The illogical Fed

If the FOMC has systematically downgraded its forecasts as shown in the table below, why is it that they “feel” the time is nearing for a rate rise?

FOMC Projections

FOMC Forecast6-15

Regarding inflation, their “anticipation” in June 2013 is quite inconsistent with their forecast at the time.

June 13

The Committee also anticipates that inflation over the medium term likely will run at or below its 2 percent objective.

In June 2014 they recognize the risk of persistently “too low” inflation. But according to their forecast at the time, it appears they thought inflation would rise on its own volition!

June 14

The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term.

Today, they finally conclude that inflation will remain low for now, but remain “wishful” it will converge to target!

June 15

Inflation is anticipated to remain near its recent low level in the near term, but the Committee expects inflation to rise gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of earlier declines in energy and import prices dissipate. The Committee continues to monitor inflation developments closely.

Could the “rate anxiety” be because the unemployment rate has persistently surprised them on the “downside”? Since the FOMC has “elected” unemployment as the “guiding light”, and think that being close to a rate around 5% is the “trigger” for the FF rate, that´s the only logical explanation.

But according to new Fed research, once again they may be frustrated.

JB, the “populist”

In his “I´m a candidate” speech, JB said:

“There is not a reason in the world why we cannot grow at a rate of 4 percent a year,” Bush said as he formally announced his presidential bid in Miami. “And that will be my goal as president — 4 percent growth, and the 19 million new jobs that come with it.”

To do that, he would first have to “recruit” the Fed. Unfortunately, if the Fed acquiesced bad things would happen.

But we see from the chart below that the Fed could help any President if it decided to undo the monetary f-up it perpetrated earlier. But almost everyone has bought the “house bubble-burst – financial crisis – demographic – great stagnation story! Plus, the Fed is “unaware” that it messed-up and is on the verge of doing an encore!
Monetary F-up


The Fed and the “Asymptotic Approach Principle”

The “principle” is well illustrated in Tim Duy´s Fed Watch:

September 2014

Bottom Line:  The baseline path for interest rates is a delayed and gradual rate hike scenario beginning mid-2015.  It seems reasonable, however, to believe that the risk is that this baseline is too dovish given the general progress toward the Fed’s goals, a point made repeatedly by Fed hawks. Internal dissension to the baseline would only intensify in the face of another six months of generally solid economic news, especially on the labor front.  Yellen would not want to risk the recovery, however, on an overly aggressive approach, especially in the face of low inflation. Considering the path of the data relative to the various policy factions with the Fed, I believe the risk is that the Fed pulls forward the date of the first rate hike as early as March – still seven months away! – while maintaining expectations for a gradual subsequent rate path.

January 2015:

If you were looking for fireworks from today’s FOMC statement, you were disappointed. Indeed, you need to work pretty hard to pull a story out of this statement. It provided little reason to believe that the Fed has shifted its view since December. A June rate hike remains the base case.

June 2015

The Federal Open Market Committee meets this week to discuss the path of monetary policy.

Any possibility of a rate hike at the meeting’s conclusion on Wednesday was already crushed under the weight of weak data early in the year. To be sure, the data support the transitory nature of the weakness, justifying Federal Reserve Chair Janet Yellen’s optimism last month, but it remains too little, too late. Instead, turn to September as the next opportunity for the first rate hike of this cycle

In a couple of months, “Tim-In” for December…

When will the Fed recognize its failures?

Everybody and the Pope is waiting for the end of the FOMC meeting on Thursday, particularly if it will signal the time of the “feared lift-off”.

The trouble is that the Fed thinks that for the past six years it has followed an “easy” or “accommodative” monetary policy by keeping interest rates on the “floor”!

The opposite, however, is true. Monetary policy has remained tight, or even very tight, throughout this time.

What if interest rates are low because expectations of inflation and nominal spending growth are low (as Friedman reminded us long ago?). This might be so because “modern” central banking has shunned what´s going on with the money supply; and low money growth is the driving force behind today´s low interest rate, inflation and spending growth!

The charts illustrate the argument. Conservatively, I have let the initial (2008) drop in the price level (relative to trend) and the initial fall in nominal spending (NGDP) relative to trend to be bygones, forever forgotten.

Even so, the price level remains far below what it should be if the 2% target had been pursued during the recovery and the level of spending remains far below the level that would have materialized if the Fed had “cranked” a 5.5% nominal spending growth (the “Great Moderation” NGDP growth rate) after NGDP tanked in 2008.

Fed Failure_1

Fed Failure_2

Not surprisingly, both medium and long-term inflation expectations have recoiled during the recovery.

Fed Failure_3

And all this naturally follows the very low rate of broad (Divisia M4) money growth observed during the so called recovery!

Fed Failure_4

By concentrating attention on interest rates and showing “eagerness” to get them up, the Fed will instead throw the economy to the ground!

Update: The “Dot Bubble

Fed Failure_5

Preparing spirits for another “postponement”!

First, the unemployment goalpost was at the 6.5% mark, then at 6%, falling to 5.5% before being revised to 5%.

With that, the “fatidic” date moved from mid-2014 to early 2015 to June 2015, to September 2015. But that will probably be changed again:

Next week, Federal Reserve officials publish new quarterly forecasts, and all eyes are going to be on where they set the job market’s Goldilocks rate.

That’s the estimated unemployment level officials figure is neither too high nor so low that it starts to drive wages and prices higher. To quote Goldilocks, it’s “just right.”

Fed officials in March estimated this “natural rate” of unemployment at 5 percent to 5.2 percent. Unemployment stood at 5.5 percent in May. A new paper by Fed board staff shakes up this view by suggesting the number could be as low as 4.3 percent.

Moving Goalpost

It´s long past the time the Fed changed its “tune-up”!

Is Iceland Krugman’s Inadvertent Case for the Monetary Policy Offset of Fiscal Policy?

A Mark Sadowski post

On May 28, Paul Krugman exclaimed:

 “Back in 2013, when Olivier Blanchard presented a paper on Latvia at the Brookings Panel, many of the participants were bemused: why was the august panel devoting so much time to a country with the population of Brooklyn? But Latvia was, for a time, the great poster child for austerity….And now, as Frances Coppola notes, the era of rapid bounce back has stalled out.”

Krugman proceeds to compare the Real GDP performance of Latvia with that of Iceland. If one clicks on through to Coppola’s post, they learn that Latvia “embarked on a brutal front-loaded fiscal consolidation in 2009, sacking public sector workers, slashing public sector salaries, cutting benefits and raising taxes.”

Then on June 9, Krugman states:

 “I was, I think, one of the first commentators to notice that a funny thing was happening in Iceland: the nation that was supposed to be Ground Zero for financial disaster was actually having a milder crisis than many others, thanks to heterodox policies — debt repudiation, capital controls, and massive devaluation. Now, as Matthew Yglesias points out, Iceland is getting ready to lift the controls, and its experience still looks remarkably good considering the circumstances.

And as Yglesias says, the interesting contrast is with Ireland, now being hailed as a success story for austerity because things eventually stopped getting worse and have lately been getting a bit better. Talk about lowering the bar.”

If one reads the post by Yglesias, they find out that one of the things that Iceland did to achieve this was to “[r]eject [fiscal] austerity.”

Anyone who came away from reading Krugman’s posts, and the posts to which he links, might be forgiven for concluding that Krugman thinks that Iceland, unlike Latvia and Ireland, did not do any fiscal austerity at all.

But Scott knows something is fishy in the state of Iceland, and looks into Krugman’s implied claim.

 “Sorry, but I don’t see it. The crisis caused the debt to balloon, presumably due to the big cost of paying off depositors of failed banks, and the effects of the recession itself. But then Iceland started reducing debt as a share of GDP, from 101% to 86.4% in just three years. That’s much better than the US and UK, which supposedly had austerity. The budget deficit in Iceland was 7.8% of GDP in 2009, but only 0.9% of GDP in 2013–better than the US and far better than the UK. So if the US and UK practiced austerity, what’s so different about Iceland?”

As often is the case, in my opinion Scott is somewhat understating things.

Scott is looking at the “net operating balance” which excludes the “net acquisition of nonfinancial assets”. Including this item results in “net lending”, which is what Europeans call “the deficit”. The net lending of Iceland’s general government fell from 9.7% of GDP in calendar year 2009 to 1.7% of GDP in calendar year 2013, a change of 8.0% of GDP.

Moreover, Iceland’s general government budget ran a surplus equal to 1.8% of GDP in 2014, or a change in fiscal stance since 2009 equal to 11.5% of GDP. This can be found on Table A1 of the April 2015 IMF fiscal Monitor.

And, according to IMF estimates, Iceland’s output gap was actually somewhat larger in 2014 than in 2009. When an economy becomes more depressed it usually results in falling revenues and rising expenditures as a percent of GDP. Not taking this into account might tend to understate the amount of fiscal austerity a country has engaged in (e.g. Greece). Table A3 shows that Iceland’s general government cyclically adjusted balance rose from a deficit of 10.0% of potential GDP in 2009 to a surplus of 2.7% of potential GDP in 2014, or a change of 12.7% of potential GDP.

But even this tends to understate the amount of fiscal austerity that Iceland has engaged in. This is because it includes the increase in spending attributable to rising interest payments on the national debt. To get a proper idea of the amount of fiscal austerity that Iceland has engaged in (i.e. cuts in direct spending and increases in taxes) one has to look at the general government cyclically adjusted primary balance which can be found in Table A4.  Iceland’s general government cyclically adjusted primary balance rose from a deficit of 6.9% of potential GDP in 2009 to a surplus of 6.2% of potential GDP in 2014, or a change of 13.1% of potential GDP.

How does this compare with other countries? The following graph shows the change in general government cyclically adjusted primary balance between 2009 and 2014 for 33 advanced nations, plus the Euro Area as a whole, and the four emerging economies of Croatia, Hungary, Poland and Romania that also happen to be EU members. (It turns out that 2009 is a good base year since the cyclically adjusted primary deficits of most advanced nations peaked that year.)

Sadowski Iceland

By this standard Iceland has done about 30% more austerity than Ireland, over double that of the UK, roughly three and a half times as much as the US, and approximately five and a half times as much as Latvia. The only country that has done more fiscal austerity is Greece.

None of this should come as a surprise. When nearly all the other OECD members were busy implementing fiscal stimuli in early 2009, Iceland (joined only by Ireland) was engaged in a massive fiscal consolidation (see Figure 3.2 and Table 3.1).

In 2012 the Icelandic Finance Ministry, in front of an audience of fellow OECD senior budget officials, patted itself on the back for a job well done.

The scope and scale of Iceland’s fiscal consolidation was truly mind boggling. Real primary expenditures were estimated to fall by 12.7% between 2009 and 2012 (Slide 16). This was accomplished by slashing current expenditures, transfers, and maintenance and investment, and by freezing public sector wages and benefits for a period of four years (Slide 13), during a time when inflation soared due to the 50% depreciation of the króna.

On the revenue side the VAT was raised to 25.5%, which at that time was the highest in the world (Slide 14). The top personal income tax rate was increased from 35.7% to 46.2% (Table 2):

The capital income tax rate was doubled from 10% to 20%, the corporate income tax was increased from 15% to 20%, the social security contribution (SSC) was increased from 5.34% to 8.65% and fishing levies (important in Iceland) were increased. In addition a whole slew of new taxes were imposed (e.g. a net wealth tax, an inheritance tax, a financial activities tax (FAT) etc. etc.)

The bottom line is that Krugman’s implied poster child for anti-fiscal austerity is in reality the advanced world’s second leading practitioner of it. If Iceland’s economy is doing as well as Krugman claims (I have my doubts), then the only real reason it is doing so well (we have yet to see what happens after capital controls are lifted) is relatively steady NGDP growth as demonstrated in Scott’s post.

Thus it seems to me that Krugman’s recent posts extolling the relative economic performance of Iceland are inadvertently strengthening the argument for the ability of monetary policy to wholly offset fiscal policy.

Human senses are wired for survival!

That´s my take from the euphoria that greeted the release of Retail Sales. This headline from the WSJ is typical: Economists See Bright Consumer Outlook:

Consumers are coming out of their shells and heading to the mall. What will keep shoppers spending for the rest of the year are much healthier labor markets, according to economists surveyed by The Wall Street Journal.

An upbeat consumer outlook was the consensus forecast of 66 economists, not all of whom answered every question. The average forecast sees inflation-adjusted household spending climbing 2.7% this quarter and more than 3% in the third and fourth quarters, much better than the 1.8% gain over the winter.

An early sign of the consumer rebound came Thursday with news that retail sales jumped 1.2% in May. Excluding autos, the gain was a solid 1%.


Of course, consumers have been fickle throughout the six-year-long economic expansion. They have spent strongly in one quarter only to retrench soon after.

But the forecasters think a high level of spending will be sustained this year because labor markets are strengthening. According to the average forecast, payrolls should increase at a monthly pace of 221,000 for the rest of the year, a notch above the 217,000 averaged in the first five months. The jobless rate is projected to fall to 5.1% by December from 5.5% in May.

But, the truth is that retail sales has done nothing more than follow aggregate nominal spending (NGDP) into a state of “semi depression”. As long as the Fed keeps AD growing at a ‘miserly’ rate, the “euphoria” is only a reflection of our survival instincts!

Wired for Survival

A Thought-Provoking Op-Ed In Forbes

A Benjamin Cole post

Advances in production and information have created an ongoing surfeit of goods, argues Kevin O’Marah, in a Forbes March 17 op-ed.

O’Marah makes a good case that the incredible U.S. retail network—think WalMart—can easily meet any increase in demand. O’Marah concludes that inflation is dead.  O’Marah could have gone further: thanks to the globalization of the U.S. supply-side, the idea of demand outstripping supply is outdated.

No longer does a Big Steel, or Big Auto, set prices. Steel, autos and consumer goods come from all over the world into the United States, and the domestic market is saturated with product.

With the passing exception of oil (a peculiar market dominated by global thug states), it is difficult to conceive of a product or good in short supply, rationed by higher prices.

Anyway, Inflation Paves The Way To Higher Supply

Supply-side improvements are always a good idea; every sensible economist agrees. That said, when there are “shortages” of a product—say oil—the way to greater supply is often paved by higher prices. Who can deny that higher oil prices led to today’s glut? To become hysterical about inflation every time oil or corn prices rise is to misunderstand the nature and beauty—and effectiveness—of the price signal. Let the price signal work.

Housing—The Exception

Market monetarists and others of late have been more closely examining housing markets, and in general concluding that onerous state and local regulations create some regional shortages, that are in fact settled by higher prices, which could be called “inflation.” In good times, bidding may propel housing prices up in famously attractive U.S. markets along the coasts.

The solution to housing costs, or “inflation,” does not lie in the U.S. Federal Reserve, and to fight housing costs by tight money to suffocate the economy to get rid of a fever.

In fact, there probably is no (political) solution to higher housing prices. Powerful and often wealthy homeowner groups do not want condo high-rises, with ground-floor retail, plopped down into their neighborhoods. Nobody wants more traffic on their streets.

Take the City of Newport Beach, a GOP-enclave in famously conservative Orange County, California. To build a structure of greater than 250,000 square feet there, you need approval…by the city voters. Every well-positioned city in California is much the same. In a free market, there would be a wall of condos along the Pacific Ocean.

Add on, that housing prices in attractive cities probably “should” rise with rising disposable incomes, and as perceived investments. The federal tax code may be  another villain in house prices, and certainly local governments are, but not the Fed.

BTW, if the Fed is causing house prices to explode, how do you explain Detroit?


Has any modern nation prospered by fighting real-estate inflation? And when was the last time the United States faced inflation even above 5%, a rate at which was once met by casual shrugs by most economists?

The Fed is fighting the last war.

Print more money.

Revisionist Thoughts: Was Australia just luckier than most?

This post was motivated by Scott Sumner´s musings about Australia: Australia´s Great Stagnation:

It looks like the Great Stagnation has hit even Australia.  In an earlier post I pointed out that Australian NGDP rose at a 6.5% rate from 1996:2 to 2006:2.  Then we had the Global Financial Crisis, and Australian NGDP growth slowed to . . . er . . . it stayed at 6.5% from 2006:2 to 2012:2.  No tight money and no recession in Australia.

Some important facts about Australia:

1 NGDP and Trend

Revisionist Thought_1

2 RGDP & Trend

Revisionist Thought_2

Notice that when NGDP climbs above trend, RGDP falls below trend!

Zooming in (circles explained later)

Revisionist Thought_3

Revisionist Thought_4

What explains the counterintuitive fact that RGDP falls below trend at the same time commodity prices take off?

Revisionist Thought_5

The rise in NGDP translates into a rise above target in core inflation.

Revisionist Thought_6

The 200 basis points increase in the cash rate (equivalent to the Fed´s FF rate) just goes to show that interest rates are bad definers of the stance of monetary policy. Despite the increase in the cash rate, inflation and NGDP were moving up, indicating monetary policy was “too easy”!

Revisionist Thought_7

With Australia being a commodity exporter, another way to gauge the stance of monetary policy is by comparing the move in the exchange rate to the dollar and commodity prices. Monetary policy is “just right” if a rise in commodity prices is accompanied by an appreciation of the Aussie Dollar (USD/A$) and a fall in commodity prices goes hand in hand with a depreciation of the exchange rate.

The chart below shows that in 2004-07 monetary policy was too loose, consistent with NGDP climbing above trend (and inflation increasing). Monetary policy was tightened in 2011-13, consistent with NGDP converging to trend and inflation decreasing (see circles in NGDP & Trend chart above).

Revisionist Thought_8

At present, NGDP is back on trend (actually just a “whisker” below it). What happens next? Will Australia go the way of Sweden, Israel and Poland, or will it get “smart”?

In the case of Sweden things started unraveling when the Riksbank decided to “prick” a housing “bubble”. According to the FT:

Sweden’s central bank has been lambasted by critics for trying to use interest rates to combat signs of a housing bubble. It lifted rates in 2010 and 2011 as it publicly worried about what it saw as high household debt levels.

In the case of Israel, it may not be coincidence that NGDP began a systematic deviation from trend when Ms Flug took over at the Bank of Israel. Maybe she prefers the role of Finance Minister:

Speaking at a Calcalist conference, Governor of the Bank of Israel said today, “Exceeding the 3% fiscal deficit target will expose the Israeli economy to significant risk and will be liable to harm us citizens. We must show responsibility and take into account the consequences of our decisions over time. Israel’s structural deficit, the deficit not subject to one-time shocks, is already one of the highest in the western world.”

This is what happened:

Revisionist Thought_9

In the case of Poland, it took three years, but in late 2011 Poland finally botched up and went the way of the majority of countries, letting NGDP fall way below trend. They didn´t (correctly) react to the 2007-08 oil price rise, like the US, UK, EZ, etc. and fared well, but didn´t resist when oil prices picked up again in 2010-11, when, among the initial group, only the ECB was dumb enough to react.

Revisionist Thought_10

By talking about house prices, the RBA is tempting the “fate” that hit Sweden and Israel. Scott links to an article in a subsequent post:

The Reserve Bank of Australia’s surprise decision to defer its widely anticipated April rate cut for at least another month might have been influenced by the increasingly pricey housing market, which it regards as posing a real “dilemma”.

This, unfortunately, has been going on for some time. Last September, RBA Governor Glenn Stevens was warning of bubble risk in the current low interest rate environment:

Addressing members of the Committee for Economic Development of Australia (CEDA) lunch in Adelaide, he said monetary policy aimed at encouraging business investment and generating employment amid global economic weakness was in danger of creating a housing bubble in Australia.

And the next chart compares two “bubbles”.

Revisionist Thought_11

Please, Governor Stevens, start thinking smart!