Even a Great Stagnation requires planning!

In a recent post, Nick Rowe gives a short reply to DeLong´s long post:

Suppose you lived in a world where, whenever the price level fell/rose by 1%, the central bank responded by decreasing/increasing the base money stock by the same 1%. A world like that would not have a long-run Omega point, from which some present equilibrium can be pinned down by back propagation induction.

That’s the sort of world we live in, under the inflation targeting regime. A drunk doing a random walk does not have a destination, from which we can infer his route by working backwards. His long run variance is infinite.

Stop arguing about whether a market macroeconomy is or is not inherently ultimately self-equilibratingIt’s a stupid question. It depends. It depends on the monetary regime.

Instead, let’s solve the stupid question by adopting a nominal level path target.

It´s even worse. If you don´t plan, i.e. provide a “destination” for it, even a “Great Stagnation” becomes “random”!

The charts illustrate.

Destination Required_1

Destination Required_2

The first shows why the “Great Moderation” happened. The “destination” was the trend level path, to which the economy returned after monetary policy mistakes dislodged it. Observe what many called a period of “too low for too long” rates doesn´t look like that at all!

In the second chart, we note that after the Fed pulled the economy down, it has been satisfied in keeping it down, i.e. “depressed”. It could come out and say that that´s the path (“destination”) it wants it to follow. But no, by saying it´s about time to “tighten” policy, it is implying that the path might be even lower. Is it A? Is it B? The truth is no one knows!

It certainly does not appear to be X!

Related: David Glasner, Scott Sumner

The Fed Can Suffocate The Economy Under NGDPLT Too

A Benjamin Cole post

Recently there has been a hubbub in Market Monetarist circles that prominent Democratic economist Larry Summers, generally a Keynesian type, tipped his hat to nominal GDP level targeting, or NGDPLT.

Well, at least in preference to inflation targeting or IT.

Said Summers at latest report, “I didn’t quite endorse NGDP targeting. I said that I would prefer a shift to NGDP targeting to a shift up in inflation targets.”

Why The Summerian Reservation?

That Summers endorsement of NGDPLT was hesitant and oblique may not be surprising. He is, after all, a Keynesian, and believes in federal deficit-spending.

But Summers may also have entirely human and sensible reason for his backhanded support of NDGPLT—that is, a central bank can just as well suffocate an economy under NGDPLT as under IT.

Indeed, the U.S. Federal Reserve has kept the U.S. economy growing at a fairly steady nominal rate since 2008. The problem is, the economy is blue in the face from monetary asphyxiation.

Remembering Milton

Forgotten today is the Milton Friedman of October 1992, when CPI inflation was 3.2%, and real GDP was expanding at about 4.0%.

Yet the title of Friedman’s October 1992 op-ed in The Wall Street Journal, after the Fed had dropped interest rates from 10% to 3%? It was: Too Tight For A Strong Recovery

That 1992 Friedman op-ed speaks worlds about the inflation-obsessed state of modern economists.

Market Monetarists of 2015

Yet some Market Monetarists recommend straitjacket nominal growth rates, succumbing to the present-day peevish fixation that inflation—even moderate inflation—cannot be endured.

We can hope someone will further flesh-out Summers’ sentiments regarding NGDPLT. But whatever Summers’ take, I hope Market Monetarists  do not mimic the inflation-nutters.

It doesn’t really matter if inflation is 1% or 4%.

What matters is robust real growth.

Kuroda nails it!

In the conclusion to “Opening Remarks at the 2015 BOJ-IMES Conference Hosted by the Institute for Monetary and Economic Studies, Bank of Japan” Governor Kuroda says:

Every word and deed of central banks around the globe has been drawing more attention as the diverging directions of monetary policy among advanced economies become apparent. The issues I have raised so far are all complex, and there are no quick, definitive solutions for them. Nevertheless, I strongly believe that, at this one-and-a-half day conference, we will address the issues we currently face and find our way forward through lively discussions.

I trust that many of you are familiar with the story of Peter Pan, in which it says, “the moment you doubt whether you can fly, you cease forever to be able to do it.” Yes, what we need is a positive attitude and conviction. Indeed, each time central banks have been confronted with a wide range of problems, they have overcome the problems by conceiving new solutions. I am sure that we all can share a conviction backed by our collective experience and wisdom. I would like to close my remarks now as we ready ourselves for discussion.

Sense & Nonsence

Unfortunately, “nonsense” “gallops ahead”!

Fed’s Bullard Upbeat on Economy, Sees No Need for New Stimulus (Nov 14)

Fed’s Bullard Still Wants Fed Rate Rise in Late First Quarter 2015 (Nov 14)

Fed’s Bullard Still Pushes for First Quarter Rate Rise (Jan 15)

Fed’s Bullard Eager to Raise Rates Soon (Jan 15)

Fed’s Bullard Shrugs Off Inflation Expectations Drop, Favors Rate Rises (Feb 15)

Fed’s Bullard: Delaying Interest-Rate Increase Much Longer Creates Risk (Feb 15)

Bullard: Now May Be Good Time to Start Raising Rates (Mar 15)

Bullard “delirates”:

May 28, 2015 01:03 p.m.

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.

Bullard not “in a hurry” any longer:

June 3, 2015 05:15 p.m.

It is appropriate to think the Federal Reserve won’t raise interest rates at its June policy meeting following a recent run of weak economic data, Federal Reserve Bank of St. Louis President James Bullard said Wednesday.

But, the “old Bullard” comes back as “Orphanides”:

Mr. Bullard spoke with reporters before Athanasios Orphanides, former head of the Cyprus central bank and an ex-Fed economist, delivered the St. Louis Fed’s annual Homer Jones Memorial Lecture. Mr. Orphanides told reporters he isquite concerned that the Fed is way behind the curve already” in terms of tightening policy.

Krugman´s answer to DeLong: We´re in a “Postmodern Economy”!

Krugman responds to DeLong´s “Backward Induction Unraveling”:

One more thing: Brad says that we came into the crisis expecting business cycles and possible liquidity-trap phases to be short. What do you mean we, white man? Again, we had the example of Japan — and even aside from Rheinhart-Rogoff, it was obvious that Postmodern business cycles were different, with prolonged jobless recoveries.

In the end, while the post-2008 slump has gone on much longer than even I expected (thanks in part to terrible fiscal policy), and the downward stickiness of wages and prices has been more marked than I imagined, overall the model those of us who paid attention to Japan deployed has done pretty well — and it’s kind of shocking how few of those who got everything wrong are willing to learn from their failure and our success.

He should have read my answer to him 4 years ago – THERE´S NOTHING “POSTMODERN” ABOUT THIS RECESSION, IT´S A FED ENGINEERED DEPRESSION where I conclude:

By calling this a “postmodern” recession, Krugman is likely saying that the only way-out is through fiscal policy. But that has been tried (according to Krugman the dosage was not big enough) and the collateral effects have been pretty damning.

What all this discussion does is to allow the Fed to stay on the sidelines. After all, it had not much to do with anything that´s been happening. It´s “Postmodern”!

(Note: Postmodernism is a philosophical movement… it holds realities to be plural and relative, and dependent on who the interested parties are and what their interests consist of.)

Let´s put up some images. The first set shows that the both the intensity of the drop in employment and the speed of increase are associated with what happens to aggregate nominal spending (NGDP), something the Fed closely controls, irrespective of where the interest rate happens to be.

Postmodernism fallacy_1

Note that things are much more subdued after the Volcker adjustment phase (1981-85). What follows is the “Great Moderation”, when NGDP grows at around 5.5% along a stable level trend.

For example, after the 2001 recession, which was quite shallow in terms of RGDP growth (never becaming negative), NGDP growth lingers for some time below the 5.5% rate of growth. Therefore, employment behavior looks like the base of a wide (shallow) bowl (“jobless recovery”)

The present cycle is another animal altogether. The Fed never had its heart in pulling nominal spending up to a reasonable level, keeping its growth stable at “slow speed”. Employment takes a deep dive and comes back at a speed consistent with the low spending growth.

The next set shows the behavior of inflation over the same periods. The pattern is easy to see. The Volcker adjustment is successful in bringing inflation down. Later, Greenspan places it on (or close to) the 2% “target”, mostly by keeping spending growth close to the trend level path. Then, Bernanke comes along and apparently decides that´s “way too high”. To keep inflation “lower than low” the Fed pulls the hand brake to slowdown nominal spending growth.

Postmodernism fallacy_2

The last set illustrates nominal and real growth over the episodes. When you look at the bottom right image, you get the hang of why thinks are so glum.

Postmodernism fallacy_3

The “novelty” of the situation depicted in the bottom right image of all the charts is what explains why people’s expectations of the length of the what Krugman calls the “liquidity-trap” phase were “miles off”, and why DeLong says “backward induction unraveled”.

Unfortunately, very few fingers point at the Fed!

A “solution” to DeLong´s “back-propagation induction-unraveling” problem

Brad DeLong has a (way too) long post. But the end gives the gist of his argument:

The problem is that the macroeconomics that Paul Krugman learned at Jim Tobin’s knee wasn’t just 1930s-style Hicks-Hansen Keynesianism. It was the 1970s adaptive-expectations Phillips Curve neoclassical synthesis–nearly the same stuff that I first learned at Marty Feldstein and Olivier Blanchard’s knees in the spring of 1980.

That is the framework that Marty is using now, and that generates his puzzlement. That framework had a short run of 1-2 years, a medium-run transition-dynamics phase of 2-5 years, and a long run of 5 years or more baked into it. You cannot–or at least I cannot–just throw away the medium run transition dynamics* and the declaration that the long run Omega Point is five years out, and say that mainstream economics does well. You need to explain why the back-propagation induction-unraveling worked at its proper time scale in the 1970s and the 1980s, but is nowhere to be found now.

And so I am much less confident that I have solid theoretical ground under my feet than Paul Krugman does.

The “solution” (or “explanation” for the absence of the “back-propagation induction-unraveling”), towards which even Brad´s pal Larry Summers is warming up to is….NGDP-Level Targeting. In fact, the Fed has (implicitly) established a much lower level target for NGDP, a level that is consistent with Summers´ “Great Stagnation” thesis.

So I hope that when Summers says “I didn’t quite endorse NGdp targeting. I said that I would prefer a shift to NGdp targeting to a shift up in inflation targets”, I also hope he has a level target at the back of his mind!

HT Scott Sumner

Bernanke´s blogging is trite!

Yesterday, Bernanke had another “the Fed did great” type post, “Monetary policy and inequality”:

Since the financial crisis the Federal Reserve has aggressively used monetary policy, including unconventional policies like quantitative easing, to promote job growth and keep inflation near the Fed’s 2 percent target. Progress has been made, even if it has been slower than we would have liked. Unemployment, which peaked at 10 percent in 2009, is now 5.4 percent and falling, and inflation appears gradually to be moving toward its target.

In this post I’ll look at another critique, that the Fed’s monetary policies have exacerbated inequality—a proposition that happens to be the subject of a June 1 symposium at the Brookings Institution’s Hutchins Center on Fiscal and Monetary Policy.

And concludes:

Monetary policy is a blunt tool which certainly affects the distribution of income and wealth, although whether the net effect is to increase or reduce inequality is not clear. More research will be needed to untangle and measure the many channels through which these effects are transmitted. But the (uncertain) distributional impact of monetary policy should not prevent the Fed from pursuing its mandate to achieve maximum employment and price stability, thereby providing broad benefits to the economy. Other types of policies are better suited to addressing legitimate concerns about inequality.

When I wrote this post, I had Bernanke´s ‘platitudes’ in mind, so I was very pleased to read Steve Randy Waldman´s “reality check”:

The expansion of inequality since 1980 is a devil with many fathers. But it was not an inexorable fact of nature. It was the product of politics and policy and institutional arrangements that stripped US workers of bargaining power, and stripped US capital of tax obligations and ties to community. The Fed played a role in those arrangements, and not an unimportant role. Yes, post-crisis, post-TARP, in the context of a dysfunctional Congress, easy money has been the best available policy, even on distributional grounds. Yes, the Fed should continue to err on the side of monetary ease, despite the harm done by asset price inflation to social cohesion and to the information content of financial markets. If anything, the Fed’s policy ought to have been even easier, as it would have been under a wiser NGDP level target, for example.

But monetary policy prior to the crisis, and decisions made at the Fed during the event, are not remotely innocent of the catastrophic stratification we face today. Bernanke judges himself and his former institution too narrowly and too generously.

Pearls of unsound wisdom

If Stanley Fischer is a representative agent for Central Bankers thinking, God help us!

From his speech “What have we learned from the crises of the last 20 years?”:

Monetary policy in normal times.6 In normal times, monetary policy should continue to be targeted at inflation and at output or employment.7 Typically, central bank laws also include some mention of financial stability as a responsibility of the central bank.

Another issue that remains to be settled is that of the possible use of monetary policy, i.e. the interest rate, to deal with financial stability.

Active fiscal policy.8 There is a great deal of evidence that fiscal policy works well, almost everywhere, perhaps especially well when the interest rate is at its effective lower bound.

We should not make the mistake of believing that we have put an end to financial crises. We can strengthen the financial system, and reduce the frequency and the severity of financial crises. But we lack the capacity of imagining, anticipating and preventing all future financial sector problems and crises. That given, we need to build a financial system that is strong enough to withstand the type of financial crisis we continue to battle. We can take some comfort–but not much–from the fact that this crisis was handled much better than the financial crisis of the Great Depression. But it still imposed massive costs on the people of the United States and those of other countries that were badly hit by the crisis.

Confidence in the financial system and the growth of the economy has been profoundly shaken. There is a lively discussion going on at present as to whether we have entered a period of secular stagnation as Larry Summers argues, or whether we are seeing a more frequent phenomenon–that recessions accompanied by financial crises are typically deep and long, as Carmen Reinhart and Ken Rogoff’s research implies. Ken Rogoff calls this a “debt supercycle”.

One reason we should worry about future crises is that successful reforms can breed complacency about risks. To the extent that the new regulatory and supervisory framework succeeds in making the financial system more stable, participants in the system will begin to believe that the world is more stable, that we suffered a once in a century crisis, and that the problems that led to it have been solved. And that will cause them to take more risks, to exercise less caution, and eventually, to forget the seriousness of the problems we are confronting today and will confront in the future.

This is a process that will one day lead to an unhappy result. You, the regulated, and we, the regulators, will have to work very hard, for a very long time, and then keep on working hard, to reduce the frequency and magnitude of those future crises.

In other words, given that the major lesson for central banks – don´t let NGDP become unhinged – wasn´t even considered, my take is: “we´re screwed”!

Monetary policy for the present depression, not for the next recession

At Bloomberg View, Clive Crook has a pretty depressing piece – “Monetary Policy for the Next Recession”:

By pre-crash standards, the big central banks have made and continue to make amazing efforts to support demand and keep their economies running. Quantitative easing would once have been seen as reckless. The official term of art — unconventional monetary policy — tacitly acknowledged that.

But QE isn’t unconventional any longer. It mostly worked, the evidence suggests. The world avoided another Great Depression. Yet even in the U.S., this is a seriously sub-par recovery; growth in Europe and Japan has been worse still. Now imagine a big new financial shock. It’s quite possible that all three economies would fall back into recession. What then?

And concludes:

What if ordinary monetary policy isn’t enough? What if central banks can’t discharge their inflation-target mandate without a hybrid fiscal-and-monetary instrument? QE has already posed that question — it’s a hybrid too — but in a much more subtle way. When the discussion turns to the Fed sending out checks, the issue is impossible to ignore.

It needs to be addressed. Independence for central banks only makes sense if they have the means to do the job they’ve been given. At the moment, they’re dangerously under-equipped.

He shouldn´t be enquiring about monetary policy for the next recession. All should be focused on monetary policy for the present depression”.

It´s amazing how many have been sold on the idea that the Fed is “out of ammo” or, equivalently, “dangerously under-equipped”.

The fact is that the Fed is not working it´s “firehoses” as it could. The only plausible answer to the “puzzle” is “because it chose not to”!

The charts below depict inflation (headline & core PCE) over different periods. This is followed by the chart depicting nominal spending (NGDP) growth (the Fed´s “firehose”) over the same periods.



The “Great Inflation” goes hand in hand with high and rising NGDP growth, i.e., the Fed is “inflaming” the economy.. Thereafter there is the “Volcker-Greenspan Adjustment” leading to the “Great Moderation”, which extends to 2007, a period during which, for much of the time, the Fed provides the “right” amount of “liquidity”.

Bernanke´s Fed thought that amount was “too much”. First, it “closed the taps” and then opened them up but with much less “water pressure”, insufficient for the “spending grass” to grow to heights it had reached during the “GM”!

This very simple story is sufficient to guide monetary policy. First to enable the economy out of the depression and then keeping it from falling into another!