial output has been treading water through the summer.

All it needs is one nasty surprise – and there are many lurking, in China and the BRICS – and Europe will lose its monetary foothold. As the Japanese learned the hard way, once you let deflation lodge in the system, it takes heaven and earth to get out again.

Some illustrations.





“Forward Guidance” – the new standard in Fed communications

Mark Wynne at the Dallas Fed has a useful compact history of the evolution of Fed communications:


Twenty years ago, when the Federal Open Market Committee (FOMC) decided to alter the stance of monetary policy by raising or lowering interest rates, it did not announce that fact to the general public. Rather, financial market participants were left to divine what the FOMC had decided by watching the behavior of the “open market desk” in securities markets.1

Today, when the FOMC decides to change the stance of monetary policy, it releases a detailed statement outlin­ing the rationale for its decisions. The Chairman holds press conferences four times a year, and FOMC members give numerous speeches and press interviews to explain their thinking.2

FOMC communications have changed radically over the past two decades. These changes have proven especially important in the current environment, where it is no longer feasible to adjust interest rates to provide monetary accommodation. By communicating its beliefs about the likely stance of monetary policy over the coming months and quarters, the FOMC can support the ongoing recovery.


Best practices in central banking call for transparency in policy deliberations and communicating the outcome in a timely manner. Over the past two decades, the FOMC has gone from being quite secretive in its deliberations to very transparent. As the committee has had to deal with the worst financial crisis since the Great Depression and exhausted conventional options, unconventional monetary policy has played a greater role. And within the class of unconventional monetary policies, forward guidance— that is, communication about the likely future course of policy conditional on economic developments—has taken on more importance. This move to increased transparency has been integral in helping the FOMC fulfill its mandate.

I wonder if the highlighted sentence above is true. Basically because the “conditionality” is too vague.

The new “communications standard” is examined in depth by a (downloadable) new e-book. I think the book editor, Wouter den Haan points the finger at the problem when he says:

Forward guidance shares the basic economic logic that links today’s decisions to future expectations, but it differs in its subject. Forward guidance focuses on the instruments of monetary policy rather than the targets of monetary policy.

Which is the better target?

All through the “Great Moderation” we couldn´t be certain of what the Fed was targeting. It didn´t have an explicit target for anything, be it inflation, the price level or nominal spending (NGDP). The Bank of Canada on the other hand had a clear explicit mandate: Target CPI inflation at 2%.

But during a period of almost two decades you couldn´t tell if the Bank of Canada was targeting inflation, the price level or NGDP. All these were observationally equivalent. In fact, in the case of the BoC we became sure that he was not targeting NGDP only when the crisis hit, but you still could think it was targeting either inflation or the price level. The chart illustrates.

Targeting Regimes_1

In the case of the Fed, the same ‘doubts’ are true, even more so because, differently from the BoC, the Fed had no explicit target. The illustration below gives you a good idea about the ‘dangers’ associated with either inflation or price level targeting, and how NGDP targeting looks like a much better proposition.

Targeting Regimes_2