Do we really have a better understanding of the dynamics of inflation & business cycles?

In “Microfoundations and Macro Wars” Simon Wren-Lewis concludes:

So it is clear why the microfoundations debate is mixed up with the debate over Keynesian economics. It also seems clear to me that the microfoundations approach did reveal serious problems with the Keynesian analysis that had gone before, and that the New Keynesian analysis that has emerged as a result of the microfoundations project is a lot better for it. We now understand more about the dynamics of inflation and business cycles and so monetary policy is better. This shows that the microfoundations project is progressive.

But just because a methodology is progressive does not imply that it is the only proper way to proceed. When I wrote that focusing on microfoundations can distort the way macroeconomists think, I was talking about myself as much as anyone else. I feel I spend too much time thinking about microfoundations tricks, and give insufficient attention to empirical evidence that should have much more influence on modelling choices. I don’t think I can just blame anti-Keynesians for this: I would argue New Keynesians also need to be more pragmatic about what they do, and more tolerant of other ways of building macromodels.

“And so monetary policy is better”. Is it really? So why is the US, Europe and several other countries “rolling in the deep“?

Hooray for Mexico?

On the 20th anniversary of Mexico´s adoption of inflation targeting a conference was held in Mexico City. Some ‘backslaping’:

John Taylor said:

But it was not only the law that made this accomplishment possible. It was the steady implementation of the law with a rule-like monetary policy (a type of inflation targeting) by three governors of the Banco de Mexico (Miguel Mancera, Guillermo Ortiz, and Agustin Carstens) and their staffs during the past twenty years.  It was also due to their maintaining a degree of de facto independence to match the de jure independence.

Bernanke said:

Federal Reserve Chairman Ben Bernanke on Monday said the independent status of Mexico’s central bank has helped Mexico achieve economic stability over the past two decades.

Mr. Bernanke praised the Bank of Mexico’s formal inflation-targeting regime, which it adopted in 2001.

Altogether, the Bank of Mexico’s framework has helped reduce the threat of financial crises, Mr. Bernanke said.

“When the recent financial crisis in the United States and other advanced economies threatened to spill over to Mexico, the inflation credibility enjoyed by the Bank of Mexico allowed it to counter economic weakness by easing monetary conditions,” even though inflation was running above the central bank’s target at the time, Mr. Bernanke said.

That doesn´t sound right. Mexico didn´t suffer from a ‘financial crisis’ because it had not been ‘victim’ to bad economic policies like the ‘homeownership program’ in the US and other countries. Like the US, Mexico let nominal spending fall way below trend. Furthermore, the way Mexico was affected by the international crisis shows the symptoms of a supply shock –fall in real growth and increase in inflation. By letting nominal spending fall, the central bank helped magnify the fall in real growth.

Additionally, Mexico´s inflation has remained near the top or above the upper bound of the target range most of the time.

Mexico 20yr_1


Mexico 20yr_2

The ‘Political Economy’ origins of the Nobel Memorial Prize in Economics

The Nobel Memorial Prize defines high achievement in economics, and it validates the discipline’s claim for scientific authority. And yet, historically, it can be understood as a reflection of domestic policy conflicts in Sweden. This, Philip Mirowski would say, is but one example of the multifaceted nature of history. He and his team investigate how the Bank of Sweden’s goal of political independence wound up elevating the status of neoclassical thinking within the economics profession. Writing the history of the Nobel Memorial Prize to tease out the influence of economic doctrines on policy norms in recent decades — this is new economic thinking.

Watch the video interview with Philip Mirowski


A Nobel winner ‘unlocks’ the door to NGDP futures

Worried About U.S. Debt? Shiller Pushes GDP-Linked Bonds

Much like corporate securities, Shiller’s Trills would have a coupon tied to the U.S.’s growth prospects. The security would have a long-term maturity that pays out an annual coupon worth a fraction of that year’s nominal GDP, nearly $15 at current levels. According to Shiller’s research, the cost of issuing a Trill may be around 150 basis points above short-term Treasurys.

Given that nominal growth over the past year has risen steadily, Shiller thinks GDP-linked securities could be sold “at a really good price.” In a recent paper, Shiller argued that returns on Trills could well rival those of the S&P 500, with a fraction of the volatility.

Saying he’s uncertain how GDP-linked bonds would be received by the public, Shiller added that the securities could lower the “immediate burden” on debt servicing. “It would be a step toward improving the budget situation.”

In the MM case NGDP futures would be tied to an NGDP Target, a monetary policy tool, not as an instrument to lower debt servicing burden.

Fed Bulletin Board: Communications specialist needed. Economists need not apply

Regional Fed Bosses Struggle With Communication Issue:

In the three weeks since the Federal Reserve shocked markets with a decision to stick with its aggressively easy monetary policy stance, regional central bank leaders have been taking stock of their institution’s efforts to clearly communicate its policy outlook.

And as much as the officials who lead the regional banks frequently disagree about the right path for monetary policy, they also are struggling to hold a coherent view about the state of central-bank communications. Some see a central bank conveying as much as it can, in uncertain times. Others fear markets see a hidden subtext to central-bank comments that doesn’t in fact exist. Others think the Fed is simply doing a bad job at managing expectations and believe the process needs a significant overhaul. (See a scorecard of the most recent comments from Fed officials.)

As the warden said to Hud:

What we´ve got here is a failure to communicate“:

Is Yellen ‘hot’ or ‘cold’, ‘hawk’ or ‘dove’?

There´s been a lot of “Yellen soul searching” lately. Gavyn Davis at the FT weighs in:

Ms Yellen is, of course, routinely described as one of the most dovish members of the FOMC and her speeches since moving to Washington as Vice Chair in 2010 have usually been one notch to the dovish side of Mr Bernanke himself. Recent speeches have established that she believes that interest rates should be held at zero for a longer period than would be implied by a normal Taylor Rule, even if inflation rises above 2 per cent for a while.

A devoted advocate of transparent communications, she firmly believes that the Fed should give explicit forward guidance about holding rates “lower for longer”, guidance which may need to be strengthened as the FOMC begins to taper its asset purchases. This could be her first task if tapering starts after she takes office in February.

On the precise date of tapering, Ms Yellen has offered five labour market tests which are usefully summarised in this brief paper by my colleague Juan Antolin-Diaz. Several of her indicators have improved somewhat since QE3 was launched, but not by enough to make early tapering an obvious decision. Furthermore, in her most recent major speech on monetary policy (on 4 March, 2013), she made it clear that she currently places more importance on maximising employment than on the inflation part of the Fed’s mandate:

With employment so far from its maximum level and with inflation running below the Committee’s 2 percent objective, I believe it’s appropriate for progress in the labor market to take center stage in the conduct of monetary policy.

Gavyn Davis´ conclusion:

The implication of this is important. If the Fed nominee is a dove, which she is, it is because she thinks that a rise in inflation is improbable, not because she thinks it would not matter. Like many Keynesians of her generation, the rise in inflation in the 1970s was a scarring experience for her. Her 2004 paper summarises her approach rather well:

Stabilisation policy can significantly reduce average levels of unemployment by providing stimulus to demand in circumstances where unemployment is high but underutilization of labor and capital does little to lower inflation. A monetary policy that vigorously fights high unemployment should, however, also be complemented by a policy that equally vigorously fights inflation when it rises above a modest target level.

The fact that Ms Yellen is a dove today does not imply that she would tolerate rising inflation tomorrow. She will need to persuade the markets, and the public, of that in the coming weeks.

is probably correct. But in 1996 Janet Yellen was a firm believer (like Laurence Meyer) in Phillips Curve macro. And she remains so today.

This is Yellen in the September 1996 FOMC meeting (pages 38-39), when contrary to Greenspan; several participants favored a rise in rates:

MS. YELLEN. Thank you, Mr. Chairman. I can support your proposal to adopt an unchanged policy with an asymmetric directive and to continue to evaluate incoming data as it bears both on the degree of momentum in demand and the inflationary pressures latent in the current environment. But I find myself very close to the margin and would also have been quite willing to support an upward adjustment of 25 basis points today, had you proposed that. I can support your proposal because, for the reasons that I outlined earlier and you explained in fascinating detail, this is an unusual episode. I believe we are still at quite an early stage of an inflationary uptick, if indeed this turns out to be one. I also agree that with demand moderating and current inflation stable or falling, we may end up deciding that it is unnecessary to move the funds rate upward.

But having said that, I believe that a very solid case can also be made for raising the federal funds rate at least modestly, by 25 basis points, on the grounds that the unemployment rate has notched down further, the decline in labor market slack is palpable, and the odds of a rise in the inflation rate have increased, whatever the level of the NAIRU and the associated level of those odds. I believe I am echoing Governor Meyer in saying that I favor a policy approach in which, absent clear contra-indications, our policy instrument would be routinely adjusted in response to changing pressures on resources and movements in actual inflation.

Which is the mirror image of what she said earlier this year!

Apparently the pressure on Greenspan to raise rates became so strong (from the outside even Krugman was ‘shouting’ that the Fed was ‘behind the curve’) that in the March 1997 meeting he ‘gave in’ and increased the FF rate by 25 basis points. And that was it. Enough to ‘shut everyone up’!

It certainly is not the time to go back in time and choose a ‘Phillips Curver’ to head the Fed. Bernanke suffered from inflation/deflation phobia and was guided by the “Creditism Gospel”. With that he missed badly on the nominal stability objective. With Yellen´s ‘Inflation-Unemployment” ‘map’ as guide the Fed is just giving itself another chance to ‘mess up’.

Update: And that´s exactly what transpired from the March/14 FOMC Meeting and in the follow-up press conference.



It´s not a date but the number of posts I have written since late August 2010 when I began on this journey. I take this occasion to first of all thank my readers for helping me to ‘keep walking writing’. The reader is the writers’ fodder. Without him it would be ‘just words blowing in the wind’. And the feed-back is immediate. I get to know, instantaneously, how many individuals patronized me, where they came from and which posts they read. It´s warming to see readers spread out over all the continents. You even get to think you are making a difference.

And there are the bonds and friendships made. I remember goggle-chatting with Lars Christensen in August 2011 while he was on vacation (was it Mallorca?). That´s shortly before he started blogging. It was a ‘defining moment’ because that´s when I asked him to do a guest-post in which the Market Monetarist name was introduced (substituting the provisory ‘Quasi Monetarist’) having, since then, become (almost) a household word. The title of Lars´ post was Market Monetarism – The Second Monetarist Counter revolution. It takes on a new significance after the conclusion to this post by Krugman, even if you discount the hyperbole:

The key point here is that to concede the obvious about nominal wages is, like it or not, to concede that Lucas, Prescott, and so on were just a great detour away from useful macroeconomics.

There´s a special place reserved for Scott Sumner who started the movement in February 2009 when he began blogging. One of his very first posts “C+I+G+NX=Grossly Deceptive Partitioning” almost instantly turned me into an ‘NGDP Level Targeter’. Soon after I became a ‘frequent commenter’ followed up by private e-mail exchanges with Scott. In one of those I sent him the now ‘famous’ Bernanke 1999 paper on “Japanese Monetary Policy – a case of self-induced paralysis”, which he posted on and was quickly picked up and referred to not only by bloggers but also the media.

I found out that writing is addictive. Something´s ‘missing’ if you spend even a little time away from the keyboard. To fill the ‘empty spaces’ I decided to write a book which goes over the economic history of the US over the last 60 years from a market monetarist perspective. But, differently from blogging, writing a book is a lonely endeavor, so I was glad that Benjamin Cole quickly accepted to share the burden. Separated by thousands of miles and a 10 hour time difference, during much of the time it felt like we were sitting and talking side by side.

To all my readers, commenters and fellow MM bloggers, a big thanks. The last three years have probably been the most nourishing in my life.

In the debris of the crisis, no one knows what monetary policy is anymore

Jerome Powell, a Fed Governor, discusses the Fed´s “bad communication”

I would like to push back against the narrative that the decision at the September meeting has damaged the Committee’s communications strategy. In its communications, the Committee seeks to influence market conditions over the medium term in a way that is consistent with its policy intentions. As I suggested earlier, as we navigate this unprecedented transition back to more normal policy, there may be volatility in the short run. And we will continually strive to improve our communications and avoid surprises. But, at the end of the day, my own judgment is that market expectations are now better aligned with Committee assessments and intentions.

The September decision underscored the Committee’s intention to determine the pace of purchases in a data-dependent way based on progress toward our objectives. Moreover, the modest net tightening in financial conditions since the June meeting has likely reduced the prevalence of highly leveraged, speculative positions. I believe that the market is now prepared for a reduction in purchases when the economic outlook and the broader situation support it.

Charles Plosser a monetary policymaker who doesn´t believe in monetary policy:

  • President Charles Plosser provides his economic outlook and notes that since there is little evidence that additional asset purchases will improve the economic recovery, the time has come for an expeditious phaseout of the purchase program.

  • He indicates that the FOMC missed an excellent opportunity to begin this tapering process in September, which illustrates just how difficult it will be to initiate any steps toward normalization of monetary policy.

  • Delaying the decision to taper the asset purchase program without clear and significant departures from prior guidelines suggested the FOMC was changing the goalposts and deviating from June’s forward guidance. Because the FOMC failed to adjust the pace of asset purchases at that meeting, he believes the FOMC undermines the credibility of its own forward guidance.

  • President Plosser expects growth of around 3 percent in 2014. He expects unemployment rates near 7 percent by the end of this year or early next year and close to 6.25 percent by the end of 2014. Inflation expectations will be relatively stable, and inflation will move up toward the FOMC target of 2 percent over the next year.

  • President Plosser notes that while some of the decline in labor force participation has been a result of transitory factors, the labor markets are also adjusting to longer-term structural adjustments driven by demographics and technological advancements. Monetary policy would be ineffective in counteracting such structural trends — and it should not be used to try to do so.

A German says “forward guidance” should be abolished for the sake of “financial stability”:

The nomination of Janet Yellen to succeed Ben Bernanke as Chair of the US Federal Reserve comes at one of the riskiest moments in the recent history of the Fed. The Fed’s announcement in May that it might start tapering its long-term asset purchases surprised many central bankers, and triggered a sell-off from markets worldwide. But some of the good news about America’s economy was bad news for financial markets, because investors considered the Fed’s potential policy tightening in response to such news to be more relevant than the news itself.

Rather than trying to nudge investors toward certain outcomes and explicit numerical targets, Yellen and other central bankers need to communicate more clearly how they think about risks and opportunities in the economy and financial markets, and then let private investors decide the balance of risk and reward for themselves. This would help markets become more self-sufficient and resilient, thereby enhancing financial stability and providing support for economic recovery.

When I saw this title – “A New Mandate for The Federal Reserve” – for a brief moment I turned optimistic. But that was soon deflated when I read:

The simplest way to encourage Fed governors to be vigilant for excesses is to make maintaining financial stability explicitly part of the Fed’s mandate. 

Lars Svensson´s analysis bolsters the case for NGDP Targeting

In his latest Vox column Svensson writes:

A dangerous thing concerning debt is what Irving Fisher (1933) called ”debt deflation.” It is usually described as deflation causing the real value of nominal debt to increase. Loan-to-value and loan-to-income ratios also increase, since the debt is fixed in nominal terms but the nominal value of assets and income fall. This may hurt the economy through bankruptcies, deleveraging, and fire sales.

  • But the important thing with the concept of “debt deflation” is not deflation, that is, negative inflation. The important thing is that the price level becomes lower than previously anticipated.

This implies that real debt and loan-to-value and loan-to-income ratios become higher than anticipated and planned for. Everyone has probably not realised that this is something that the Riksbank has caused with its “leaning against the wind” policy, by neglecting the objective of price stability and conducting a monetary policy that has resulted in inflation below target.

The majority of the Riksbank Executive Board maintains in their latest policy decision and in the minutes that “although a lower repo-rate path could lead to inflation attaining the target slightly sooner, it could also increase indebtedness and thus the risks to economic development in the longer run” (the minutes from the meeting on September 4, 2013, summary).

As we can see in Figure 1, the price level in Sweden has now fallen significantly below the level it would have been at if inflation had been on average 2% since 1997. In this context, the Riksbank stands out among the other central banks that have had inflation targets for the same length of time. The other central banks have kept average inflation on or very close to their targets, as I have shown in another Vox column. For instance, in Figure 1 we see that the Bank of Canada, which also has an inflation target of 2%, has kept average inflation almost exactly at 2% since 1997.

Svensson Vox_1

In “Three dogs; two didn´t bark”, I comment on a wonderful post by Nick Rowe, who says:

The real world (OK Canada) looked very much like that imaginary world from around 1992 to 2008, the golden years of inflation targeting. We can’t tell which of the three policies the Bank of Canada was following, just from looking at the data. All we know from 1992-2008 data is that either IT or PLT or NGDPLT seemed to work pretty well, but we don’t know which. It took a shock to let us see the difference.

In brief, it’s because deviations of inflation from target, or deviations of the price level from the implied target, were the guard gods that didn’t bark right when we needed them to bark. And deviations of NGDP from the implied target was a guard dog that barked loud and clear.

In Svensson´s chart above it is clear that the ‘Canadian dog’ didn´t bark, but the ‘Swedish dog’ had been barking like crazy for many years! One would think that the performance of the Canadian economy has been much better than the performance of the Swedish economy. Let´s take a look.

The charts show that while inflation in Canada has averaged close to 2%, in Sweden it has averaged only 1.3%. But real growth has been the same in both countries (3.3% on average excluding the post crisis years, and 2.6% if they are included).

Svensson Vox_2

The ‘dog’ that barked in both countries at the same time was the ‘NGDP dog’. This is shown in the charts below:

Svensson Vox_3

Note in the NGDP and Trend charts that up to end 2010 Swedish spending was on a convergence path to the trend level. This is reflected in the higher real growth rate for Sweden in the previous chart. Since then Swedish NGDP has flattened by even more than Canada´s, a fact reflected in the lower real growth rate in Sweden more recently.

Bottom Line: Keeping NGDP close to the trend level is much more important than keeping inflation (or the price level) on target. As Nick Rowe implies, we want a dog that only barks (and does so loud and clear) when the house is ‘broken in’!