“Oil & Water don´t mix”



The Federal Reserve is creating “unacceptable” downside risks to U.S. inflation by signaling it will gradually remove monetary stimulus next year despite low inflation, Minneapolis Federal Reserve Bank Narayana Kocherlakota said on Friday.

Instead, Kocherlakota said in a statement to be posted on the regional Fed bank’s website, the U.S. central bank should have pledged to keep rates near zero until the inflation outlook improves. He added that the central bank should also have signaled its willingness to restart its controversial bond-buying program if that pledge does not work to bring inflation expectations back to the Fed’s 2-percent target.


The Federal Reserve should have left itself more flexibility to raise interest rates sooner should the U.S. economy continue to improve, a top U.S. central banker said on Friday.

Instead, the Fed left its rates guidance intact, a decision that “strongly suggests” that short-term borrowing costs will not be significantly above their current near-zero levels by next June, Philadelphia Federal Reserve Bank President Charles Plosser said in a statement on its website.

Ladies & Gentlemen, Inflation!


The Fed Will Almost Certainly Fail the Next QE Test

A Benjamin Cole post

The results are in, and it appears the Fed’s use of QE—faltering, dithering, at times mindlessly circumscribed in advance—was moderately successful in helping the U.S. climb out of recession.

Europe is still mired in econo-gloom, courtesy of the ECB’s monetary noose around its neck. Japan may only now be fighting its way out of perma-gloom by way of aggressive QE.

The U.S., in contrast, has posted slow growth since the end of the 2008-09 “great recession”.

True, the Fed should have been much more forceful in its application of QE, and its QE should have targeted results—such as “The Fed will conduct $100 billion a month in QE until we see four quarters of 6% NGDP growth.”

Recall now, the Fed announced in advance of its first two rounds of QE—QE1 and QE2—that the limited bond-buying programs would halt on a pre-determined schedule, regardless of economic circumstance.

In a sense, the Fed signaled retreat from the battlefield, afore setting foot therein. Even so, QE worked.

The Next Time

Looking ahead, the question is whether any central bank—including the Federal Reserve—will use QE to fend off a recession, or will central bankers only belatedly and begrudgingly resort to QE after millions are unemployed, and businesses start going belly up in droves?

Despite the qualified success of QE in the United States, and still near-dead prices, there remains a curious if unfounded aversion to QE in central banker circles.

For example as late as June of 2013, readers of the Marketwatch website were told the Fed’s QE program risked the “debasement” of the dollar, high inflation and “the ruination of our economy and lifestyle.”

That might sound like the ranting of an obsessed extremist who should be kept away from the microphone, but in fact it was mouthed by Dallas Fed President and FOMC board member Richard Fisher. (BTW, the core PCE inflation index is up by 1.4% in the last reported 12 months.)

But With Interest Rates Dead Already…

No recovery lasts forever, and the current (if flaccid) U.S. “recovery” is already longer than the post-war average. And interest rates are near zero now.

That makes the prospective use of QE all the more important. The Fed is likely out of ammo even before the next recession hits—lowering interest rates? They are dead now.

If the Fed shirks it duties due to an institutional bias against QE, the price will again be paid by millions of employees and employers, who will find total demand sinking, but due to no fault of their own.

Yet can one imagine the Fed using QE prospectively?


How nice.

The Fed´s motto: Mistakes must be repeated!

At the WSJ, Jon Hilsenrath has an interesting take:

Imagine for a moment an exchange like the one below between Federal Reserve Chairwoman Janet Yellen and New York Fed President William Dudley  Vice Chair Stanley Fischer at the Fed’s policy meeting Dec. 16-17. Officials will be considering whether to drop from their post-meeting statement an assurance that short-term interest rates will stay low for a considerable time and replace it with a vaguer indication that they’ll be patient before raising rates. They’re entertaining the move with some trepidation:

CHAIR: I think today is the day we should adjust our press statement and move to a reference to “patience.” I do think the market will react “negatively” as we used to say, but I’m not sure such a reaction would have negative implications. If we were to retain the “considerable period” wording, I would hate to find us in the position of seeing [forecasts] of a 300,000 increase in the January employment number actually materialize. We would be in a very uncomfortable position. If we go to “patience,” we will have full flexibility to sit for a year or to move in a couple of months. I don’t think we’re going to want to do the latter, but I’d certainly like to be in that position should a rate increase become necessary.

VICE CHAIR: I would be very cautious about moving from the very accommodative stance we currently have. Rates are extremely low and obviously much lower than they have to be over the long run. But from a risk-management perspective, I think they are at an appropriate level right now. I think that keeping them low and moving aggressively if necessary makes sense in a situation in which the risks on productivity, costs, and prices are still pointed down. Total inflation is likely to fall. We haven’t seen [much] closing of the output gap. This is a situation in which we ought to be taking our risks on the side of ensuring a rapid return to full employment. The benefits in economic welfare would be considerable. A small overshoot that pushed inflation up a little would have essentially no cost and might even be desirable.

Having said that, however, I still support dropping the “considerable period” language and substituting “patience.” The “considerable period” phrase was inserted as a form of unconventional policy when we were concerned about deflation. That’s not an issue anymore. There will never be a good time to eliminate the “considerable period” phrase. But I think that doing so today will be seen as a logical extension of what we did last time in terms of tying policy actions to economic developments and to the words that you and other members have used in speeches rather than as a sign of immediate action. You will have an opportunity in your [public comments] to expand on “patience” and that theme.

Such a shift is not only about restoring our flexibility; with the economy strong, it might be a good time to let the market react more to incoming data. Sitting on expectations in these circumstances might not be stabilizing from the long-run perspective. This could damp some of the interest rate risk-taking that we see in the market.

Fiction? No, fact and it is in the transcript for the FOMC meeting of January 2004.

And Hilsenrath concludes:

The exchange is a window into the Fed’s thinking today. Officials want to shape their policy statement to give them flexibility to raise interest rates when needed, presumably next year, without being locked in to a timetable. They are worried about markets overreacting to a new signal and how that might affect the economy. They are acting in a time of low and possibly falling inflation. Some will be reluctant to move. They don’t want investors to think a wording shift means they’re planning to move any more quickly toward higher rates than they’ve already indicated. But they do want the option to do so when needed because the economy shows underlying strength. They know they need to change the wording eventually. A very real risk of financial instability looms if they suppress interest rates too long. They’ll lean on the chair to explain later as needed.

It sure is a window into present day Fed thinking. But that´s only because they have great difficulty in thinking outside the box, ceaselessly repeating themselves. If they stopped to think for a moment they would see what´s very different now from what presented itself ten years ago. And the significant difference is not in the rate of inflation or the rate of unemployment, but in the level trend and growth rate of nominal spending, as illustrated in the charts below.

Repeating Mistakes_1

Repeating Mistakes_2

Repeating Mistakes_3

So it´s pretty useless to jabber about semantics. What´s needed is a change in strategy.  Even if that is unimaginable for the Fed, they should heed to Ryan Avent´s very clear warning in “The Fed prepares to make a mistake”:

Rushing to raise rates while inflation is low is the best way to make sure the Fed stays in the zero rate business for years to come. That was the lesson of the 1930s and of the Japanese experience. It has been the lesson of this recovery. The European Central Bank and the Swedish Riksbank have already made this error. So has the Fed, in its way; several times the Fed sought to end asset purchases before the economy was ready, then had to restart purchases to get recovery back on track. Its impatient rushes toward the exits led to more purchases and a bigger balance sheet.

And the worst part is: the risk to waiting to tighten is so comparatively small. That’s the worst bit. In a year or two people will find themselves wondering why the Fed made this particular error, and there simply will not be good answers to give.

Australia: “Getting too close for comfort”

Australia´s last recession was almost a quarter of a century ago. That time frame spans both the Asia crisis of 1997-98 and the more recent 2008-09 international crisis. A distinguishing feature of Australia is how close it has come to a de facto NGDP Level targeting regime.

The chart illustrates

Australia in Danger

Alas, that “consistency” is in danger of being lost. The commodity price boom of 2004-08 lifted nominal spending above trend, giving Australia a nice “cushion” which helped it avoid the debacle that befell many countries, including neighboring commodity exporter New Zealand.

The just released consumer sentiment survey is not encouraging:

The Westpac-Melbourne Institute Consumer Sentiment Index fell 5.7% in December from 96.6 in November to 91.1 in December.

This is a very disturbing result. The Index is now at its lowest level since August 2011 when it briefly fell below 90. Prior to that you have to go all the way back May 2009 to see a period when the Index printed consistently below today’s level.

And advocates Australia join in the “currency war”:

While this survey may prove to be an overreaction to the sobering news from the national accounts and ongoing concern around the Commonwealth Budget, it appears that the messages around spending, the labour market and housing are clearly signaling the need for a further boost in the form of lower interest rates.

In a world where other developed economies have near zero interest rates and, accordingly, the Australian dollar is overvalued, Australia should seize the opportunity to provide further interest rate relief to the economy and exert some more downward pressure on the Australian dollar.

But more likely the RBA has caught a whiff of the “Swedish Riksbank virus”:

In its severest warning yet on house prices, the RBA said surging investor demand for property may cause the market to overheat and invite sudden price falls.

A housing-market crash might undo a lot of the central bank’s efforts supporting a still-fragile economy trying to cope with a downturn in mining investment.

Record-low interest rates were supporting the economy, but policy makers needed to be aware of the risks to future growth accompanying “a large further build-up in asset prices,” the minutes of the bank’s September 2 policy meeting said.

It would be a pity if this late into the game Australia “crossed the Rubicon” and let NGDP go south of trend!

Draghi in drag

FRANKFURT—The European Central Bank opened the door to a dramatic escalation in its campaign to stimulate the eurozone’s stagnant economy early next year, signaling a new chapter in the bank’s fight against excessively weak inflation in the heart of Europe.

ECB President Mario Draghi said after the bank’s monthly meeting that officials discussed purchases of government bonds, known as quantitative easing or QE, but that they needed more time to gauge the effects of policies that they have already implemented while assessing how falling oil prices may affect the bank’s consumer-price outlook.

It´s like an Opera Buffa conducted by Mario!

Does he remotely think the steep drop in oil prices will “help” the price outlook, when inflation is now crawling near zero?

Mario, beware! Time is running out! No, it has already done so!

“Normal”: a word in search of a new definition

You would never guess this guy was head of the Bank of Israel before, during and following the crisis of 2008-09. Now that he´s Vice-Honcho at the Fed, Stanley Fischer “reverts to form”:

In public appearances this week, Janet Yellen’s two top lieutenants sounded like individuals who want to start raising short-term interest rates in the months ahead, despite mounting uncertainties about growth abroad and associated downward pressure on commodities prices.

I had a chance to interview Fed vice chairman Stanley Fischer at The Wall Street Journal’s CEO Council on Tuesday. Foreign demand “is not the main driver of the United States economy,” he noted. “If (U.S.) unemployment continues to decline, if the labor market continues to strengthen and if we see some signs of inflation beginning to increase, then the natural thing is to get the interest rate up. We call it normalization.”

It is clear we are getting closer” to dropping an assurance that rates will stay low for a considerable time, he said. Mr. Fischer repeatedly emphasized his desire to get back to normal. “We almost got used to thinking that zero is the natural place for the interest rate. It is far from it,” he said.

It seems “normal” has nothing to do with the overall economy, it´s only about the level of interest rates!

As the chart shown in a previous post attests, for the past several quarters the economy is doing worse than terrible, what with NGDP persistently falling below the “uninspiring” lower trend level!



If you get the bubble you wished for, it´s easy to predict “there´s a bubble”: The case of Krugman

In 2002, worried about the “jobless recovery”, PK “voted” for a house bubble (to replace the “internet bubble”):

The basic point is that the recession of 2001 wasn’t a typical postwar slump, brought on when an inflation-fighting Fed raises interest rates and easily ended by a snapback in housing and consumer spending when the Fed brings rates back down again. This was a prewar-style recession, a morning after brought on by irrational exuberance. To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.

In 2005, he “predicted” the house bubble pop:

Now we’re starting to hear a hissing sound, as the air begins to leak out of the bubble. And everyone – not just those who own Zoned Zone real estate – should be worried.

And he gets incensed when “accused” of not having “predicted” something:

Dean Baker is annoyed, and rightly so, at claims that Keynesians failed to predict the slow recovery. Dean and I were both tearing our hair out in early 2009, warning that the Obama stimulus was too small and too short-lived.

No matter that the slow recovery had little or nothing to do with the size of Obama´s “stimulus”. How do we know that? Because the “drive towards austerity” beginning in 20010, whose epic moment was the 2012-13 “fiscal cliff”, did not make a dent in real growth, which kept humming along at a (low) 2.2% clip during the last four and a half years!

And folks, that was and is.99% due to monetary policy!

Even ‘big wigs’ reason from a price change!

From Vice Chair Stanley Fischer:

“I’m not very worried,” Fischer told an audience at the Council on Foreign Relations. “The lower inflation that we’ll get from the lower price of oil is going to be temporary.”

He also said lower oil prices were “a phenomenon that’s making everybody better off.”

Interestingly, in 2007-08 when oil prices rose FOMC discussions showed they were very worried that would have a permanent effect on inflation expectations. But a drop in prices is seen as having only a temporary effect!

The part of the fall in prices due to increased supply is “positive”. The part due to a fall in demand is the outcome of something “negative”, i.e. “everybody being worse off”.  How can the consequence of being “worse off” make you “better off”?

Update 12/14/14: Jim Hamilton quantifies the higher supply/lower demand effects:

West Texas Intermediate sold for $105 a barrel at the start of July, but ended last week at $58. The most important factor has been surging U.S. production. But another reason oil prices have slid so much is weakness in demand for the product, which may be related to a slowdown of overall world economic growth. Here I comment on the importance of that second factor.

And concludes:

In other words, of the observed 45% decline in the price of oil, 19 percentage points– more than 2/5– might be reflecting new indications of weakness in the global economy.

“Happy days are here again”

That´s what New York Fed Dudley seems to think:

“The U.S. economic outlook looks brighter, with growth likely to be somewhat above the trend of the past five years,” Dudley said in a speech on Monday

In fact, Dudley thinks the economy could soon be healthy enough for the central bank to lift interest rates off the ground.

He pointed to a number of issues that have gone from the equivalent of traumatic injuries to mere bumps and bruises.

Fed hike = good news: Of course, Dudley acknowledged the economic outlook could darken once again, especially given that ongoing geopolitical risks “remain substantial.”

Still, he’s signaling the Fed will likely be able to raise interest rates in 2015.

“While raising interest rates is often portrayed as a difficult task for central bankers, in fact, given the events since the onset of the financial crisis, it would be a development to be truly excited about,” Dudley said.

“When the [Fed] begins to raise its federal funds rate target, this would indicate that the U.S. economy is finally getting healthier,” he explained.

Interestingly, contrary to what Dudley thinks, since early last year (and despite QE3) NGDP has come in stubbornly below the “depression trend level” which also has a lower trend growth rate than the previous trend.

Happy Days_1

Concomitantly, inflation expectations dropped and more recently dropped further and way below target!

Happy Days_2


Update: The market doesn´t see “eye to eye“:

The CHART OF THE DAY shows the derivative traders foresee federal funds, or the rate for overnight loans between depositary institutions, trading at the end of next year at less than half of where Fed officials project it to be. The Fed publishes officials’ quarterly estimates for the funds rate, which are displayed as dots on a chart.

Happy Days_3

But economist John Ryding shows little respect for the market:

“The market is so far removed right now,” said Ryding, the chief economist of New York-based RDQ, in a Nov. 26 telephone interview. “The trend in jobs has been getting stronger, theunemployment rate is at 5.8 percent and broad measures of the labor market are improving. When the FOMC statement and the press conference finally reflect the dots then the market is going to get hit over the head with a 2×4.”

Update 2: Ryan Avent is not into “happy days are coming”:

Being down so long things look like up is not optimism. America should be performing better, and I find it disappointing that it hasn’t and that the Fed doesn’t seem particularly interested in working to improve matters. And so I’m pessimistic. I will turn optimistic when the Fed convinces me such a turn is warranted.

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