Eurozone inflation ceiling still mostly offsets the good stuff

A James Alexander post

Yet again today we saw the “zero (long and variable) lags” in monetary policy. Central bankers moving markets and thus changing NGDP Expectations happens all the time. It’s perfectly rational too.

JA Draghi

The ECB has been on the front foot for a while this year, especially in the first quarter when it surprised markets with the size, scope and unlimited length of its QE programme. Since the long summer break things have drifted and monetary policy has in effect tightened again. The Eurozone had got caught up in the US tightening concerns as much as anywhere.

Mr Draghi wasn’t happy and made this clear at the press conference today in Malta. The currency duly weakened and stock markets rallied. Although this may have been more due to the hint that US rates will not rise.

However, Nominal GDP growth and thus Real GDP growth cannot get that much better in the Eurozone as a whole while the overarching target remains the self-defeating one of the <2% inflation ceiling. Draghi can prevent tail risks with the QE programme, lower rates for longer and even more negative rates. But it will never be enough to see healthy growth. The inflation ceiling offsets almost all of the good work from the other policies.

Overall, monetary policy is just not that accommodative. Draghi says he and his fellow governors and their staff are working hard:

“the strength and persistence of the factors that are currently slowing the return of inflation to levels below, but close to, 2% in the medium term require thorough analysis.”

Please, Mr Draghi, it is the mandate itself that is the obstacle. In the UK we may be looking soon at the mandate  and there were hints that the European Parliament is also looking into the mandate. At least talk about NGDP Targeting and you can then “Feel The Power” in time for the pre-Christmas release of Star Wars 7.

Is there any ‘goodness’ about Swiss Deflation?

George Selgin thinks so “In Switzerland, Tolerating Deflation isn’t Cuckoo”:

Although the “long deflation” of 1873-1896 was roughly consistent with a productivity norm — albeit one adhered to more by accident than by design — and more specifically with “good” deflation, one rarely witnesses good deflation these days.  The Swiss case is a rare exception.  As Mr. Blackstone reports,

evidence of deflation’s pernicious side effects—recession, weak employment, rising debt burdens—is pretty much nonexistent in Switzerland.  Its economy is expected to expand this year and next, albeit slowly, in the 1% to 1.5% range.  Unemployment was just 3.4% in September.  Government debt is low.

Compared to the US, Switzerland has been a low inflation country, but the recent turn to deflation smacks a lot of too low NGDP growth, as the charts indicate.

Swiss Deflation

The Fed is holding the economy down!

The Peterson Institute for Intenational Economics has a piece titled “The Fed’s Confusion over Interest Rates“. At the end we read:

The Fed insists it wants to raise rates before the end of the year, but markets insist in not believing it, because if one uses the reaction function the Fed has always communicated there is no reason to do it. The markets have followed Bernanke’s teachings and learned the Fed’s reaction function over the years, and have concluded that, in view of the economic outlook, interest rates should not be raised until mid-2016.

If the Fed has changed its reaction function, it should explain it and openly acknowledge that there are factors beyond the inflation outlook that are affecting its decision making. Transparency is critical. If the Fed is not able to explain convincingly why it wants to start raising rates, the risk of failure will be high. The world economy is in transition and developed economies have to replace emerging markets as a source of stability.

The Fed is caught in its own inertia, as it has spent many months preparing the ground for a rate hike in the second half of this year. But the reality is that if one ignores the inertia, there is no good reason to raise rates this year. And, with rates at zero, there is little room to correct mistakes. The Fed is confused, and the cost of this confusion could be very high.

The Fed certainly is confused (and after recent talks by Lael Brainard and Daniel Tarullo, divided). It´s not a question that the costs could be very high, the costs are already rising strongly!

Since the tapering and post tapering, monetary policy is being tightened. No one would notice that from looking at the Fed Funds rate, which has remained at “zero”. Bernanke himself long ago said that to gauge the stance of monetary policy, don´t look at interest rates, look at things like NGDP growth and inflation.

The chart provides clear evidence that according to those two gauges, monetary policy is in tightening mode. The Fed´s revealed confusion only adds to uncertainty and worse outcomes. In other words, the Fed is already failing!

Fed Confused

The economy behaved just a ‘prescribed’ by monetary policy

Econbrowser links to a study by Blinder and Zandi, who develop the counterfactual::

Or, one can appeal to extant estimates of multipliers to estimate how the economy would have performed in the absence of fiscal and monetary stimulus and financial system rescuses. That is exactly what is done in a Blinder-Zandi CBPP study, with the results shown in Figure 1.


My take is simpler. There was an initial massive monetary failure, which allowed nominal aggregate spending (NGDP) to crumble. A belated and timid monetary policy reaction, starting with QE1 breathed a little air into the tire, enough for it to “slowly” roll up the hillside.


I agree that the rescue operation for banks and others, in addition to the timid monetary policy reaction, “saved” the economy from the financial propagation mechanism that continued to punish the economy in 1931/32.

In their exercise, B-Z write:

To quantify the economic impacts of the aforementioned panoply of policies, we simulated the Moody’s Analytics model of the U.S. economy under different counterfactual scenarios. In all scenarios, the federal government’s automatic stabilizers—the countercyclical tax and spending policies that are implemented without explicit approval from Congress and the administration—are assumed to operate. So is the traditional monetary policy response via the Federal Reserve’s management of short-term interest rates, albeit constrained by the zero lower bound

To assess the full impact of the policy response, the “No Policy Response” scenario assumes that, apart from the above, policymakers simply sit on their hands in response to the crisis.

So I wonder what makes the economy turn around so briskly after 2011. The turnaround in March 1933 was the direct and immediate result of a monetary regime change.


A “Follow-the-leader” Monetary Policy Game

Lars has a good short post on China:

Yesterday we got the the Q3 numbers and as the graph shows the sharp slowdown in Chinese NGDP, which started in early 2013 continues. A similar trend by the way is visible in Chinese money supply data.

This is of course very clearly shows just how much Chinese monetary conditions have tightened over the past 2 years and this is of course also the main reason for the sell-off global commodity prices and in the Emerging Markets in the same period.

I suppose it has nothing to do with Janet & Friends “wrongful” monetary policy. Maybe I´m wrong.

Follow the leader

UK Socialists show interest in NGDP Targeting, BoE proxy moans

A James Alexander post

Scott Sumner is both warming up to Bernie Sanders and getting excited by growing signs of acceptance for Market Monetarism. In the UK we seem to be getting both things in the one package.

Writing in the Financial Times our new, “hard-left socialist”, senior opposition spokesman on finance, Shadow Chancellor of the Exchequer John McDonnell, has said he is interested in NGDP Targeting.

McDonnell has created a group of leading, if left-leaning. macro-economists to advise him on macro-economic policy. Their first job is to lead a review of the Inflation Targeting mandate of the Bank of England. The group includes many names familiar to Market Monetarists like Adam Posen, David Blanchflower and Simon Wren-Lewis. We know them because of their willingness to debate about NGDP Targeting and even broadly accept it as at least partially useful – though they all prefer active fiscal policy at the ZLB over what they consider to be unconventional monetary policy.

“The last time the Treasury tweaked the MPC’s remit was in 2013, when George Osborne, chancellor, clarified that the committee need not force inflation back to the target by the fastest possible route if a slower one would be better for growth. We will consider whether such trade-offs should be formalised. And we will look at more radical ideas, such as introducing a target for nominal gross domestic product — a suggestion Mr Carney broached in 2012.”

This is great news.

The diehards at the Bank of England won’t like it. An initial response from one of the leading UK economist who often represents mainstream BoE views was distinctly lukewarm.

Tony Yates even addressed himself to the NGDP Targeting idea:

“I’ve blogged a lot about this before, and haven’t the heart to repeat it here.  Very briefly.  Growth targets would not make a whole lot of difference.  Levels targets rely on being a rational expectations nutcase, and even then would probably be incredible.”

The attack on Rational Expectations is the oddest thing. It’s not clear what his problem with RE really is. It’s very hard to figure out. Yates is clearly a clever guy, but like most central bankers and their supporters, they distrust markets and prefer discretion. Yates seems to think that elite central bankers sitting around a table with lots of different models, lots of data and super-smart intuition is better than clear rules. We only need to ask how that worked out in 2008 to see what was wrong: internal politics, confusion and hopeless or downright counter-productive signalling. To recognise that central bankers were the prime cause of the recession is a step too far for the self-same central bankers and their proxies.

From an earlier anti-NGDP Targeting piece Yates demonstrates clearly the knots he ends up tying himself in when thinking about RE:

“Policymakers at the BoE used an RE model, but when they thought it was relevant, would often adjust forecast profiles by hand afterwards to try to offset what they thought were the effects of rational expectations.  (Highly unscientific and hopelessly imprecise in doing it this way, but well-intended).  However, whether central banks assume RE or not, it’s not a good defence of a regime that it works well in a false world those central banks happen to believe in.”

Who’s the nutcase?

Update. Excellent blog from Ben Southwood at the Adam Smith Institute.

Offset here, offset there, offset everywhere

A James Alexander post

I have been away on vacation. Unlike the BoE’s Kristin Forbes I haven’t come back with a homily about the need to wear suntan lotion as a good analogy for monetary policy. Walking along, or rather up and over, the Amalfi Coast did make me very much acquainted with concrete steps as well as the beautiful views.

The effort of walking up all those steps did set me thinking about monetary offset as my muscles wearied. Analogies of pushing water uphill also came to mind as I lugged several plastic bottles of water around. It made me think of my earlier matrix that tried to distinguish various economic states dependent on the stance of monetary and fiscal policy. While helpful, I think it was also somewhat misleading.

On another view, there is only monetary policy, defined as the value of money relative to real goods and services. All else is just tools: official short term policy rates, IOER, targeting or guidance, QE, fiscal policy.

JA Offset_1

Scott Sumner has been dogged in drawing attention to the fact of “monetary offset”, whereby the tool of expansionary fiscal policy is offset if the overarching policy tool is inflation targeting. Monetary policy will stay tight if the market believes the central bank thinks their inflation target is at risk under the expansionary fiscal policy. The riskiness of an expansionary fiscal policy is moot, but if the market believes the central bank is concerned then the policy will be offset.

Market Monetarists have gone further and shown how the targets morph into ceilings  with terribly depressing results on inflation, but unconcerning to the central bankers.

The theory of monetary offset can also apply to “monetary” tools themselves. The intended help given to an economy from low official interest rates can also offset by those, more important, inflation targets. Paying IOER offsets the impact of low official rates. QE will be offset by strict inflation targeting. Using the targets of “full employment” or “lack of slack”, ie the once discredited Philips Curve, will also offset the benefits of other monetary policy tools.

Formal models like to work with concrete things, like the actual level of official rates, the actual level of employment/unemployment, the targeted “inflation rate”, the actual amount of QE, the actual amount of deficit spending or the actual size of the debt. But all these actuals come into conflict,and can and do offset each other. In Brazil at the moment fiscal expansion is beginning to offset inflation targeting as Marcus Nunes  has recently shown. When that happens the monetary policy is effectively set to high or even hyper nominal growth, most of it or even all of it inflation.

So many tools, so many offsets actually leads to a kind of policy chaos

The big point here is that, more than ever, the monetary policy is whatever society (or the market or economic participants) believes it is, not what officials say it is. Central bank officials like to bang on about “credibility”, and in a way they are right. It is what the society believes about the central bankers’ goals that matters, that influences economic activity: spending, saving, working, investing.

JA Offset_2

If society believes they are poodles of an irresponsibly expansionist and corrupt government then we know what happens. If society believes they are, like today, prisoners to a bankrupt theory like the Philips Curve then the goals will be very unclear and society will grasp at whatever seems to be uppermost in the minds of those in charge. Hence. we see the constant and detailed parsing of every speech or interview given by the policy makers. It is a social position  that many seem to rather enjoy, and even milk for their own private benefit, especially once they’ve left office.

The tidy world chart is too formal. The real world is the tidy world but enveloped in a cloud of expectations about what the future holds for monetary policy, which tools will be pre-eminent and for how long. And this just serves to emphasise the central role of expectations in monetary policy, especially when the tools are so numerous and the policy is so vague.

Keep It Simple Stupid

Market Monetarists believe that the policy makers should go back to basics and simply target stable expectations for the growth rate for the nominal economy, or NGDP forecasts. It’s a highly prudent and responsible policy and very transparent, far more so than targeting inflation, “full” employment  or worse the output gap or “slack”.

The tools by which they choose to achieve that goal are not that relevant.  The central banks can then step out of the limelight and leave economics and politics to debates over micro-economics.

The multiple faces of inflation

The Atlanta Fed´s “inflation project” provides us with alternative measures of CPI inflation. It separates flexible prices from sticky prices and, in addition, subdivides both the flexible and sticky components into their core measures. It also provides the sticky measures excluding shelter inflation.

Yesterday, the St Louis Fed tweeted the following chart, indicating that headline sticky annualized CPI inflation had reached 3.5% (Oh my God!) in September.

Inflation Faces_1

In a recent post, Kevin Erdman arrives at a very sensible conclusion:

This week, expectations of a Fed rate hike have moved back from the December meeting toward the March meeting.  That would be helpful, given that outside of the rent inflation caused by the housing supply depression inflation continues to be at a 50 year low.

In the meantime, considering the decade long depression-level behavior of housing starts, calls for monetary contraction because of inflation that is largely the product of rising rents are indefensible.

My point is that a target that has “multiple faces” is a dangerous target indeed!

In addition, presenting the multiple-faced target in a noisy format (annualized rates), is “criminal”.

Let´s see some examples.

Superimposing the headline sticky year on year (YoY) rate to the headline sticky annualized CPI inflation tweeted by the St Louis Fed, we get a very different picture of trend inflation.

Inflation Faces_2

And comparing the sticky YoY Core-CPI with the sticky YoY Core CPI-Ex shelter we see the reason for Kevin´s conclusion.

Inflation Faces_3

Note: House Starts:

Inflation Faces_4