The 2002-04 period in the limelight once again

Tony Yates:

It’s highly contestable that the Fed set too-loose monetary policy in the early 2000s.  Bernanke made a stern and convincing case in favour of what they did while still Fed chair.  He pointed out that if you substituted inflation for forecast inflation in the Taylor Rule, for which a convincing case can be made that one should, you find that Fed policy was not too loose.  Specifically, rates were so low because the Fed were worried about deflation, and the zero bound.  They had watched what they saw as slow and weak Bank of Japan monetary policy, and had seen its consequences, and were doing what they could to avoid that experience being repeated.

David Beckworth in the comment section of Yates´post:

I would note that one of the largest surges in U.S. productivity growth occurred between 2002-2004. This was a well publicized development and raised trend productivity growth as seen in consensus forecasts at the time. All else equal, this development would imply a higher natural interest rate and lower inflation. Ironically, following a Taylor Rule-like reaction function can cause monetary policy to be too easy given these developments. It is more pronounced when the Taylor Rule uses forecasted inflation.

George Selgin, Berrak Bahadir and I build upon these papers and others by showing how the 2002-2004 productivity surge lured the Fed into complacency during the housing boom. We do not say it was the only cause for the boom or that the easing was intentional, but only that it failed to properly handle the productivity surge. And that is how it contributed to the boom.

In addition, David Beckworth has a post on the topic:

George Selgin, Berrak Bahadir, and I recently published an article that lends support to John Taylor’s view of Fed policy during this time. It received some pushback from Scott Sumner who is sympathetic to both the saving glut and secular stagnation views. At the same time, Tony Yates provided a critique of John Taylor’s argument on the financial crisis that was heartily endorsed by Paul Krugman. So the debate over the Fed policy during this period continues.

A little over 4 years ago, I did a lengthy post on this topic under the title “BERNANKE´S GSG HYPOTHESIS: A COP-OUT”. In that post I gave a coherent explanation of why house prices took off in late 1997 (long before the period of interest rate being “too low for too long”).

In their paper, BBS put a lot of emphasis on the productivity surge, a fact that tends to lower inflation and increase real GDP growth, so that if the Fed reacts to the fall in inflation below target by “loosening” monetary policy, it will cause instability.

I want to tell an alternative story, the conclusion of which is that monetary policy in 2002-04, particularly after mid-2003 was, to use an expression favored by Greenspan, the “appropriate monetary policy”.

The model behind the story is the dynamic aggregate demand-aggregate supply model, and the stance of monetary policy is defined by NGDP relative to trend. If NGDP is above trend monetary policy is “easy”, if it´s below trend, monetary policy is “tight”.

As the pictures illustrate, the “problem” began in late 1997. At that point, productivity started to increase above trend (a positive productivity shock). At the same time, oil prices fell, impacted by the fall in demand following the Asia crisis. From the vantage point of the US, this is also a positive supply shock. As a result, inflation fell way below “target”. Meanwhile, monetary policy became “easy”, with NGDP rising above trend (as did RGDP).

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In 2001, monetary policy tightened, with NGDP falling back to trend. However, the tightening was excessive, with NGDP falling below trend (as does RGDP, which contradicts Beckworth´s argument that the economy was “overheating during the housing boom”).

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From late 2001, a positive productivity shock was accompanied by a negative oil shock. After late 2003, it appears that the negative supply shock from rising oil prices was stronger than the positive supply shock from productivity. This is consistent with inflation picking up.

At that point it appears that the easing of monetary policy – forward guidance – guiding NGDP back to trend coupled with a slight leftward shift in the aggregate supply curve resulted in inflation moving back closer to target.

As the house price chart shows, throughout 1997 – 2005, house prices were on the rise. That story is quite separate from the monetary policy story. From late 1997 to late 2004, the Fed lost and regained nominal stability. It was left to Bernanke´s Fed to lose it “majestically”!

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A Challenge For Supply-Siders: Name the Industry To Invest In For Next Five Years Answer: Print More Money, And Maybe I Can Tell You

A Benjamin Cole post

The secular stagnation arguments in many ways boil down to a supply-side vs. demand-side joust.

For now, I am on the demand-side: Print more money.

Why? Name for me the industry that is supply-constrained, that needs lower taxes, regulations or more capital to expand to meet unmet demand.

When we look at autos, computers, energy, clothing, commercial real estate, we see again and again glutted supply.

Name a single automaker you would invest in confidently for the next five years—and I believe Ford is a very sharp outfit. Trouble is, there are more auto factories than the globe needs.

If there is an industry that will be supply-constrained in the next five years, I want to know about it. Seriously! I will happily invest in an ETF that mirrors that industry.

For a fleeting few years, it appeared the commodities were supply-constrained. Now, glutted. By the trillions of dollars money has flowed into energy sectors, financing every good, many so-so, and a lot of dubious ventures. There is no shortage of capital in the energy sector, or other commodities. I see gluts for a long, long time in most commodities. Even ethanol is glutted.

A possible exception to the glut rule is residential real estate in limited geographic areas. As widely noted, the most ardent right-winger becomes an anti-growth, anti-capitalist NIMBY-king in their own neck of the woods.

While commercial real estate markets tend to become glutted anyway, residential markets may be supply constrained. Thus we see West Los Angeles homes and Manhattan condos selling for centi-millions.

The solution to tight residential markets is on the supply-side, but also impossible to implement nationally. Every local government in the United States is beholden to (often wealthy and powerful) homeowner groups.

Yes, any successful economy must invest in infrastructure, plant and equipment, education, and promote work ethics and contractual honesty. These are basics, and we all salute.

But when a global economy appears chronically over-supplied with everything…then the problem is on the  demand side.

As I always say, print more money.

IMF Growth Forecasts: “Going, Going…Gone?”

Jon Hilsenrath has a take in “What If This Is As Good As It Gets?”:

The International Monetary Fund’s spring meetings are turning into a depressing affair. By April every year in the wake of the financial crisis, it seems the world’s top finance officials and central bankers are busy revising down expectations for annual growth and navigating some brewing financial storm. And so it is in 2015. Washington’s cherry blossoms are in full bloom and so is economic angst and frustration.

Unfortunately, world growth forecasts are still “shrinking”, so it “could get worse”!

IMF Forecasts

What a difference one month makes in the views of John Williams

On March 23 it was “up, up and away”:

“Things are looking better–in fact, they’re looking downright good,” the official said in a speech to be delivered to an audience in Sydney and Melbourne via video.

Given how much the economy has improved and is likely to continue to gain ground, “I think that by mid-year it will be the time to have a discussion about starting to raise rates,” Mr. Williams said.

On April 20 another FOMCer is not so sure any longer:

Hopefully” the economic data will “support a decision to lift off later this year,” Mr. Dudley said, in reference to taking the first move to push interest rates off of their current near-zero levels.

But, “because the economic outlook is uncertain, I can’t tell you when normalization will occur,” he said. When it comes to rate rises, “the timing is data dependent. We will have to see what unfolds,” he said.

And on goes the FOMC, directionless!

PS Could have titled this post as “Random Walks at the FOMC”

Reincarnation exists

John Tamny is Andrew Mellon reincarnated! In “Recessions Are Absolutely Beautiful, And Should Be Renamed ‘Recovery‘”, he concludes:

Thinking about all this, what’s plainly missed by Ip is the unseen.  Indeed, imagine how much lower unemployment would be and how much higher asset prices would be today if the Fed had allowed the economy to cleanse itself of all that was restraining it back in 2008.


“Three coins in the fountain” of the monetary policy stance. Unanimously, they say interest rate does not define the stance!

First Milton Friedman:

The Federal Reserve cannot and does not control interest rates, though its actions clearly have an effect – but in a more complex way than would justify the identification of easy money with low interest rates and tight money with high interest rates.

Followed by Bernanke:

The imperfect reliability of money growth as an indicator of monetary policy is unfortunate, because we don’t really have anything satisfactory to replace it. As emphasized by Friedman  . . . nominal interest rates are not good indicators of the stance of policy . . .  The real short-term interest rate . . . is also imperfect . . .  Ultimately, it appears, one can check to see if an economy has a stable monetary background only by looking at macroeconomic indicators such as nominal GDP growth and inflation.

Then Mishkin:

What I’d like to spend some time on—because I feel this is sort of my swan song, but maybe because I’m a classy guy, I’ll call this my “valedictory remarks”—are three concerns that I have for this Committee going forward. I’m not going to be able to participate, but I have a chance now to lay them out.

The first is the real danger of focusing too much on the federal funds rate as reflecting the stance of monetary policyThis is very dangerous. I want to talk about that.

So what best defines the stance of monetary policy? Let´s check Bernanke´s alternatives. The charts show NGDP relative to trend, Inflation and the FF target rate for different periods.

In 1992, Friedman wrote about monetary policy being tight with reference to money supply (M2) growth. Unfortunately, that´s not a good measure of the stance. He should have said monetary policy had been tight, because at that moment the Fed was just getting it right given NGDP was fast converging to trend, despite the falling/low FF target rate and falling inflation.

MP Stance_1

The 1993-97 period describes what a “perfect” monetary policy looks like.

MP Stance_2

NGDP hugged the trend, the FF target rate initially low, was subsequently raised (does that mean it was initially “easy” and then “tightened”?) and inflation fell throughout (does that mean the stance of policy was “tight”?).

The end of the decade describes what an “easy” stance of monetary policy looks like. Despite the increase in the FF target rate and inflation remaining below the “desired” (2%) level, the fact that NGDP rose above the trend level accurately describes the easy stance of monetary policy.

MP Stance_3

The subsequent period includes John Taylor´s “too low for two long” level of the FF target rate. According to the deviation of NGDP from trend, monetary policy was initially too tight, only becoming stimulative in the second half of 2003, when forward guidance was introduced, even though the FF target rate soon began to rise.

MP Stance_4

The following period accurately describes what a very tight monetary policy looks like, despite an initially constant and then falling FF target rate and inflation. Soon after taking the Fed´s helm, Bernanke proceeded to tighten monetary policy, and the “screws” turned until NGDP “crashed”! It looks like Lehman was a consequence and not the trigger.

MP Stance_5

And monetary policy, despite all the “highly accommodative” talk, has in fact remained pretty tight ever since!

In 1992, Milton Friedman Said the Fed Was Too Tight!

A Benjamin Cole post

“The Federal Reserve has reduced the federal funds rate repeatedly from nearly 10% in 1989 to about 3% recently. According to conventional wisdom on Wall Street, that is evidence that monetary policy has been extremely easy, that the Fed has done all it can to stimulate the economy, and that it is pushing on a string, as another ancient cliché has it. This wisdom may be conventional, but it is incorrect.”—Milton Friedman, The Wall Street Journal, October 23, 1992.

It was October 1992, inflation as measured by the CPI was running at about 3.2 percent, and real GDP was expanding at about 4.0%.

Yet the title of Friedman’s op-ed concerning the Fed? Too Tight For A Strong Recovery

The monetary master added, “It is hard to escape the conclusion that the restrictive monetary policy of the Federal Reserve deserves much of the blame for the slow, and interrupted, recovery from the 1990 recession.”

If readers are surprised, maybe they should not be. Three other times in his career—at least three—Friedman bashed central banks for being too tight: The Great Depression, the 1956-7 recession in the United States, and the Great Stagnation of Japan in the 1990s.

In that long-ago October in 1992, Friedman also opined that Fed open-market operations—the buying of bonds—would be the most effective tool, even if commercial banks were loath to lend. It was paleo-QE.


As many others have pondered, what has happened to America’s right-wing economists? There was a time when the preeminent right-winger—Milton Friedman—would call for robust, pro-growth policies from the Fed, even when the economy was growing and inflation was a little above 3%. And The Wall Street Journal would print it!

Can anyone name an establishment right-wing economist today who would demand a more growth-oriented central bank? Who is not obsessed with 0% inflation, if not deflation?

When did America’s right-wing economists become “higher interest-rate crack-heads”?

And why?

A peek at inflation expectations

Excluding short-term (1-year) Inflation expectations, which dances to the tune of oil prices, medium and long-term CPI inflation expectations did not react when the 2% target became official in January 2012. More than one year later, they stabilized at a higher level. Lately, maybe because of all the “time has come to increase rates” talk, they have come down a bit and are still probing to find s new stable, but lower level!

Inflation Exp_415

Note: Since this reflects CPI inflation expectations and the CPI inflation is a few points above the PCE inflation, the CPI “target” is a bit above 2%.

Fed As Interest-Rate Crackheads? The Funny Letter Received By Former FOMC’er Bob McTeer Regarding Cocaine Junkies

A Benjamin Cole post

“What is it about the Fed and raising rates? They are addicted to it like a junkie is addicted to cocaine as the one answer to every situation other than outright depression.”—A letter received by Bob McTeer, former Federal Open Market Committee (FOMC) member, as revealed on his blog.

The portrayal of the FOMC as interest-rate crackheads is funny—and yet falls short of the mark.

Not only do various FOMC members seem to have a monomaniacal obsession with raising rates, but the tool of QE has vanished from the short-term collective memories of FOMC’ers and Ben Bernanke.

The Fed Wants To Live in Yesterday

I have been reading Ben Bernanke’s blog, and wondering when he will tackle the topic of QE, which was, after all, his monetary policy flagship for several years.

Evidently I will have a long wait. Bernanke blogs long and hard about interest rates, and also about “normalizing” Fed policy—that is, raising rates. Maybe Bernanke is not yearning like an interest-rate crackhead, but…what happened to QE?

The policy of central-bank buying of bonds, aka quantitative easing or QE, seemed to work in the United States to boost aggregate demand and resulted in little if any inflation (while paying down the national debt, no less). What is not to like?

You would think central bankers would wheel out QE as the super-weapon to end all recession-depressions forever.

But endlessly we hear Fedsters crying to get back to the good old days, when a central bank could jigger interest rates and obtain macroeconomic results. The Fed seems to want to good old days of moderate inflation and a viable Fed policy consisting of hopping interest rates around—but without the moderate inflation.

Is that not a null set? Interest rates do not work at ZLB. And with a 2% inflation target then ZLB is always on the doorstep—when not in the house.

Bernanke Talks Up Big Federal Deficits

“But economically, it would be preferable to have more proactive fiscal policies and a more balanced monetary-fiscal mix when interest rates are close to zero.”—Bernanke, in his latest blog post.

In a fleeting mention, Bernanke relegates QE back “to the shelf,” once everything gets back to normal, presumably after Washington borrows and spends gobs of taxpayer money.

Yet, what has been the success of Japan in fighting deflation, after years—even decades—of mind-boggling and world-record federal deficits?

Until they recently got serious about QE, they were still in deflation!

Interest-rate Crackheads?

You know, the more I re-read that letter to Bob McTeer…the less funny it becomes.