Dear BOJ Top Banana Kuroda: Damn the Torpedoes and Full Stream Ahead! Structural Impediments Are Eternal In Democracies—So What?

A guest post by Benjamin Cole

The Bank of Japan’s quantitative easing program has worked. Begun 13 months ago, the BoJ QE program buys about $50 billion a month in securities in an economy roughly one-half the size of the United States.

So the BoJ is going into QE with more resolve than the clay-footed United States Federal Reserve and the Federal Open Market Committee (FOMC), which have consistently wavered and quailed about inflation, instead of aggressively targeting nominal growth, level targeting.

The results in Japan?

The Nippon economy grew at a 5.9 percent annualized rate in the first quarter. Inflation is still microscopic, at 1 percent or so, excluding the effects of a recent sales tax hike. In Texas they say, “We’ll dance with what brung us,” and the Japanese economy has been brung by QE.

So again, a central bank QE program is coincident with growth, not inflation, just as in the United States in recent years (though the U.S. QE program should be much larger), and in Japan 2001-2006.

Some say Japan’s Q1 economy got a boost from pre-tax increase buying by Japanese consumers. Maybe so, but 5.9 percent is a big number, and Japan got there despite weak export sales (due in large part to the asphyxiating monetary policies of the ECB and the Fed, btw).

And remember—Japan is a nation in the grips of a 20-year-long deflationary economic Ice Age, only warmed a bit by BoJ QE efforts in 2001-2006. For the BoJ’s current QE program to work so well is remarkable.

Of course, modern day central bankers have a squeamish aversion to prosperity—and some BoJ’ers are talking already about a QE “exit” program. To his credit, BoJ Governor Haruhiko Kuroda seems steady, but the snivelers and inflation-hysterics are predictably howling.

Hideo Hayakawa, a former top BOJ economist, said the BoJ needs to clarify what it will do after the battle with deflation is won. “If 2 percent inflation comes into sight, the BOJ should taper its asset purchases,” Hayakawa, of Fujitsu Research Institute, told Reuters.

If 2 percent inflation “comes into sight”? This is what frightens central bankers these days. It is like listening to an anorexic compulsively discuss her weight.

The success of Japan’s QE program challenges another nostrum ever squawked by the Chicken Inflation Littles, and that is that every modern nation is bottlenecked by “structural impediments.”

To be sure, every economist will aver that lighter taxes and less regulation are better for economic growth, and more competition in the private sector is better, with less unionization and industry concentration. But, in fact, many nations have improved structurally in the last 50 years, including Sweden and especially the United States.

A curious historical fact: In the 1960s boom-times in America, the private-sector was heavily unionized, international trade and competition was limited; the financial, transportation and telecommunications industries were heavily regulated; and the top marginal income tax rate was 90 percent. The minimum wage was much higher than today, adjusted for inflation. You had Big Labor, Big Steel, Big Oil, The Big 3 (autos), Ma Bell. You had stodgy retailing, pre-Wal Mart, pre-Internet, pre-eBay, pre-Amazon, and pre-Craigslist, pre-China manufacturing platforms.

But the U.S. economy rocketed up, routinely posting real growth figures at or above five percent a year. If macroeconomic structural impediments are so important, then explain the 1960s. In 1965, real GDP in the United States expanded by more than 8 percent! The US economy was one large impediment in the 1960s, but it boomed like it has never since.

Back in those salad days, the Fed chief was Arthur Burns. The record will show he courted inflation and growth, and he got both. But the record also shows structural impediments did not prevent a glorious economic expansion.

Growth today is clearly asphyxiated by monetary policies, and inflation-fixated central bankers, the kind who say when 2 percent inflation can be seen on the horizon, it is time to hit the brakes.

It wasn’t always this way. The Great Inflation Fighter Paul Volcker, Chairman of the Fed 1979-1987, declared victory when inflation dipped towards 4 percent. He never called it a floor, but he was okay with it.

Now, the inflation-hysterics say 2 percent inflation is a ceiling better never approached. While cowering, the central bankers then blame “structural impediments” for glacial growth.

Central banking cannot be trusted to central bankers.

It has taken long, but finally Fed policy is being recognized for what it is: Mediocre!

And it is being recognized as such by none other than Tim Duy, the quintessential “Fed watcher” in “Policy Induced Mediocrity?“:

Why did the Federal Reserve lean against their optimistic 2014 forecast? It seems that monetary policy over the past year can be summarized as a missed opportunity to supercharge the recovery, thereby locking the US economy into a suboptimal growth path.

He shows this actual and potential RGDP chart:

Duy Mediocrity_1And says:

It seems reasonable to believe that if the economy regains potential output by the end of at best 2016, it will be attributable only to further downward revisions to potential output.  And I even wonder whether the Fed would act to achieve their current growth forecasts or ultimately be content to continue along the current trend.  The economy appears to be already molding itself around the lower output path.

Deep down he doesn´t want to believe that such a tragedy was possible in this day and age. But this being the day and age of inflation targeting, there´s no “seems” or “appears” about it. The Fed is getting exactly what it wants!

And the NGDP chart confirms that policymakers are pleased with their actual trend level path! While Duy´s chart shows the consequence the chart below shows the reason.

Duy Mediocrity_2

The “Higher Inflation Target” Dead-end

A couple of weeks ago I wrote commenting on Krugman´s paper – suggesting the need for a higher inflation target – to be presented at the ECB Sintra Conference:

It´s a waste of time because it is the wrong product to the wrong customers at the wrong time!

Lo and behold, this was Draghi´s response at the Conference:

Try telling that to Germany. “What would it mean for a German, for example, to have a 5% objective in the whole of the euro area?” Mr. Draghi asked later Tuesday. “I don’t even want to think [about] that.”

But to some, like Edward Lambert:

I think that higher inflation targets is a solution for some who cannot accept the dynamics of the Fisher effect where inflation is low due to low nominal rates from the central banks.

Mario Draghi needs to think about the Fisher effect instead of higher inflation targets.

Nothing like a ‘lesser depression’ to mess people´s head!

On the “Fischer effect controversy” see this Josh Hendrickson post:

There is an important lesson to be learned from this controversy and debate. The lesson is that even though policy is conducted with the federal funds rate as an intermediate target or with interest on reserves as an instrument, it is still necessary to know the underlying path of the money supply associated with this interest rate policy.



The “Great Inequality Debate” is a “fallback position”

It´s interesting to observe that when opportunities to “move forward” are blocked by the policies that gave us the “Great Recession”, and that now are responsible for keeping the economy depressed, the debate on inequality flourishes. In that sense it´s a fallback or second-best debate. Once you´re ‘stuck in the mud’ the only option you have is to fight over relative positions.

On this topic it is also worthwhile to listen to Milton Friedman.

From a PBS interview (undated):

MILTON FRIEDMAN: In the particular problem of inequality, what is true, what is unquestionably true, is that there’s been a widening difference in wages earned. You have had the skilled wages go up relative to the unskilled wages. However, there has been no comparable widening in the levels of consumption. If instead of looking at income, you look at levels of consumption, if anything that’s become more equal. The fraction of families that have a dishwasher, that have a sewing machine, that have a television set. In respect to consumption, it’s very hard to avoid the view that people have been getting more equal rather than more unequal.

So, partly it depends on what questions you’re asking what you want to get an answer to. I don’t believe that statistics, as somebody has said, statistics do not speak for themselves. Alfred Marshall once said, “There is no person, no theorist so reckless as he who says that the facts speak for themselves.” The facts never speak for themselves. They have to be interpreted in terms of some understanding of where they come from and what the relation between them is.

And from chapter 5 of Free to Choose, the definitive statement

A society that puts equality–in the sense of equality of outcome–ahead of freedom will end up with neither equality nor freedom. The use of force to achieve equality will destroy freedom, and the force, introduced for good purposes, will end up in the hands of people who use it to promote their own interests.
On the other hand, a society that puts freedom first will, as a happy by-product, end up with both greater freedom and greater equality.

Uncle Milt was always worth listening to

In 1997 he wrote:

The drive for the Euro has been motivated by politics not economics. The aim has been to link Germany and France so closely as to make a future European war impossible, and to set the stage for a federal United States of Europe. I believe that adoption of the Euro would have the opposite effect. It would exacerbate political tensions by converting divergent shocks that could have been readily accommodated by exchange rate changes into divisive political issues. Political unity can pave the way for monetary unity. Monetary unity imposed under unfavorable conditions will prove a barrier to the achievement of political unity.

The European Parliament election result is consistent with his views on the matter.

Wolfgang Munchau dismisses NGDP Level targeting too quickly

He has the Eurozone in mind:

Another option would be to target nominal output growth – which is best thought of as the sum of real economic growth and inflation. The trouble is that nominal output growth is so slow that, if you started this regime today, hitting the target would entail a larger stimulus programme than anyone would have the nerve to implement. If you are looking for a new policy, targeting the price level is a better choice.

The recent macroeconomic literature suggests that price-level targeting is superior to inflation targeting – if not in theory then in practice. Price-level targeting would be especially suited to the policy rules most central banks have adopted.

How would a price-level target work in the current setting? First you choose the historic price-level trend, from which we have departed. The policy goal would be to join up with the trend [that´s exactly the required procedure for an NGDP level target].

A price-level target constitutes a very strong form of forward guidance. You tell the markets that you will not raise interest rates immediately once inflation begins to rise. But you do not just make a vague promise. You commit to allowing inflation to rise for an extended period, as part of your main policy target [it´s better in the case of NGDPLT. You don´t have to commit to rising inflation (something which would give the Plosser´s and Weidman´s of this world a “seizure’), only to overall nominal spending].

I do not want to play down potential problems. For example, if inflation rates were to stay above the target for too long, a price-level targeting central bank would have to get really tough – much tougher than it would have to under an inflation target. Since central banks rarely want to precipitate recessions, the whole policy may lack credibility from the outset.

It´s funny how he sets up the arguments: For NGDP targeting the problem is that the stimulus program would have to be unrealistically large.

But for price level targeting he puts the initial condition (to give an example of implementation difficulties) as the price level being well above target (due to previously high inflation) which would force the central bank to “get really tough”…but the true initial condition is the opposite; the price level is way below target (due to inflation having been too low in the past few years), just like NGDP. Let´s see if a central bank would have the guts to say that for the next periods inflation would increase considerably to put prices back on the previous trend!

With NGDP Level targeting you do not utter the word inflation, and that´s a big advantage!

PS It seems that after a lull, PLT is being peddled again. Just last week Kocherlakota discussed it in a speech.

HT Miguel Navascués

How can this exercise be in any way edifying?


Investors are especially focused these days on where the Federal Reserve’s target interest rate is likely to end up in the years ahead. During the tightening cycle that ended in 2006 the Fed pushed its target fed funds rate up to 5.25%. In 2000 it pushed it to 6.5%. Fed officials say they don’t expect rates to go very high this time around because the economy will remain fragile for years after the 2008 financial crisis.

The ‘edifying’ exercise should be to find out why the “economy will remain fragile for years”. And while it remains “fragile” it is very likely rates will remain low.

Notably, the incoming Vice Chairman once said:

In the short run, monetary policy affects both output and inflation, and monetary policy is conducted in the short run–albeit with long-run targets and consequences in mind. Nominal- income-targeting provides an automatic answer to the question of how to combine real income and inflation targets, namely, they should be traded off one-for-one

And when you look at images such as these, the ‘solution’ jumps at you!

Hilsenrath Exercise


“Heretics at the gate”

Yesterday I linked to a “Great Moderation is back” article at The Economist. Today Ryan Avent, at The Economist´s Free Exchange blog, concludes:

If you want more volatility without driving yourself into economic ruin, you need something that looks more like the first half of this chart [pre Great Moderation and includes the Great Inflation period]: More Vol Higher and more variable inflation certainly has its costs. But making low and stable inflation the overriding goal of macroeconomic policy ties your hands in many ways. Eventually, we may decide the trade-off isn’t worth it.

Gee, “moderation” leads society to “sin” – speculative behavior that ends in tears – so society might be better off – avoid “sin” – and “economic ruin” – if monetary policy acts so as to keep people “on their toes” – living with rather high uncertainty.

That´s quite wrong; it is not macroeconomic stability, more precisely nominal stability, which brings “economic ruin” to society. That is usually the fault of government policies giving out the wrong incentives (like the “homeownership for all” program, for example). Actually, countries that managed to retain nominal stability in the face of the international crisis (and even bad incentives in their own backyard) – countries such as Australia and Israel, among a few – are the ones that didn´t experience “economic ruin”.

This is a straightforward argument for NGDP Level targeting!

What does Stanley Fischer, just confirmed by the Senate as Fed Governor, think?

Almost 20 years ago Stanley Fischer gave his views on Central Banking in “Central Bank Independence Revisited” American Economic Review, 1995:

In the short run, monetary policy affects both output and inflation, and monetary policy is conducted in the short run–albeit with long-run targets and consequences in mind. Nominal- income-targeting provides an automatic answer to the question of how to combine real income and inflation targets, namely, they should be traded off one-for-one…Because a supply shock leads to higher prices and lower output, monetary policy would tend to tighten less in response to an adverse supply shock under nominal-income-targeting than it would under inflation-targeting. Thus nominal-income-targeting tends to imply a better automatic response of monetary policy to supply shocks…I judge that inflation-targeting is preferable to nominal-income-targeting, provided the target is adjusted for supply shocks” [not easy or even “practical”].

Fast forward: In a speech in April 2013, just before stepping down from Governor of the Bank of Israel, Fischer said:

In the past 20 years, an approach to monetary policy has developed in which the central bank must strive for a flexible inflation targetOver time, this belief has become an almost religious imperative.  However, in the US, the law defines a dual mandate for the central bank, according to which it must give equal weight to real activity and inflation. The Federal Reserve recently surprised observers when it announced that it would continue its quantitative easing until the unemployment rate reaches 6.5 percent, on condition that inflation does not reach 2.5 percent. They did this despite the natural tendency of every central banker to try not to give quantitative targets to his policy. I was surprised by the fact that the Fed was ready to give a forecast to monetary policy with a range of more than 2 years, since in general it is very hard for us to forecast developments at such ranges.

The world with which we must deal is the world of the next quarter, not just the world of after the storm is past. The central banks tend to focus on the inflation target since it is easier to forecast that in the long term we will stand at the target inflation rate, and it is harder to forecast developments in (real) GDP or unemployment.

I believe that the fact that the most respected central bank in the world set itself a quantitative target for real activity without being asked to do so by the government will lead other central banks to set such goals. This will confuse the life of the central bankers, but that is what they pay us for.


There are those who support setting a nominal GDP target. I think that this is very impractical. The data that we receive on nominal GDP are very unstable.  There are changes of whole percentage points between the various estimates of GDP.  For this reason, I think that there is no reason to use nominal GDP as a target.

Interesting to observe that for “most respected central bank in the world set itself a quantitative target for real activity without being asked to do so by the government”, is “fine and practical”; but to set a target for a nominal variable isn´t! [although he thinks adjusting the inflation target for supply shocks is]

Ironically, as Governor of the Bank of Israel from 2005 to 2013, Stanley Fischer (managed) to keep NGDP growing at a stable rate along a level path!

As he wrote in 1995: “Because a supply shock leads to higher prices and lower output, monetary policy would tend to tighten less in response to an adverse supply shock under nominal-income-targeting than it would under inflation-targeting. Thus nominal-income-targeting tends to imply a better automatic response of monetary policy to supply shocks”.

And that perfectly explains the difference between what happened in Israel and what came about in the US as the charts indicate. While in the US the rise in oil prices led the Fed, (for fear of inflation) to “tighten” (constrain aggregate nominal spending (NGDP or Aggregate Demand (AD)), in Israel NGDP remained “on trend”. The result was a deep recession in the US while Israel experienced only a real growth slowdown.



And it´s not like Bernanke was not aware of the effects of supply shocks. In 1997 he had written:

The results are reasonable, with all variables exhibiting their expected qualitative behaviors. In particular, the absence of an endogenously restrictive monetary policy results in higher output and prices, as one would anticipate. Quantitatively, the effects are large, in that a nonresponsive monetary policy suffices to eliminate most of the output effect of an oil price shock, particularly after the first eight to ten months. The conclusion that a substantial part of the real effects of oil price shocks is due to the monetary policy response helps to explain why the effects of these shocks seems larger than can easily be explained in neoclassical (flexible price) models.

Bottom Line: When the time comes, knowledge has to be used.

There´s an ‘unlearning’ process going on

Greg Ip has a post “When moderation is no virtue”. I was particularly interested in this exchange with someone with a very broad financial market experience, including a long stint at the Fed (my observations inside brackets):

I recently had an interesting exchange with Lewis Alexander. He’s  now chief U.S. economist for Nomura but spent much of the 1980s and 1990s at the Fed, before going to Citigroup and finally, during the crisis, to Treasury. He recalls:

In the spring of 2007 I was asked to give a presentation on the great moderation to Myron Scholes’ hedge fund.  I talked about the key themes … – inventories, consumer credit, and the stabilizing role of policy.  Just five minutes into my presentation Myron cut in and asked “But won’t people just take on more risk?”  That was the most prescient question I heard before the crisis.[Definitely NO. Portfolios are being rearranged or rebalanced because risk has fallen. In a sense they are taking less risk]

I have come to believe that the ultimate cause of the financial crisis in 2007-2009 was the great moderation.  The financial system responds to volatility.  When volatility declines the natural tendency is to use more leverage and to concentrate risk.  That was the essence of Myron’s question.[I´ll smoke, drink and eat junk food, all immoderately. Maybe I´ll live forever!]

It is natural, in some sense that the broad response of the financial system to the decline in macroeconomic volatility would play out in mortgage finance because mortgage finance is the biggest part of the system.  Of course policy mistakes in housing finance played a role and with better policies we probably could have avoided the particular problems that arose in that sector.[that´s right. See here]

I’ve come to believe, however, that had we gotten everything right in housing finance the tendency of the financial system to take on more leverage and to concentrate risk in response to lower macroeconomic volatility would have played out in some other part of the system.  The crisis would no doubt have been different, and possibly less severe and later.   But I think it would have come.  That’s what comes from studying financial history.[Keep on thinking, but having been at the Fed for many years you should know better]