Why doesn´t Martin Feldstein take a hike?

MF is back at his favorite subject: US inflation:

The Federal Reserve now faces the tough task of unwinding the easy-money policy that has helped bring about the current solid economic upturn. But its projected path for increasing the short-term federal-funds rate over the next few years is dangerously slow. Most members of the Federal Open Market Committee want the real interest rate to be negative at the end of 2015 and approximately zero at the end of 2016. Only in 2017 would the real fed-funds rate even exceed 1%.

Overall unemployment now is 5.5%. This has historically been regarded as about the lowest rate that can be sustained without starting an inflation spiral. The Fed is nevertheless projecting that its policies will cause unemployment to decline to 5% by the end of 2015 and even lower in the next two years. Historical experience suggests that means inflation would eventually increase year after year.

And on he goes, wrong on all counts!

But his views have become a stale joke. Six years ago [April 09], for example, he saw “inflation looming”:

The US last week showed its first signs of deflation for 55 years, prompting inevitable fears of further deflation in the future. Yet the primary reason for the negative rate of US inflation is the dramatic 30 per cent fall of commodity prices. That will not happen again [what certainty]. Moreover, excluding food and energy, consumer prices are up 1.8 per cent from a year ago. That is the good news: the outlook for the longer term is more ominous.

However, we know commodity and oil prices have fallen again – headline inflation is again courting negative rates while core prices are now up only 1.4% –  and the (inflation) outlook is anything but ominous! That´s not just hindsight. MF had (and has) only a few inflation-nutters of this caliber riding along.

Drinking buddies: One wants to slow down the refills, the other wants the punchbowl taken away


“The projected combination of a gradual rise in the nominal federal funds rate coupled with further progress on both legs of the dual mandate is consistent with an implicit assessment by the Committee that the equilibrium real federal funds rate–one measure of the economy’s underlying strength–is rising only slowly over time.”


“In current circumstances, raising the funds rate target a notch or two is less like taking away the punch bowl and more like just slowing down the refills,” he said. “We will still be spiking the punch–just not quite as rapidly as we have been.”

Outside the “bar”, Kevin pickets:

“Now, I would say the markets are exhausted. They’re exhausted that the Fed has decided there’s a new set of benchmarks,” . “Before it was forward guidance. Now it’s, ‘Just kidding about forward guidance. Citing the sliding unemployment threshold for considering an interest rate hike, he said it’s now 5.5 percent or even 5 percent, down from 6.5 percent not too long ago.

What would we be hearing from the Fed if, instead of 0.3% headline 1.4% core, we had 2.9% headline 1.7% core?

Any doubt they would raise rates immediately (through a Conference Call)? However, that was the combination that existed in September 2011 (“9/11”), when QE3 was still to come!

Today both headline and core are far from target, but Yellen is all the time “justifying” the need for a rate increase soon:

“Policy makers cannot wait until they have achieved their objectives to begin adjusting policy,” Fed Chairwoman Janet Yellen said last week in a speech:

“I would not consider it prudent to postpone the onset of normalization until we have reached, or are on the verge of reaching, our inflation objective.”

The “heartbeat” of nominal and real growth has not changed during this time, remaining close to 4% and 2.2%, respectively year on year.

Yellen´s Fetish_1

Overall, both measures of inflation have been well below target for most of the time since 2008.

Yellen´s Fetish_2

What has changed is unemployment, which has dropped from 9% in September 2011 to 5.5% in February 2015 and is getting “dangerously close” to her latest “estimate” of NAIRU (5% – 5.2%)!

Yellen´s Fetish_3

She should remember James Tobin, her thesis adviser at Yale who, on the year she was awarded her PhD, 1971, wrote “Living with Inflation”. Only now she wants to change that a bit and push for “Living without inflation”!

So I find Tony Yates´ “insistence” on raising the inflation target “romantically naïve”!

When “mumbling with great incoherence” beats “clarity”

Ben Bernanke inaugurated his blog. In the introductory post he writes:

When I was at the Federal Reserve, I occasionally observed that monetary policy is 98 percent talk and only two percent action. The ability to shape market expectations of future policy through public statements is one of the most powerful tools the Fed has. The downside for policymakers, of course, is that the cost of sending the wrong message can be high. Presumably, that’s why my predecessor Alan Greenspan once told a Senate committee that, as a central banker, he had “learned to mumble with great incoherence.”

And in the June 2008 FOMC meeting he spoke “clearly”:

My bottom line is that I think the tail risks on the growth and financial side have moderated. I do think, however, that they remain significant. We cannot ignore them. I’m also becoming concerned about the inflation side, and I think our rhetoric, our statement, and our body language at this point need to reflect that concern. We need to begin to prepare ourselves to respond through policy to the inflation risk; but we need to pick our moment, and we cannot be halfhearted. When the time comes, we need to make that decision and move that way because a halfhearted approach is going to give us the worst of both worlds. It’s going to give us financial stress without any benefits on inflation. So we have a very difficult problem here, and we are going to have to work together cooperatively to achieve what we want to achieve.

The last thing I’d like to say is on communications. Just talking about communications following this meeting, I’d like to advise everyone, including myself, to lean, not to lurch. That is, we are moving toward more concern about inflation, but we still have concerns about economic growth and financial markets. We should show that shift in emphasis as we talk to the public, but we should not give the impression that inflation is the entire story or that we have somehow decided that growth and financial problems are behind us, because they are not. So if we can convey that in a sufficiently subtle way, I think we will prepare the markets for the ultimate movements that we’re going to have to make.

Unfortunately, and that was to be expected, the “public” gathered that inflation, if not the entire story, was the major part. In the Minutes, of that meeting, released 3 weeks later, we read that “likely the next move in interest rates will be up”!

Any wonder NGDP tanked after that?

Bernanke follows that introductory post with the first post, which is all about how the Fed has to pursue an “imaginary number”, the natural interest rate!

China Has A Better Central Bank Than The United States Sino-Superpower To Surpass States Sooner?

A Benjamin Cole post

It is one of the oddities of our time that Communist China has a central bank that is more growth-oriented than that of the bastion of free enterprise, the United States.

The Federal Reserve’s FOMC should pack their bags and fly to Beijing to see what real central banker looks like, that being Zhou Xiaochuan, top man at the People’s Bank of China (PBoC).

Zhou, 67, just issued a warning “about signs of deflation and said he was closely watching slowing of global economic growth and declines in commodity prices, while speaking at forum on the island of Hainan.”

BTW, we Market Monetarists often beat up on media-folk for their inept reporting. But I agree with this bit of in-story editorializing from Reuters, “Beijing is determined to keep the Chinese economy…from taking the same path of recession and deflation that has blighted its neighbor Japan for the past 20 years.” Maybe even wire-reporters are better central bankers than the present FOMC.)

The Stats: China vs. U.S.A.

Now consider this: inflation in China is not much different from that of the United States, coming at 1.4% in February. The U.S CPI for last 12 months is 0.0%, but to bend over backwards to be fair, it is 1.7% core.

China’s GDP is growing by about 7%, and the U.S posted 2.2% in Q4 2014, and may be slowing.

So which central bank (if either) should be thinking about stimulus and fighting deflation? Is something backwards?

The PBoC vs. The Fed

But it is the PBoC that has cut interest rates twice recently, and lowered bank reserve requirements, while the Fed endlessly pines for the day it can raise rates, and rhapsodizes euphoric at suggestions it sell off its balance sheet.

The PBoC sees inflation under 2% and moves to stimulus. The Fed sees inflation under 2% and moves to..,tighten?

The Upshot

Economists, at least of certain stripes, love to blame structural impediments for slow growth in Western democracies, and in the United States. But that does not explain the 20% real growth of U.S GDP from 1976 to 1979, when the U.S. had an expansionist central bank.

And are we to believe that centrally planned, hopelessly corrupt, state-controlled communist China does not have structural impediments? How does China grow at 7% annually?

It is unknown if China can prosper in years ahead. Due to barbaric government civil-rights policies and communist party control of everything, the rich and smart want to leave China. That is a very serious structural impediment.

But I suspect the United States cannot prosper with ongoing Federal Reserve policies. The States are headed down the Japan road. The blighted one.

The future belongs to China? Maybe. If so, the central banks played lead roles in the tale of two nations.

What´s constraining monetary policy?

“Zero” rates

For more than six years monetary policy has been “unconventional”; meaning that interest rates have not been available to do the work.

Over the ages, monetary policy has become synonymous with interest rate policy. If, for example, the interest rate goes down/is low/or even zero, monetary policy is deemed easy/expansionary/accommodative, and vice-versa.

The tight association of monetary policy with movements and levels of interest rates is not only stupid but has for long been discredited by many, including such high profile “outsiders” as Ben Bernanke and Frederick Mishkin.

Why does this misconception endure?

One possibility is that it has become ingrained. More recently, textbooks, which tend to lag “practice”, have elevated the interest rate to the category of “the” monetary policy instrument. An ironic example is given by Mishkin´s Macroeconomic Theory and Practice textbook.

Although laughable, it is not surprising to read this comment from Fed Vice-Chair Stanley Fischer:

For over six years, the federal funds rate has, effectively, been zero. However, it is widely expected that the rate will lift off before the end of this year, as the normalization of monetary policy gets underway.

The approach of liftoff reflects the significant progress we have made toward our objectives of maximum employment and price stability. The extraordinary monetary policy accommodation that the Federal Reserve has undertaken in response to the crisis has contributed importantly to the economic recovery, though the recovery has taken longer than we expected. The unemployment rate, at 5.5 percent in February, is nearing estimates of its natural rate, and we expect that inflation will gradually rise toward the Fed’s target of 2 percent. Beginning the normalization of policy will be a significant step toward the restoration of the economy’s normal dynamics, allowing monetary policy to respond to shocks without recourse to unconventional tools.

Translation: Lift rates now so you can lower them when the need arises!


The fact that inflation has remained well below “target”, for most of the last six years is bothersome to the Fed, because it “constrains” their desire to quickly become “conventional”.

Yellen tries to get around the “inflation constraint” saying:

…that inflation is currently depressed by the fall in oil prices and other one-time factors the Fed regards as “transitory.” As a result, she said that she might favor raising rates ahead of any indications that prices excluding the energy market started picking up significantly. Otherwise, she said, the Fed would risk significantly overshooting its inflation target.

Note the subtlety. Inflation has not been depressed for more than six years, only currently, and that´s transitory; and if we delay raising rates we risk significantly overshooting the target. The fact that the target has been undershot for six years is conveniently “erased”!

If they only recognized that the target has been missed from below for most of the time during the past six years, they would have to conclude that monetary policy has not been easy or highly accommodative, as they like to say, but in fact unduly tight.

That would bother them no end!

Hiding behind “Secular Stagnation”

Scott Sumner comments on a post by Edward Hugh:

The focus of Hugh’s piece is Finland.  He points to the very weak recovery, and suggests that structural factors are involved. Perhaps so, but some of the data he cites point in exactly the opposite direction.  Finnish unemployment has been rising, and at 9.2% is at the highest rate in more than a decade.  Meanwhile Hugh’s post shows inflation in Finland falling to zero. Those data points suggest a lack of aggregate demand, not structural problems.

EH shows several charts to further his “secular stagnation” claims. One chart he doesn´t show is a comparative chart of nominal spending (NGDP) relative to trend. I do so below and add Austria and Spain as “evidence” of the degree of the AD shortfall in Finland.


Every country in the world could do with some structural reforms, some more, some less, but the big problem with most of those economies, as exemplified by the charts for the three countries above, where all are subject to the same monetary policy, is differing degrees of  aggregate demand shortfall.

Yellen faces the “Iron Ladies” in the FOMC

It seems Esther George (EG) and Loretta Mester (LM) are stand-ins for the departed Fisher and Plosser! Since they can´t play the role of “Inspector Clouseau”, let´s call them “Maggies in Drag”.


This balanced approach framework supports taking steps to remove the extraordinary amount of monetary accommodation currently in place. The next phase in this process is to move the federal funds rate off its near-zero setting. While the FOMC has made no decisions about the timing of this action, I continue to support liftoff towards the middle of this year due to improvement in the labor market, expectations of firmer inflation, and the balance of risks over the medium and longer run.


Most times in life, moving from extraordinary to ordinary is considered a bad thing.  In the case of monetary policy, such a move should be viewed as a good thingbecause it means conditions are in place for a sustainable economic expansion with maximum employment and price stability.

The Chair tries to “sooth them”:


I would be uncomfortable raising the federal funds rate if readings of wage growth, core consumer prices, and other indicators of underlying inflation pressures were to weaken, if market-based measures of inflation compensation were to fall appreciably further, or if survey-based measures were to begin to decline noticeably.”

The underlying economy has been “quite weak by historical standards” and thus in need of low interest rates to sustain progress on unemployment; inflation remains very low; the risk that because of a stagnant global economy, the U.S. might not be able to bear very high interest rates in the future; the experiences of other countries with early rate increases, such as Japan and Sweden, point to caution; it pays for the Fed to take out “insurance” against a return to exceptionally low inflation and high unemployment by making sure with sustained low rates that the economy gets on a stronger track.

The chart shows important Yellen concerns. Core inflation and expected long-term inflation have mostly stayed well below target for the past seven years. Even the volatile headline measure has underperformed!

Iron Ladies_1

For the past five years, after “emerging” from the “Great Recession”, the economy  has yet to find a “stronger track”.

Iron Ladies_2

When will they ever learn about love NGDP-LT

The “(Stan) Fischer Effect”

In 1995, while a managing director of the IMF, Stanley Fischer wrote an essay titled: “Modern Central Banking”, where he ardently defends “Inflation Targeting” (The NBER version is here):

…The issue of a target price level (PLT) versus target inflation rate (IT) nonetheless remains. Compare the goal of being close to a target price level that is growing at 2% per annum from a given date, say 1995, with the goal of achieving a 2% inflation rate each year from 1995 on.

With a target price path (PLT), the monetary authority attempts to offset past errors, thus creating more uncertainty about short-term inflation rates than with an inflation target (IT). The gain is more certainty about the long-term price level.

My present view is that the inflation target with its greater short-term inflation rate certainty is preferable, despite its greater long-term price level uncertainty.

I thought that view was “narrow-minded”, in particular given that important firm and individual decisions tend to be longer term ones. Does Fischer still hold those views from 20 years ago?

By 2011 he had come to favor a flexible IT regime:

“A central bank should aim to maintain price stability and support other goals, particularly growth and employment. So long as medium-term price stability — over the course of a year or two or even three — is preserved.”

Price stability means 2% inflation. But for at least six years inflation (as measured by PCE Core prices) has been well below target except for a fleeting moment in early 2012, coinciding with the moment the 2% target was made official. Barring people like Bullard who think the “Core is rotten”, most people think core prices provide a better indication of the inflation trend. (The chart indicates how fickle the Fed would be if it targeted headline inflation at 2%!)

Stan Fischer Preferences_0

So by Fischer´s own definition we haven´t experienced “price stability” for several years, implying a lot of uncertainty about “short-term inflation rate certainty”.

In fact, “long-term price level uncertainty has been lower than short-term inflation uncertainty”, especially if you associate the price level with the core measure of the PCE.

As the panel below shows, core prices evolved very close to trend until 2012, after which they fall a little short. The headline price level was impacted by the persistent oil shocks during 2003-08. More recently, the negative oil shocks have brought it back to trend. Meanwhile, core inflation has spent most of the time below the target (initially implicit) level.

From a PLT perspective, the Fed is doing OK. From an IT perspective, it is doing a pretty awful job. But note that trying to “correct” inflation (bring it to target) will likely “disturb” the PLT (at least the headline price level). But the Fed doesn´t target the price level!

In 2008 the Fed botched the job because it became “afraid” of the increase in headline inflation that was rising on the heels of oil prices. That shows the main deficiency of both IT and PLT. Both are sensitive to real or supply shocks. Since the Core measure of the price level is much less sensitive to supply shocks, the fall in the core price level below trend over the past few years is an indication, contrary to FOMC conventional wisdom, that the drop in inflation is due to more than recently falling oil prices! Would that be related to a monetary policy that is implicitly tight?

On that score, the panel also shows that the major factor behind both the depth of the recession and the weak recovery was the Fed letting nominal spending drop way below trend and then not allowing it to climb back towards trend, i.e. keeping monetary policy too tight!

The NGDP & Trend chart is also evidence that the prevalent view that monetary policy was “too easy” in 2002-05 is misguided. With the FF rate at 1%, in August 2003 the FOMC decided to undertake forward guidance. All measures of inflation were below the target, and so was the NGDP level. It was effective in bringing both NGDP and core inflation back to target (headline was impacted by oil, and that shouldn´t concern the stance of monetary policy).

Bernanke took over with a “clean slate”! And proceeded to botch the job!

Stan Fischer Preferences

Unfortunately, those responsible for monetary policy simply won´t recognize the need for an overhaul in how monetary policy is conducted. Simply “endowing” the inflation target with more flexibility, imposing interest rate rules (aka “Taylor-type” rules) or even adopting a PLT won´t cut it. One of the consequences of this “hard-headedness” will be increasing claims for the use of distortionary fiscal policies (“stimulus”).

Unfortunately as he has made abundantly clear over the years, Stanley Fischer is quite against it, although he left a door open in a 2011 speech called “Central Bank Lessons from the Global Crisis”:

During and after the Great Depression, many central bankers and economists concluded that monetary policy could not be used to stimulate economic activity in a situation in which the interest rate was essentially zero, as it was in the United States during the 1930s – a situation that later became known as the liquidity trap.  In the United States it was also a situation in which the financial system was grievously damaged.  It was only in 1963, with the publication of Friedman and Schwartz’s Monetary History of the UnitedStates that the profession as a whole1 began to accept the contrary view, that “The contraction is in fact a testimonial to the importance of monetary forces.”

In this lecture, I present preliminary lessons – nine of them – for monetary and financial policy from the Great Recession.  I do this with some trepidation, since it is possible that there will later be a tenth lesson: that given that it took fifty years for the profession to develop its current understanding of the monetary policy transmission mechanism during the Great Depression, just two years after the Lehmann Brothers bankruptcy is too early to be drawing even preliminary lessons from the Great Recession.  But let me join the crowd and begin doing so.


The ninth:

In a crisis, central bankers (and no doubt other policymakers) will often find themselves implementing policy actions that they never thought they would have to undertake – and these are frequently policy actions that they would prefer not to have to undertake. Hence, some final advice for central bankers :

Never say never