Are we being brainwashed?

Peter Rupert at the Cooley-Rupert Economic Snapshot has comparative charts on RGDP components over the last several economic cycles. As they say, the Q1 GDP report was dismal. But the pictures can be condensed more informatively if, instead of having to look at several components, you concentrate on the behavior of NGDP over the cycles.

As the chart shows, the ranking of employment perfectly matches the ranking of NGDP. Some will say that employment could be the driving force. Actually that would be a bit of a stretch, especially given that it is well known that employment is a lagging indicator (for very good economic reasons. For example, before doing any new hiring, firms tend to increase hours. Only when the recovery is seen as ‘solid’, does new hiring occur).

So the “dismal performance” over the present cycle may be debited to the relative weak growth of nominal spending, especially given how far it has fallen below the level trend that was in place throughout the “Great Moderation”.

But why did this happen? One reason may be seen in the chart for prices (PCE-Core) over the different cycles. Inflation has fallen through time, having been reduced from 4.2% on average per year in the 1981 cycle, which follows on the heels of the “Great Inflation” of the late 1960s and 1970s, to 1.4% per year in the current cycle.

During Greenspan´s tenure as Fed Chair, there was no explicit inflation target. The “target” was that amount of inflation that did not ‘disrupt’ or ‘distort’ economic decisions. In quantitative terms it was viewed as something around 2%.

The chart shows that the ‘optimal’ inflation was obtained over the 1990 and 2001 cycles. Then Bernanke takes over and the 2% target was ‘written in stone’. Surely there has been overkill. The inflationphobia (something that comes out clearly in the 2008 Transcripts of FOMC Meetings) that became prevalent focused almost exclusively on headline inflation. We know that´s a bad move when there are real or supply shocks (oil prices in this case). Monetary tightening will enhance the negative effects of the shock on real output and employment, even though core prices are well behaved. Given the weak state of the economic fabric at the time the cure “killed” the patient!

Some questions come to mind. Does the price (inflation) pattern observed over the cycles indicate that the end-game is absolute price stability (zero inflation)? Were the “benefits” of a half point reduction in inflation worth the immense sacrifice in terms of output and employment that it entailed? Is the Fed set to continue on that route? Is the Jeremy Stein-implied association between low interest rates and financial instability a ploy to justify raising rates sooner than later and thus obtain further gains in the holy-war against inflation? Is the “Neo Fisherite” view that says that to increase inflation interest rates have to rise a bait to entice those that favor a higher inflation target to ‘vote’ for an increase in rates (even though the end result will be the opposite)?

And is the view that we are in a “Great Stagnation”, which is becoming more ‘popular’ every day, a ruse to sell the idea that that´s the “new normal” and we should accept and be resigned?