The lack of imagination is pervasive!

Gavyn Davies summarizes:

The great financial crash of 2008 was expected to lead to a fundamental re-thinking of macro-economics, perhaps leading to a profound shift in the mainstream approach to fiscal, monetary and international policy. That is what happened after the 1929 crash and the Great Depression, though it was not until 1936 that the outline of the new orthodoxy appeared in the shape of Keynes’ General Theory. It was another decade or more before a simplified version of Keynes was routinely taught in American university economics classes. The wheels of intellectual change, though profound in retrospect, can grind fairly slowly.

Seven years after 2008 crash, there is relatively little sign of a major transformation in the mainstream macro-economic theory that is used, for example, by most central banks. The “DSGE” (mainly New Keynesian) framework remains the basic workhorse, even though it singularly failed to predict the crash. Economists have been busy adding a more realistic financial sector to the structure of the model [1], but labour and product markets, the heart of the productive economy, remain largely untouched.

What about macro-economic policy? Here major changes have already been implemented, notably in banking regulation, macro-prudential policy and most importantly the use of the central bank balance sheet as an independent instrument of monetary policy. In these areas, policy-makers have acted well in advance of macro-economic researchers, who have been struggling to catch up.

The IMF has tracked this process well, and it has just held its third post-2008 conference on Rethinking Macro Policy under the leadership of chief economist Olivier Blanchard. Olivier has summarised the conference (here and here) but so far it has it not been much discussed by macro investors.

I have therefore taken the liberty of organising Olivier’s summary and the conference material into the three tables below. Although highly simplified, the tables represent a snapshot of the current “state of the art” in macro policy, at least as seen by today’s mainstream luminaries of the subject.

And concludes:

In conclusion, what should we expect from macro-policy makers in future, assuming the economic back-drop remains relatively benign? Probably, more of the same: broadly stable central bank balance sheets, very slow declines in public debt ratios and a gradual return to using interest rates as the main weapon of monetary policy. A more rapid return to pre-2008 norms for fiscal and central bank balance sheets is somewhat unlikely.

To call the economic back-drop benign is a stretch; but while that remains the conventional thinking, Summer´s “Great Stagnation” thesis will continue to be ‘celebrated’!

Why can´t they see that the “GS” is the exact opposite of the “Great Inflation”? Interestingly, while the “GI” was going on, the prevalent thought was also that monetary policy couldn´t do much to abate it!

Much later, the “Great Inflation” was pinned on poor monetary policy. How long will it take to blame monetary policy for the “repressed economy” since 2008?

The conflicting conclusions from these “old” arguments are still present today!

Alan Blinder (2009)

From the end of 2002 to the middle of 2008, the US economy was in the throes of a significant oil price shock. The dollar price of oil rose fivefold, with spot prices briefly hitting $145/barrel. Even adjusting for inflation, the rise in oil prices was stunning. At their peak, real oil prices stood about 50% above their previous record high – reached following the second OPEC oil shock of 1979-80. (After hitting its 2008 peak, the price of oil fell rapidly, tumbling over the past six months into the $30-$50/barrel range.)

Although the recent run-up in oil prices is comparable in magnitude to the first two OPEC shocks, its effects on the economy seem to have been very different. Textbook accounts of the 1970s and early 1980s blame “supply shocks” (which included sharp rises in the price of food as well as oil) for the prolonged periods of both high unemployment and high inflation, or “stagflation,” that followed.

By contrast, the most recent increase in oil prices appeared to have very little effect on the expansion that followed the 2001 recession. (While the US economy did enter a recession at the end of 2007, this was widely attributed to the collapse in consumer and business confidence that attended the subprime crisis and subsequent financial panic.) Similarly, core consumer price inflation – inflation excluding food and energy prices – was relatively stable over this period, which again contrasts sharply with the earlier episodes.

One interpretation of the experience of the past several years is that it vindicates “revisionist” views of the role played by oil shocks (and other supply shocks) in precipitating the stagflation of the 1970s. According to this view – variants of which have been propounded by DeLong (1997), Barsky and Kilian (2002), and Cecchetti et al. (2007) – the root cause of the abysmal macroeconomic performance from 1973 to 1983 was poor monetary policy, not the oil shocks.

Jim Hamilton (2009)

The implication that almost all of the downturn of 2008 could be attributed to the oil shock is a stronger conclusion than emerged from any of the other models surveyed in my Brookings paper, and is a conclusion that I don’t fully believe myself. Unquestionably, there were other very important shocks hitting the economy in 2007-08, first among which would be the problems in the housing sector. But housing had already been subtracting 0.94% from the average annual GDP growth rate over 2006:Q4-2007:Q3, when the economy did not appear to be in a recession. And housing subtracted only 0.89% over 2007:Q4-2008:Q3, when we now say that the economy was in recession. Something in addition to housing began to drag the economy down over the later period, and all the calculations in the paper support the conclusion that oil prices were an important factor in turning that slowdown into a recession.

Let´s consider Jim´s arguments first: There´s no doubt, just imagining a dynamic AS-AD model that a price shock increases inflation and reduces real output, so Jim´s conclusion is not special. But the strength of the oil price effect on real output is predicated on how the Fed reacts to the shock.

If the Fed reacts to the rise in inflation by contracting nominal spending (NGDP), real output is going to decrease more than if the Fed kept nominal spending “constant”. This is clearly seen in the following graph, representing a dynamic AS-AD model, where point 1 is the initial state and points 2 and 3 represent, respectively, the states following the oil price shock and the oil shock cum contraction in AD:

When will MP take blame_1

There´s an interesting experiment to be made. In 2003-2006 the economy was buffeted by an oil price shock that was even stronger (higher percent price increase) than the one that occurred in 2007-08. This is shown in the charts below.

When will MP take blame_2

As the next charts indicate, in the 2003-06 period NGDP growth was kept stable, so that RGDP growth was only little reduced. This was not the case in 2007-08. In the later period, the Fed remained so worried about inflation that it kept contracting NGDP and that´s the reason a “run of the mill recession” became “Great”!

When will MP take blame_3

Going back to Blinder, he´s very off hand about the “Great Recession”. Unlike the 1970s, he thinks it had nothing to do with monetary policy. Maybe that reflects his concentration on the inflation side of the ledger!

I wonder if it will take another 25 or thirty years for someone to say “the root cause of the abysmal macroeconomic performance from 2008 onwards was extremely poor monetary policy, (not the oil shocks, subprime crisis and ensuing financial panic)

Will new tools help to “save” the economy?

The BEA has announced the forthcoming release of new analysis tools:

The Bureau of Economic Analysis plans to launch two new statistics that will serve as tools to help businesses, economists, policymakers and the American public better analyze the performance of the U.S. economy. These tools will be available on July 30 and emerge from an annual BEA process where improvements and revisions to GDP data are implemented. BEA created these two new tools in response to demand from our customers.

Average of Gross Domestic Product (GDP) and Gross Domestic Income (GDI)

Final Sales to Private Domestic Purchasers

This new data tool is just one of the ways that BEA is innovating to better measurethe 21st Century economy and provide business and households better tools for understanding that economy. Providing businesses and individuals with new data tools like these is a priority of the Commerce Department’s “Open for Business Agenda.”

Meanwhile the “more government crowd” is strident.

Simon Wren-Lewis:

When we have a recession caused by demand deficiency such that interest rates hit their Zero Lower Bound (ZLB), the obvious response from a macroeconomic point of view is fiscal stimulus. Instead governments have become obsessed by their debt and deficits, and so we have austerity instead.

Brad DeLong:

Arithmetically, the U.S. economy is depressed because residential construction and government purchases are well below previously-expected trend levels

New Tools_1

And governments are not responding to market signals: financial markets are telling them that they have a once-in-a-lifetime opportunity to advantageously pull spending forward from the future into the present and push taxes back from the present into the future. But, because of the ideology of austerity, they are not taking advantage of this opportunity.

Brad calls a spade a spade: “Economy is depressed”, but it´s not because of his GDP components reasons.

Take Final Sales of Domestic Product (FSDP), to remove some of the volatile components of NGDP. The charts below show how it has performed relative to the “Great Moderation” trend. You also see that the 90/91 and 2001 recessions were “overcome” when FSDP growth managed to get FSDP back on trend. Not so following the “Great Recession”, with the result being a depressed economy.

New Tools_2

This predicament is not due to “residual seasonality”, “inappropriate tools for analyses” or “ideology of austerity”. It´s wholly due to the Fed constraining the growth of nominal spending at an inadequate level, one that has persisted for 5 years! It´s beyond belief that “growth stability” for that length of time is just a coincidence!

I´m reminded of the wisdom of James Meade, who in his 1977 Nobel Lecture said:

Earlier I spoke of ‘price stability’ as being one of the components of ‘internal balance’. Yet in the outline which I have just given of a possible distribution of responsibilities no one is directly responsible for price stability. To make price stability itself the objective of demand management would be very dangerous.

If there were an upward pressure on prices because the prices of imports had risen or because indirect taxes had been raised, the maintenance of price stability would require an offsetting absolute reduction in domestic money wage costs; and who knows what levels of depression and unemployment it might be necessary consciously to engineer in order to achieve such a result?

The “price stability” obsession is the reason the economy was “knocked down” in 2008!

His “solution”:

I have told this particular story simply to make the point that the choice between fiscal action and monetary action must often depend upon basic policy issues which should certainly be the responsibility of the government rather than of any independent monetary authority. Perhaps the best compromise is an independent monetary authority charged so to manage the money supply and the market rate of interest as to maintain the growth of total money income on its 5-per-cent-per-annum target path, after taking into account whatever fiscal policies the government may adopt.

Unfortunately, the economy has remained depressed for too long. That has certainly “sapped its strength”. Nevertheless, a higher level of spending is certainly achievable. Maybe, for incomprehensible (to me) reasons, it´s not desired!

Pity the “magic acronym” was uttered by someone as fickle as Bullard!

Just a few examples of Bullard´s fickleness in chronological order:

In “The core is rotten” (2011):

In my remarks tonight I will argue that many of the old arguments in favor of a focus on core inflation have become rotten over the years. It is time to drop the emphasis on core inflation as a meaningful way to interpret the inflation process in the U.S. One immediate benefit of dropping the emphasis on core inflation would be to reconnect the Fed with households and businesses who know price changes when they see them. With trips to the gas station and the grocery store being some of the most frequent shopping experiences for many Americans, it is hardly helpful for Fed credibility to appear to exclude all those prices from consideration in the formation of monetary policy.

In “Faulty reasoning” (2012):

The 2014 language in effect names a date far in the future at which macroeconomic conditions are still expected to be exceptionally poor,” Federal Reserve Bank of St. Louis President James Bullard said in a speech in St. Louis. “This is an unwarranted pessimistic signal for the [Federal Open Market Committee] to send,” given that the economy is recovering and forecasters can’t really tell what will happen that far down the road.

In “Bullard needs psychiatric meds” (2014)

On October 9:

In a speech that offered an upbeat assessment of the economy, Federal Reserve Bank of St. Louis President James Bullard said Thursday he is worried about what he sees as disconnect between what central bankers think will happen with monetary policy, and the view held by many in the market.

Right now, “the markets are making a mistake” and expect the Fed to maintain its ultra-easy policy stance longer than Fed officials themselves currently expect, Mr. Bullard said. When it comes to these expectations, “I would prefer that those be better aligned than they are.”

On October 16:

The Federal Reserve may want to extend its bond-buying program beyond October to keep its policy options open given falling U.S. inflation expectations, Federal Reserve Bank of St. Louis President James Bullard said Thursday.

It would keep the program alive,” and the Fed’s options “open as to what we want to do going forward,” Mr. Bullard said during an interview on Bloomberg TV.

In Bullard “Trail & Track” Nov 6 2014:

He´s an “off” “on” switch type of central banker. On October 9 he “switched off”, on the 16th he “switched on” and “switched-off” again today:

Federal Reserve Bank of St. Louis President James Bullard said in a television interview Tuesday that he is upbeat about the economy and doesn’t think any new central bank stimulus is needed to help keep the U.S. on track for 3% growth.

In “In a hurry” (Feb 2015):

Federal Reserve Bank of St. Louis President James Bullard said the U.S. central bank needs to change its policy statement to give it more room to maneuver with interest rate increases, in comments that also expressed hope the first rate rise will come soon.


The Federal Reserve should consider new policy options, including directly targeting a non-inflation-adjusted level of economic growth, after more than six years of sustained monetary easing failed to spur a boom, Federal Reserve Bank of St. Louis President James Bullard said Thursday.

Recently, Scott Sumner visited the St Louis Fed. It wasn´t for naught!

Today Bullard comes out of the closet with a euphemism:

The Federal Reserve should consider new policy options, including directly targeting a non-inflation-adjusted level of economic growth, after more than six years of sustained monetary easing failed to spur a boom, Federal Reserve Bank of St. Louis PresidentJames Bullard said Thursday.

“It’s time to question the current theory and explore other models about what’s going on at the zero lower bound,” Mr. Bullard said, referring to the Fed’s zero-rates policy that has been in place since December 2008.

Mr. Bullard was presenting new research conducted with three other economiststhat he says shows “the monetary authority may credibly promise to increase the price level…to maintain a smoothly functioning credit market.”

The model could be “broadly viewed as a version of nominal GDP targeting,” the paper says, referring to a policy in which a central bank would set a target for gross domestic product growth without an inflation adjustment. The idea would be to signal to markets and the public that the Fed is serious about generating a recovery, thereby spurring investment and spending.

The Fed is a “tighten-only screwdriver”!

From SF Fed John Williams:

Anyone who knows me, or has listened to my speeches, will notice three recurring themes. The first, and foremost, is that monetary policy is data-driven. I am so data-focused that I literally had a T-shirt made to express my personal policy mantra. The second is that I think patterns and history are important indicators of our economic present and future—they are, frankly, just another form of data to be mined. As is the case with the effect that wages have on overall inflation, sometimes the theory doesn’t play out in practice, and history is an eloquent teacher. The third is that I believe policymakers have to be very careful about not reacting to blips. This again is an extension of the “data, data, data” view: We have to look at what’s happening in the economy not just today, not just this month, but over the medium term, analyzing trends and looking at multiple indicators.

That’s why we should be very circumspect about reacting to short-term fluctuations in commodity or other import prices. Just as the Fed didn’t immediately intervene in the spring of 2011, when inflationary pressures from oil and import prices were going up, we shouldn’t jump the gun now that they’ve gone down. I take a perspective that looks one or two years ahead, which research shows is the minimum amount of time it takes for monetary policy to have its full effect (Havranek and Rusnak 2013). What I’m considering is what impact those factors that are currently unfolding—movements in the U.S. economy, weakness abroad, oil prices—will have not next week or next month, but later this year and the year after that and the year after that. My goal is policy that meets the needs of the path we’re on, not where we’re standing this second.

With that in mind, history and experience show that energy price swings leave an imprint on inflation in the short term, but don’t affect underlying inflation rates over the medium term (Evans and Fisher 2011, Liu and Weidner 2011). The same holds true for movements in the exchange value of the dollar: They obviously affect inflation in the short run, but they don’t have much of an impact further down the road (Gust, Leduc, and Vigfusson 2010).

I’m therefore looking at underlying rates of inflation. Fed economists are frequently accused of neither eating nor driving, because we prefer to measure “core” inflation, which excludes food and energy prices. For the average consumer, those matter a lot—you can’t talk about what a dollar can buy if you don’t look at those products. But for economic trends, and for guiding monetary policy, measures of inflation that remove the most volatile components, like core or “trimmed mean” inflation, give a better lay of the land (see FRB Dallas 2015).

And here´s the “lay of the land” for the past decade or so.



The question that jumps out: Why the FOMC´s ‘state of mind’ was so different, in fact, diametrically opposite, in 2008. Here´s from Bernanke´s summary at the June 2008 FOMC meeting:

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

One answer might be that there is an asymmetry in FOMC thinking. When oil (and commodity) price goes up, the risk to inflation rises, so policy must tighten. But when oil prices goes down, they shouldn´t be concerned (or react) about too low inflation. “Keep policy steady, but be prepared to tighten”!

And note that between 2011 and mid-2014, both headline and core were coming down even though oil prices were stable!


To Yanis Varoufakis, the “EZ bed” is not comfortable!

The problem is simple: Greece’s creditors insist on even greater austerity for this year and beyond – an approach that would impede recovery, obstruct growth, worsen the debt-deflationary cycle, and, in the end, erode Greeks’ willingness and ability to see through the reform agenda that the country so desperately needs. Our government cannot – and will not – accept a cure that has proven itself over five long years to be worse than the disease.

Our creditors’ insistence on greater austerity is subtle yet steadfast. It can be found in their demand that Greece maintain unsustainably high primary surpluses (more than 2% of GDP in 2016 and exceeding 2.5%, or even 3%, for every year thereafter). To achieve this, we are supposed to increase the overall burden of value-added tax on the private sector, cut already diminished pensions across the board; and compensate for low privatization proceeds (owing to depressed asset prices) with “equivalent” fiscal consolidation measures.

The view that Greece has not achieved sufficient fiscal consolidation is not just false; it is patently absurd. The accompanying graph not only illustrates this; it also succinctly addresses the question of why Greece has not done as well as, say, Spain, Portugal, Ireland, or Cyprus in the years since the 2008 financial crisis. Relative to the rest of the countries on the eurozone periphery, Greece was subjected to at least twice the austerity. There is nothing more to it than that.

Not so fast Yanis! I concur that largely, the EZ crisis was mostly an NGDP (i.e. monetary crisis). The charts show that clearly. (Note: the scale is the same in all charts)

Yanis Complains_1

Greece has not done as well as Spain or Ireland mostly because initial conditions in Greece were much “worse”. While Spain and Ireland were forcefully reducing their government debt ratios before the crisis, reaching debt ratios of less than 40% and 30%, respectively, Greece´s debt ratio remained at the 100% level.

Also, Greece had the highest structural deficit relative to potential GDP going into the crisis, so naturally, Greece had to be more “austere” than either Ireland or Spain. There´s also the fact that Greece´s credibility is extremely low!

Yanis Complains_2

Later, YV writes:

Following Prime Minister David Cameron’s recent election victory in the United Kingdom, my good friend Lord Norman Lamont, a former chancellor of the exchequer, remarked that the UK economy’s recovery supports our government’s position. Back in 2010, he recalled, Greece and the UK faced fiscal deficits of more or less similar size (relative to GDP). Greece returned to primary surpluses (which exclude interest payments) in 2014, whereas the UK government consolidated much more gradually and has yet to return to surplus.

At the same time, Greece has faced monetary contraction (which has recently become monetary asphyxiation), in contrast to the UK, where the Bank of England has supported the government every step of the way. The result is that Greece is continuing to stagnate, whereas the UK has been growing strongly.

Not quite true. In 2010, Greece´s Structural Deficit relative to potential GDP was about 50% higher than Britain´s, but I agree that Greece has experienced “monetary asphyxiation”. The UK is fortunate to have an independent monetary policy!

Yanis Complains_3

Bottom Line: If Greece was willing to “get in bed” with the likes of Germany, now it must try to become more like them, and if that´s not palatable…

Lars Christensen has a post on Yanis.

Thinking About Martin Feldstein Again

A Benjamin Cole post

Market Monetarists have already done a superb job explaining why NGDPLT is the best tool for a central bank, especially if measuring real GDP is guesswork—the latter point Martin Feldstein made recently in The Wall Street Journal.

Feldstein’s extraordinarily oblique point was that the CPI or other indexes overstate inflation, something he could not say out loud, so un-PC is such a sentiment. But his conclusion is much more palatable to certain classes, and that is that middle-class America is better off than ever, even if they don’t know it, as wage stagnation is a mirage.

University of Chicago scholar John Cochrane leaped on the Feldstein bandwagon to posit that maybe the CPI overstates inflation by 3%, essentially meaning Fat City for Mr. and Mrs. America. This is a reprise of Bush-era sentiments of economist and right-winger Don Boudreaux of George Mason University.

Is The Fed Suffocating The Economy?

That Cochrane likes the Fed now is not much of a surprise; he has argued that deflation is the economic cure-all, notwithstanding the 20-year long debacle with falling prices that is Japan.

Cochrane says that Feldstein’s premise today means in the United States “we really have 0% nominal interest rates, 1.5% deflation rather than 1.5% inflation; +1.5% real rates rather than -1.5% real rates. That is about the ideal monetary policy.”

Cochrane then exults, “We live the (Milton) Friedman optimal quantity of money.”

But others may wish to ponder if the Fed, by accomplishing less than 2.0% inflation as measured on the PCE, is actually obtaining minor deflation, and thus Japan-like results.

As widely noted, economic growth in the United States since the Fed ostensibly set its 2% PCE IT (which many suspect works out to 1.5% in practice) has been…well, Japan-like.

In 2015, the first half GDP may exhibit some real economic growth, but may not with any bad luck. Industrial production has been falling through most of the year. And the previous seven years have been anemic. If this is the Friedman optimum….*


If after seven years in the United States, and 20 years in Japan, the Friedman optimum does not work in real life, then we can dispense with deflation as reasonable monetary goal. It just does not work in the here and now.

On the contrary, I wonder how long the United States could be in boom times before we saw old-fashioned demand-pull inflation. The 1990s was pretty boomy, and inflation remained moderate. Maybe there is another lesson there, too.

As I always say, the Fed should print more money.


*Friedman may have opined about a theoretical optimum. But in practice he advised Japan to pursue QE hard and heavy, and three times criticized the Fed for being too tight; in the Great Depression; in 1957; and in 1992. Did Friedman ever advocate a real-world policy of deflation?

The IMF Tells the Bank Of Japan To Hit The Gas? What About The U.S. Federal Reserve?

A Benjamin Cole post

The International Monetary Fund on May 22 badgered the Bank of Japan to adopt a more-aggressive growth stance, even though the island nation posted Q1 real GDP growth of 2.4%, and an annual inflation rate of 2.3%—along with an unemployment rate of 3.4%.

Moreover, under the leadership of Governor Haruhiko Kuroda, the BoJ is buying about $83 billion in bonds a month, a quantitative easing program equal in size to that of the U.S. Federal Reserves’ Q3 at its peak—except that Japan has an economy one-half the size of the United States.

Nevertheless, the IMF warned the “BOJ needs to stand ready for further easing, provide stronger guidance to markets through enhanced communication, and put greater emphasis on achieving the 2% inflation target.”

Fair enough. Maybe the BoJ needs to really pour it on.

Um. What About the Fed?

So, the United States’ posted Q1 real GDP dead in the water, and many are forecasting Q2 not much better. The core PCE deflator is now running at 1.3% YOY, with headline deflation, and the Fed has not reached its 2% inflation target for seven years, except once, and that fleetingly. The U.S. producer price index has been in deflation for several months. The U.S. unemployment rate is 5.4%, and a squishy figure at that.

Yet Fed Chair Janet Yellen never misses a chance to rhapsodize about raising interest rates, and on May 21 warned that Fed cannot wait too long before tightening the monetary noose or it will “risk overheating the economy.”

BTW, also from the Fed: “Industrial production decreased 0.3% in April for its fifth consecutive monthly loss.” Capacity utilization is at 78.2%, below the long-term average.


Yellen has new definition of “overheat,” and that is any room temperature warm enough to melt ice cream. And the IMF…well, what can you say. They appear seriously confused.