Central Bankers Are Blind to New Phillips Curve? Or Just Sadists?

A Benjamin Cole post

No, I do not have dense pages of calculus for the reader, purporting that QE would be ruin or divine salvation, or that minor deflation is the theoretical apex of an economic model.

Just some numbers from the back of The Economist. Simple stuff.

But Jeez, eyeballing the figs, it sure seems like the price of small inflation is big unemployment.  The Phillips Curve looks more like a low-trajectory missile—to get minor deflation, you need killer unemployment.

Moreover—and most importantly—low unemployment does not provoke much inflation.

Just some simple empirical observations ahead, no theories.

Low Unemployment, But Little Inflation

Take a country I know something about: Thailand. I live here now. Anyone can get a job—my sister-in-law, in a sparsely settled rural area, found a job walking distance from her house. They asked her to put in nine hours a day, extra pay on the ninth hour. Then they asked her to work six days a week. Grape farmers.

The official stats say Thailand has an unemployment rate of 0.7%, and inflation of 2.7%. The unemployment rate has been near zero for a long time, btw. The reports of Thai public companies often say they could make money if they could find more employees. The Thai inflation rate is one that would have been politically acceptable in the U.S. until recent times, perhaps as recently as 2007.

Now the U.S. Fed applies the monetary noose if the country approaches 2% inflation. Our central bankers detest unemployment below 6%. (No, they are not Putin surrogates).

Singapore has a 2.0% unemployment rate and a 1.5% inflation rate. S. Korea is at 1.5% inflation and 3.2% unemployment. China is 2.1% inflation and 4.1% unemployment. The Far East looks like this.  Low inflation and low unemployment.

Okay, that’s the other side of the globe. So let’s look at Poland. They have the utopia of low inflation at 0.2%, but also have 11.7% unemployment. To confuse matters a bit we also see Switzerland at 0.1% inflation, but 3.2% unemployment. Sweden also has 0.1% inflation, but a higher 7.4% unemployment rate.

It is possible to get to the supreme exalted state of deflation that so enchants so many right-wing economists in the U.S. In fact, Greece has done it, a hero nation with a 1.5% deflation rate, although they also have 26.4% unemployment rate. Spain gets into the deflation zone too, at negative 0.2% and 24.4% unemployment. Italy fares similarly, with 0.3% inflation and 12.3% unemployment.

There are more countries, but you get the picture.  There are some women ugly enough to deflate men, and some economies ugly enough to deflate prices. But is that the way to live?

The Upshot: Central Bankers Are Sadistic, Nuts

Comparing macroeconomic statistics across nations is fraught with difficulties. Who knows if they measure inflation in Thailand as they do in Switzerland or Poland? And unemployment figures are squishy.

But looking at these figs, my take is you have to be sadistic or nuts to unemploy millions of people, and lose trillions of dollars of output, sacrifice untold profits just to cut reported inflation rates a percent or two.  To get inflation below 2.5% is very expensive.

And low unemployment no longer appears associated with much higher inflation rates.

The global economy has changed mightily in the last 40 years, supply chains are worldly, capital flows are gigantic. Old-fashioned demand-pull inflation may be nearly impossible to obtain. It would take an awful lot of prosperity to generate that 1970s inflation again.

I wonder how much growth in the U.S it would take to get back to 4% inflation, the rate 1980s Fed Chairman Paul Volcker obtained in his great war on inflation.

President Jimmy Carter oversaw a 20% increase in real GDP from 1976 through 1979.

Maybe that is what it would take to generate inflation. Worth a stab, no?

Some are having “second thoughts” about the stance of monetary policy

Lars sends an ‘unsual’ news article published in Forbes:” Consensus Building That the Fed’s Policies Were Too Tight”

At the beginning:

Is the Fed’s current stance too “loose,” running the risk of triggering inflation? That’s the current debate, and we probably won’t get broad agreement on the answer until the recession is much further in the rearview mirror. Economic consensus tends to build slowly – frequently only in hindsight.

Only now, for example, does consensus seem to be developing among conservative economists over how the Federal Reserve’s monetary policy during 2008 affected the recession. The general feeling now is that the Fed contributed to – and likely worsened – the crisis by keeping money too tight.

At the end:

Even for those who insist on clinging to the interest rate fallacy, there’s a problem: the Fed started raising its target rate in the middle of 2004, and never lowered it again until September 2007.  Over that period, the fed funds target rose from 1 percent all the way to 5.25 percent.

This trend may well indicate the Fed held its target too high for too long.  Regardless, the economy collapsed on the Fed’s watch, and preventing economic collapse is the reason Washington created the Fed in the first place.

The “in between” is well worth reading.

The chart illustrates, showing the three important components from a market monetarist perspective: Broad Money Supply growth, Money Demand (velocity) and NGDP growth.

Forbes on MP

See, when the Fed allows money supply to contract while money demand is rising (velocity falling), the result is a massive AD (NGDP) negative shock, something that David Beckworth argues does not mesh at all well with an inflation targeting regime.

But at Forbes, there´s also the “bad cop“!

What the election result in Brazil means?

Disclosure: I´m not registered with any party and don´t much like politics.

But danger lurks for Brazil. After three unsuccessful bids for the presidency, in 2002, at the last minute, the Workers Party (PT) but on “sheep´s clothes” and got elected. That was the first stage of their three-stage program.

The second stage involved “financing”, so corruption grew exponentially over the last 12 years. Now the coffers are full and, having won Sunday´s election (no matter the narrow margin) they are ready to begin the third and final stage for their perpetuation in power and the ‘unmaking’ of Brazil.

Corruption will be drastically toned down (after all the money is in and public opinion is wary). This stage will be defined by a sequence of plebiscites, each one geared to concentrate power in the hands of the Executive, bypassing tortuous Congressional proceedings and trampling over individual liberties.

For several years now, for example, they have tried to gag the press by introducing what is euphemistically called “Social Control of the Media”. This will likely be discussed more forcefully now and in the near future we can expect “society will be called to manifest its opinion”. Other plebiscites will follow. When people realize what´s really going on, it will be too late!

That´s the “democratic” route to Dictatorship; it has happened in Venezuela, Bolivia and is in full bloom in Argentina (once again).

Central Banks that make the same mistake are ‘rewarded’ with similar outcomes

While the Riksbank can focus exclusively on Sweden, the ECB has a more complicated task, having to ‘oversee’ a bunch of countries.

Both central banks have an exclusive mandate: “Price stability”. While in Sweden that is understood as 2% inflation, in the EZ it is something slightly lower.

Nevertheless, the two ‘countries’ central banks acted in tandem, tightening as a reaction to higher than target inflation due to oil price shocks. Not surprisingly, they ended up in the same “alley”, but the EZ side of the “alley” is a bit “darker” because of its more diffuse clientele.

Common Mistake_1

Common Mistake_2

Common Mistake_3

This is certainly more evidence against inflation targeting. It´s a “guide dog” that can easily lead you astray!

PS The US turned out different because, although it fell into the “first trap”, it didn´t repeat the mistake. Instead it did QE. Australia did even better because it didn´t fall even into the first trap, keeping NGDP evolving close to trend!

The Riksbank thinks inflation is a “price phenomenon”

The Riksbank´s “Monetary Policy Report” asks the question: “Why is inflation low” and this is a summary of the answer:

Inflation has been low in Sweden in recent years and fell further in the latter part of 2013, mainly because the rate of price increase for services slowed down. This article points to the existence of several different factors that have contributed to this low inflation at different points in time. Demand has been weak for many years, which has contributed to cost increases being moderate and price mark-ups low. Energy prices have also developed weakly over the past few years. A stronger exchange rate contributed to lower inflation in 2011–2012, but probably to a lesser degree since 2013. Food prices have increased more slowly since the end of last year.

The only reason that makes sense is “Demand has been weak” (the others fall under “reasoning from a price change”), but they never ask why! Maybe the Riksbank does not like to say “my fault”, as is clearly shown in the chart below.


The next charts clearly demonstrate the danger of monetary policy reacting to price (oil) shocks. It did it in mid-2008 and then again in late 2010. In the second round of tightening the “justification” was “exuberance in the real estate market”.


Responding to circumstances

Monetary Policy has been a failure. A sure sign of that is the number of new “Monetary, Fiscal and Financial Centers” being set up.

The latest “confront the Fed” attempt is the new “Center for Monetary and Financial Alternatives” at the Cato Institute:

The Center for Monetary and Financial Alternatives is dedicated to finding better alternatives to today’s discretionary monetary and counterproductive financial regulatory regimes. By studying and making academics, policymakers, and the general public aware of possibilities for monetary and financial reform ranging from strict monetary rules to self-regulating cyber-currencies, the Center will develop practical policy strategies for building a monetary and financial system that is both more competitive and far more stable than the status quo.

That follows on the steps of the “Hutchins Center on Fiscal and Monetary Policy” launched last December at the Brookings Institution”:

The Hutchins Center provides independent, non-partisan analysis of fiscal and monetary policy issues in order to further public understanding and to improve the quality and effectiveness of those policies.

I see David Beckworth is attached to Cato´s new Center, so I sincerely hope Market Monetarism and NGDP-LT will be aired.

While they bicker the Zone flounders

Travis links to a piece that would make the deviousness of Frank Underwood (of House of Cards fame) look like child´s play!:

In early October, European Central Bank board member Benoit Coeure paid a discreet visit to the Chancellery in Berlin to express concerns about rising criticism of the bank from German politicians.

The Frenchman, one of ECB President Mario Draghi’s closest allies in Frankfurt, hoped for reassurances that the bank bashing, led by Finance minister Wolfgang Schaeuble, would stop.

But the message from Chancellor Angela Merkel’s advisers was not entirely comforting, according to one official familiar with the discussion.

Merkel would continue to refrain from questioning the ECB’s policies in public. But the broader backlash would be difficult to contain, especially if Draghi pressed ahead with unconventional measures to bolster the European economy, for example buying mass quantities of government bonds.

“Then you would see a real debate,” a top German official told Reuters on condition of anonymity. “Public criticism in Germany would take off.”

At the end:

Earlier this month, Hans Michelbach of the Bavarian Christian Social Union (CSU), the top conservative in the Bundestag’s finance committee, went so far as to label Draghi’s appointment to the top ECB post a “mistake”.

Meanwhile, the real people in the real world weep!

Drag it down

HT Becky Hargrove

With incredible headlines like these, who can believe inflation is the “proper” target?

It´s from The Economist over a span of 17 years!

In 2014: Politicians and central bankers are not providing the world with the inflation it needs; some economies face damaging deflation instead

IT IS a pernicious threat, all the more so because, at its onset, it seems almost benign. After two generations of fighting against inflation, why be worried if the victory looks just a bit too complete, if the ancient enemy is so cowed as to no longer strain against the chains in which it is bound? But the stable low inflation fought for in the 1980s and 1990s and inflation hazardously close to zero are not so far apart. And as inflation drops, slipping into deflation becomes ever easier. It is in that dangerous position that the world now stands.

In 1997: “America’s inflation rate is low and stable. This has rekindled an old debate over the benefits of price stability

But how low should inflation go? Many economists argue that a small amount of it may not be a bad thing and could even be beneficial. One of the first was James Tobin of Yale University, who suggested in 1972 that a bit of inflation helps “grease the wheels” of the economy. In today’s world of low inflation, the validity of his argument is increasingly important for policy-makers. If it is correct, then the pursuit of extremely low levels of inflation may be misguided—not only because of the short-term rise in unemployment that can result from cutting inflation, but also because zero inflation might cause permanently and unnecessarily higher levels of unemployment. This is why the concept of inflation as economic grease has become the focus of controversy anew.

The charts indicate very clearly that the problem does not reside with the level of inflation but with the level of nominal spending, even if at present you “pull-down” both the level and growth rate of nominal spending. A large gap is still present!

Incredible headlines_0

Incredible headlines

Professor John Cochrane and Money Manager Peter Schiff Agree: Zero Percent Hyperinflation Ahead

A Benjamin Cole post

“Of course, the idea that governments can hold inflation to just 2% per annum is preposterous. Once it breaches that level, governments will be powerless to contain it. The endgame will be hyperinflation…. Since the central banks are now destined to forever remain behind the inflation curve, it will continue to accelerate until the real threat of hyperinflation looms much larger than did the contrived threat of deflation.”

You might think above diatribe was delivered, well, 2008-9 or so.


Try Oct. 16, 2014, by Peter Schiff, CEO of EuroPacific Capital, in blogland RealClearMarkets. That is when he thundered against monetary laxness and the dire pending results.

The oddity is the Schiff blog was highly recommended by John Cochrane, the University of Chicago professor who has been pushing a neo-Fisherian view that huge QE and lower interest rates are the road to the desired nirvana of exactly dead prices.

Cochrane has blogged to the effect the market will think the Fed has “expectations” of lower inflation if it stays with QE and low interest rates, and so the market will tag along to a non-inflationary path, tricked by the Fed.

While we mull the odds of that, there is another tangle in the Schiff piece: Schiff says only governments want inflation, as it makes government debt easier to pay off. (Homebuyers? Leveraged enterprises? Employers? Oh, shut my mouth).

But then Schiff says that galloping inflation will lead to skyrocketing interest rates, and that will make it impossible for governments to pay off their ballooning debts. Huge amounts outstanding of 10+% government bonds will break governments and taxpayers.

I guess Schiff is saying governments want lots of inflation to make debt cheaper, but they do not foresee the higher interest costs that will break government. You know those central bankers and treasury officials are rather shortsighted, given what Schiff says.

Schiff has some views that might be controversial, which is to put it mildly. “But given the strict monetary restrictions that were needed to grease the skids toward [European] union,” Schiff says, “the European Central Bank has not been able to create inflation as freely as the U.S. or Japan.”

Most people note that the Japanese economy actually shrank over the past two decades in nominal terms, caught as it was in a long, persistent deflationary perma-recession. In the U.S., the inflation rate has been below target almost continuously since 2008, and is sinking again.

And nowhere in modern economies has deflation bedded down with prosperity.

QE Has Driven the Right-Wing Nuts

For whatever reason, the right-wing (except for maybe John Cochrane) detests QE and they detest low interest rates.

But low interest rates and QE we have had since 2008 in the U.S., and rather than hyperinflation, we see microscopic inflation rates. The Fed has consistently undershot even its anemic 2 percent inflation target. In terms of containing inflation, Fed Chief Janet Yellen makes heroic Fed Chief Paul Volcker look like a liberal pansy.

The left-wing is clueless, militating for more and more federal deficits.

But if we believe the right-wing duo of Schiff and Cochrane, we are headed straight into the gut of zero-percent hyperinflation.


Matt O´Brien posits the wrong choice

In “The terrifying idea that the economy might stay stuck forever just got more terrifying” Matt evokes Reinhart & Rogoff plus Summer to argue:

The U.S. economy has fallen, and it can’t get up.

At least that’s the way it seems. That’s because our slump hasn’t really ended, even though the Great Recession officially did more than five years ago. Growth has been low, unemployment is still high, and it’d be even more so if the labor force hadn’t shrunk so much. And all this, remember, has happened despite interest rates being zero the whole time. It’s the opposite of what we would have expected: big crashes are usually followed by big comebacks. So why has this time been different?

Well, it hasn’t — not if you compare it to other recoveries from financial crises. These, as economists Carmen Reinhart and Ken Rogoff have shown, tend to be nasty, brutish, and long.

At the conclusion he borrows my “it´s a choice” concept:

It’s a grim picture of a recession stamping on a human face — forever. But it wouldn’t be too hard to save ourselves from this dystopian future. All it would take is a higher inflation target that would let real rates go lower, and help households reduce their debt burdens. Immigration reform that boosted the workforce wouldn’t hurt either.

Stagnation, in other words, is a choice.

But the choice is not about a higher inflation target. It´s really about choosing higher level of spending, or NGDP, target.