On the CPI

A James Alexander post 

We have written on the causes of the oil price collapse and why it isn’t very good news, mostly just a consequence of falling AD, or at least a lot less fast growth in AD than expected.

US CPI showed it bouncing along the bottom again in November 2015 .Yet we have to put up with the usual charts of CPI excluding volatile items like food and energy – or anything not going up fast enough to prove the inflation-phobics right.

When CPI is high this asymmetry of reaction is sickening as the inflation-phobics worry about the public being fooled by temporarily high oil prices (or whatever) into thinking a high headline will translate into an unanchoring of inflation expectations. Unanchored inflation expectations are, apparently, incredibly dangerous as they are assumed to directly drive inflation into a never-ending upwardly vicious circle. Only counterproductively aggressive Fed action could prevent this situation from getting out of hand.

In fact, successful monetary policy should un-anchor inflation expectations: how else will velocity of circulation be driven upwards to drive NGDP higher when necessary? It’s a feature of monetary policy not a bug. It is also known as the hot-potato monster.

When headline is low all the experts “know” it’s going to bounce back and few worry about the downside of unanchored inflation expectations. Suddenly the public is trusted to keep their expectations “well-anchored”. Mean reversion is a fact, isn’t it?

This is all highly confusing. But will headline inflation really bounce back up as the Fed and mainstream macro forecast? For sure, as the drops in energy prices must eventually come to an end they must also eventually drop out of headline inflation indices. But if the energy price drops are mostly a symptom of weak demand, as Market Monetarists suspect, then at least part of the faster rising prices in other parts of the economy are also temporary as consumers resources are only redirected in a one-off move, and those non-energy prices must also slow. “Core CPI” will thus fall back to headline CPI and not the other way around.

One way to look at this is to assume 100 total money units and that velocity is constant. Assume 20 units are of money are spent on food and energy and 80 on “other items”. If the price of food and energy drops by 25% and the demand curve is inelastic, 15 units will be spent on food and energy and 5 units redirected to chasing “other items”. If there is no additional money injected into the economy the relative increase in demand for “other items” will be seen as just a redirection of resources. No new “other items” are produced and the producers of the “other items” will just take the gain off the food and energy producers, thank you very much. The overall price level will remain unchanged as will overall production.

If we constructed a core “other items” price index then we would see inflation of nearly 6% (5/85). But should monetary policy really be changed just for a core items index temporarily inflated by a fall in prices elsewhere in the economy? Of course not.

The numerous alternatives for core inflation show a lovely, but inevitable, range around the headline 0.5%, and you can make a good case for any of them. Shelter is a particularly good candidate to be excluded given the complexity of creating a reliable index of actual rent for a whole economy and the even tougher task of creating an index of Owners Equivalent Rent for the majority of households who are owner occupiers. This latter group’s assumed benefit takes up 25% of the CPI basket with their “benefit in kind”. Excluding shelter, inflation was a negative 0.8% YoY in November 2015. Sure “services” inflation is 2.5% but services less shelter is only 1.8%. And only 30% of the total basket.


It is the same for regions of the US. Some metro areas have inflation over 2.6% YoY, but so what? Others are in deflation. It’s one economy, one aggregate. Some go up, some go up less, some are flat and some go down. How could such a large economy as the US be anything else?


Those who focus at present on non-food and energy inflation are kidding themselves about an impending inflation take-off given NGDP is rapidly slowing and the Fed has been on a passive tightening bias for a year or more and is now actively tightening.

James, the commodities expert

A James Alexander post

The Market Monetarist view on the reasons for the oil price has been discussed by Marcus NunesDemand fell as global growth has slowed, or at least risen a lot less fast than expected. The demand curve shits to the left as in the chart. But there is another element, supply conditions that have worsened the fall.

The oil supply curve is driven by a lot of things, but two of the biggest are simple cost of production and then the politics of production.

Most commodity cost curves show a long flat line where representing all the existing cheap plays, oil is no exception. And then the curve rises more or less quickly as unconventional or just new, unexplored/low invested capital areas are stuck on the curve. Shale oil is a great example, Artic oil another.

The shape of the cost curve tells us that if the market is in equilibrium on a steep part of the cost curve, a small shift in demand can have quite devastating consequences on the price (Phase One, equilibrium 1 to equilibrium 2).

And then when this happens the politics of oil kicks in as sovereign producers (think Saudi Arabia, Russia and Venezuela) cannot accept for all sorts of reasons less production/less revenues and so shift their production strategies and pump more oil at the lower prices. These changed strategies cause the oil supply curve to shift to the right and the oil price spirals lower (Phase Two, equilibrium 2 to equilibrium 3).

JA Oil

Add the Iraqi, Kurdish and Iranian increases in oil connectivity and it just adds fuel to the fire of falling oil prices and rightward shifting supply curves (pardon the pun).

It’s not the complicated to explain post hoc. Predicting beforehand means predicting monetary policy and the course of international relations, and that´s tough.

The Fed insists in hanging on to a wrong model

As the R-Day (that´s rate rising date) approaches, we read in The Mystery of Missing Inflation Weighs on Fed Rate Move that:

Federal Reserve officials this week are expected to raise interest rates for the first time in nine years on the expectation that employment and inflation will hit targets reflecting a healthy U.S. economy.

But Fed officials face a troubling question: Jobs are on track, but inflation isn’t behaving as predicted and they don’t know why. Unemployment has fallen to 5%, a figure close to estimates of full employment, while inflation remains stuck at less than 1%, well below the Fed’s 2% target.

Central bank officials predict inflation will approach their target in 2016. The trouble is they have made the same prediction for the past four years. If the Fed is again fooled, it may find it raised rates too soon, risking recession.

Why don´t they let go of their misleading model, instead of hanging on?

According to former Fed staffer Jon Faust:

“We thought we figured out macro policy, and we could deliver low, stable inflation and stable output and low unemployment and all things good.”

The financial crisis deflated that confidence. Confronted by low inflation and sluggish economic growth, the U.S. and U.K. nearly seven years ago—and the eurozone three years later—slashed interest rates to near zero.

But they got low stable inflation, stable output and (now also) low unemployment. Why, then, aren´t they happy?

The problem is that the LEVEL of inflation and real output stability is too low! And, as the charts show, that´s because the LEVEL of NGDP growth, although also stable, is nevertheless too low to provide an inflation rate closer to target and a more robust real output growth (and a more convincing low rate of unemployment that is not so dependent on low rates of labor force participation).

Hanging on

Let´s Hang on (to what we´ve got)

Donald Trump, Courtesy Of The Federal Reserve

A Benjamin Cole post

America’s chattering elites cannot say enough bad things about GOP presidential candidate Donald Trump, the billionaire celebrity real-estate developer. He is decried as xenophobic, economically clueless, a buffoon.

Among his cardinal sins, Trump bashes Chinese imports and 13 million illegal immigrants, most of whom are in the U.S. seeking work, but who lack protection of law.

Meanwhile, the Federal Reserve has suffocated the U.S. economy for at least eight years, while all along some Fed officials rhapsodized about zero inflation. Tens of millions Americans lost jobs or left the labor force.

So what see the American middle- and working-classes? They see Wal-Mart full of Chinese goods, foreign cars clogging the roads, weak job markets, feeble economic growth, and (at least) 13 million Third Worlders who want American jobs. The Rust Belt is so old it is passé to mention it.

Then average Americans hear from established party leadership how wonderful immigration is, and that even illegal immigration must get a free pass as it is impossible to do anything about it, and that free trade makes your life better. Why, a wall across the border would cost $6 billion, too much money. (BTW, federal outlays in last fiscal year were $3.59 trillion).  The GOP party hails tight money.

Then Mr. and Mrs. America see Donald Trump.  Egads, the question is not, “What is propelling Donald Trump?” but rather, “Why hasn’t Trump effectively won this election already?”

If a central bank chooses asphyxiation as the norm, are voters wrong to seek the protection of socialism from unfettered free markets? Or a candidate who talks about what they see?


Trump should be winning easily, but he has kneecapped himself at every turn. Instead of legitimately questioning the role of illegal immigrants in U.S. job markets, Trump denigrates the motives of Mexicans border-hoppers, most of whom only want jobs. Trump pointlessly belittles women, a huge voting block, to say the least. He alienated natural ally of Fox News. He wantonly castigated Sen. John McCain’s war record. Trump’s latest miscue, of course, was to advise Moslem immigrants be kept out of the United States. And lastly, Trump has dropped only faint come-ons to the big GOP-bloc of evangelical voters, a mysterious blind spot.

And yet Trump still dominates the GOP field.


Because Trump gets it: Tight money, large-scale immigration and free trade have not resulted in higher living standards for a big swath of Americans, certainly not if the Fed is going to perma-suffocation as their default mode. You have to be blind not to know illegal immigrants work for the wealthy, as maids, nannies, gardeners, in restaurants, and for agri-business. The middle class can’t afford such luxuries, and rarely owns farmland. Immigrants have crowded the U.S. unskilled and semi-skilled job markets—a world invisible to the chattering classes.


The Fed has helped bring about Trump, but unfortunately Trump seems to understand little about monetary policy, even though he is a real estate-developer. He might understand city zoning and its effects on housing costs, but again he has not said as much. It is sad to see such an irreverent and potentially positive national character gut his own campaign through ugly, hurtful, pointless and divisive barbs at one voting group after another.

It is even sadder to consider that the other contenders for America’s highest office offer less.

PS Yes, Kevin Erdmann’s pioneering work on housing costs is very important. Yes, Trump is a bit of a “Trumpenstein”—the right-wing has scare-mongered for generations about overseas threats and terrorism. So, Trump says he will answer the terrorists with steel. But at the core of Trump’s appeal is that he appears to offer a solution to weak job markets (suffocated by the Fed).

An AD shock spits in their faces but they don´t feel it!

This is how insensitive FOMC participants are. Typical comment:

From Vice Chair Stanley Fischer:

“I’m not very worried,” Fischer told an audience at the Council on Foreign Relations. “The lower inflation that we’ll get from the lower price of oil is going to be temporary.”

He also said lower oil prices were “a phenomenon that’s making everybody better off.”

He gets it wrong on both counts!

The chart shows daily 10-year breakeven inflation and oil price.

Spit in the face_1

Between mid-2003 and mid-2008, there were two back to back significant oil shocks, with prices more than quadrupling over the period.

Note that despite the strong increase in oil prices, inflation expectations remain stable, even falling and becoming more stable during the second leg of the shock.

The reason the oil shock did not affect inflation expectations will be seen below.

Notice, however, that when a gargantuan negative demand shock hits, oil prices and inflation expectations tumble.

Later, when the environment turned “peaceful” again, oil prices stabilized at a high level and inflation expectations fluctuated quite a bit, but showed no trend, responding to the on/off nature of monetary policy (the QE´s). And when the taper begins, inflation expectations “settle down”.

In mid-2014, oil prices and inflation expectations drop significantly. This is consistent with a negative demand shock. In this case the oil price drop is not “making everybody better off”, but is a reflection of reduced nominal growth expectations, “making everyone worse off”!

When I put up the chart showing NGDP growth, things become clear.

Spit in the face_2

The reason rising oil prices did not increase inflation expectations in 2003-08, is due to the fact that, contrary to what happened in the 1970s, NGDP growth remained stable (in the 70s it showed a rising trend). Interestingly, in 1997 Bernanke had said that the impact of an oil price shock depended on the behavior of monetary policy!

As soon as Bernanke takes over at the Fed, NGDP growth drops, which is consistent with the fall in inflation expectations observed in the first chart. When NGDP growth sinks, so does inflation expectations and oil prices. This is the prototype negative AD shock.

More recently, the Fed has talked a lot about policy “normalization”. But the simultaneous fall in inflation and inflation expectations make them sound “funny”. To counter that impression, they allege that the low inflation observed is a temporary thing, associated with the fall in oil prices, and that this effect will soon “dissipate”. And in order for the Fed not to fall behind the (inflation) curve, they have to “act” now!

They miss the fact that the joint behavior of oil prices and inflation expectations is reflecting the fall in nominal growth expectations. In fact, since the middle of last year, monetary policy, as gauged by NGDP growth has been tightening. But our genius monetary policy makers think monetary policy has been extremely accommodative!

On the 16th they are likely to throw salt in the wound. Any pain will likely be temporary because the economy has been “duly prepared”!

When a blip denotes “strength”!

The “reasoning from a price change” mistake # 5432

Diane Swonk ‏@DianeSwonk  2h2 hours ago

Core retail sales strong as saving at gas pump fueled some eating out and drinking and holiday purchases at sporting goods stores

As the chart shows, that doesn´t sound right! Otherwise, retail sales growth, core or otherwise, should have climbed a lot over the past year!

Diane Swonk_1

What´s really going on is that AD growth is faltering.

Diane Swonk_2

Reasoning from a price change will set you on the wrong path!

According to the WSJ´s Boost From Oil-Price Drop Is Elusive:

When oil and gasoline prices began to tumble in mid-2014, experts widely expected it would jolt spending by U.S. consumers and businesses. It hasn’t turned out that way.

Instead, the pace of business investment has slowed significantly, due to drags from weak commodity prices, a strong dollar and concern about the global economy. Consumer spending, meanwhile, has been uneven, with car and home sales up, but inflation-adjusted spending at retailers sluggish since the middle of this year.

Now, oil and commodity prices are showing still more weakness, with wide ramifications to U.S. industry and the Federal Reserve.

Just an example of the gross error: Fourteen months ago, the Economist´s Buttonwood wrote “Blessing in Disguise”:

WHEN Winston Churchill, having led Britain to victory in the second world war, was defeated in the 1945 general election, his wife Clementine remarked that it might be “a blessing in disguise”. If so, the great man replied grumpily, it was “very well disguised.”

Could the same be true of yesterday’s market sell-off? Some investors were arguing the case yesterday. Eric Lonergan of M&G, an investment firm, tweeted that

Falling yields and oil price (are) far more of a stimulus than recent data is negative. Expect growth momentum to improve.

Certainly, lower oil prices are a tax cut for western consumers. Although, of course, the result is an income loss for oil producers, the marginal propensity to consume of consumers (as it were) is higher and this helps demand.  Rising oil prices have been a harbinger of recession, whether in 1973-1974, 1979-1980 or 2007. Lower government bond yields are a help, to the extent that they also bring down corporate borrowing costs.

Isn´t it confusing? Oil prices fell largely because oil demand fell due to contracting economic activity. So it´s not at all like a tax cut! In the 2000s, prior to 2008, oil (and commodity) prices were rising AND the world economy was booming. Is that like a tax hike or reflects greater oil demand?

In the 1970s, oil prices were rising because oil supply was constrained. That felt like a tax increase, so economic activity contracted.

Falling yields were also a reflection of falling NGDP growth expectations, and therefore cannot be a source of improvement in “growth momentum”!

Circular logic gets you nowhere! Maybe only to a misguided rate hike!

A UK case against NGDP Targeting turns mostly on the alleged quality of the data

A James Alexander post

We have already posted 0n the growing debate in the Euro Area on NGDP Targeting. The first of three papers was leaked in September and Scott Sumner commented  on its positive case for NGDP Targeting. The other two papers presented to the European Parliament argued against. The first was from a French team that we have already dealt with, the second is by Andrew Hughes Hallet (AHH) of the University of St Andrews.

The case for NGDP Targeting

AHH first sets out some weak arguments for NGDP Targeting and then criticises each one in turn. It may just be me but I got the feeling Hughes Hallett’s heart was not in the game. It seemed to consist mostly of arguing that Inflation Targeting or a revised version of the Taylor Rule was superior. So the case “for” starts with this not so open-minded assumption:

“It is undeniable that nominal income targets will deliver worse inflation outcomes on average than a single (inflation) target regime or an inflation focussed Taylor rule.”

It is unclear why this should be so when you consider the actual, even if unintended, consequences of IT or an IT-focused Taylor Rule. Theory may be one thing, but practice delivers something else. IT targets have become rigid ceilings delivering very poor outcomes for inflation, on the low side. Where has Hughes Hallett been for the last few years?

More from the case “for”:

“So, to say that nominal income targeting is suitable is not to say that better rules cannot be found, especially when some flexibility is needed.”

Well, you could adopt flexible NGDP Targeting too. All he is really saying is that flexible rules are flexible, and this may be a good thing.

But what exactly is a flexible rule? Flexibility risks huge discretionary mistakes, as when “inflation nutters” (arguably Trichet) or “macropru nutters” (arguably Mervyn King, or even Ben Bernanke’s Fed) are at the monetary controls. The phrase actually comes from a (gated) Meryvn King paper arguing most central banks weren’t “inflation nutters” quoted favourably by the French team.

Hughes Hallett is a classic example of the strange and strong desire of the mainstream macroeconomics profession to not even consider the possibility of gross errors by central banks in recent times. I suppose it is still much more than their jobs are worth to challenge openly central bank authority.

“A positive demand shock for example will raise both incomes and prices. Higher interest rates, the response of inflation targeting, is the right response for both problems. A nominal income targeting rule will react the same way, although possibly more vigorously because it is acting against both excess prices and greater output. This raises the possibility of overcompensation and induced instability.”

But what is this “positive demand shock”? It’s hard to think of one except perhaps a fiscal policy expansion, but these need to be seen as permanent and not likely to be offset by monetary policy tightening as usually happens. In any case it’s unclear why higher (presumably real) income is seen as a “problem”. It’s a good thing, isn’t it?

It’s hard to bring about a permanent overshoot in nominal income that needs correcting that is not caused by some previously easy monetary policy. Real events don’t cause permanent inflation or excessive nominal growth, only monetary authorities can achieve this outcome.

“Nominal income targeting can be expected to help limit asset price bubbles.”

I’ve never heard this claim made by advocates of NGDP Targeting. However, this is a good thing for Hughes Hallett.

The case against NGDP Targeting

Having turned a weak case “for” NGDP Targeting into the case against and thus not really given a fair hearing to NGDP Targeting Hughes Hallett moved to its drawbacks. There seems to be only one as far as I can judge:

[paraphrasing] Real output data is late and subject to heavy revision versus CPI data that comes out up to one year earlier and is not subject to revision. The output gap is equally hard to measure.

Well, this is just a bit silly, as we have shown before, CPI data is not proper macro data precisely because it is not revised. It is simply not credible to use these figures for steering an economy, real time or looking forward. The GDP deflator is a high quality number and is, obviously, revised, like all quality macro data. CPI is not revised due to politics and other factors related to linkages to financial contracts, pensions etc.

In any case, NGDP Targeters favour targeting the forecast, expectations, just like most mainstream Inflation Targeters including, supposedly, the Bank of England. The question of data reliability of NGDP Targeting misses this really important point.

NGDP Targeting is about ensuring nominal stability, it claims nothing about the “output gap”. This is a concept that can happily be left to economic historians. If NGDP turns out to have been 5% inflation and 0% real no great harm is done, if it turns out to be 5% real and 0% inflation, then whoopee! What is seriously dangerous is too low NGDP growth because of the risks of negative demand shocks causing horrific recessions and unemployment.

The weakness of Hughes Hallett’s argument is shown by his sympathetic summing up of the case against:

… it is not difficult to agree that nominal income targeting makes a great deal of sense as a policy regime. It is simple and intuitive. But the practical difficulties involved in measuring the output term in real time, defining the output target accurately, explaining the necessary revisions, make it a difficult and risky rule to maintain in practice.

The next major section (3.1) of Hughes Hallett’s report is hard to follow. He seems to claim that NGDP Targeting is optimal when labour supply is totally inelastic, and most effective when it is highly inelastic. Then he also claims that it becomes progressively less effective “as the elasticity of labour supply responses diminishes”. Perhaps there are some typos here.

Section 3.2 acknowledges the role of markets in targeting, but says the Bank of England already does this by targeting inflation two years out. One of the current Deputy Governors of the Bank of England has recently shown that the BoE in its actual interest rate decisions  targets real output and not inflation. This is a confusing situation at the very least.

Hughes Hallet then dismisses level targeting as an objective by quoting a 2013 ex-BoE MPC member Charles Bean speech that argued there would have to have been a 15% extra growth in 2008-12 to make up for losses in the recession. Maybe. But the real argument is that a clearly signalled level target in place from before the recession would probably have meant no recession, or at least a very quick recovery. And Bean was a key member of the now discredited team at the BoE operating under the “marcopru nutter” Meryvn King.

Section 3.3 appears to take issue with a claim that NGDP Targeting would promote more discipline. It is a rather obscure discussion and not a claim with which I am familiar. Discipline, to what end?

Section 3.4 frets about dual mandates and how to prioritise them. NGDP Targeters urge monetary policymakers not to fret and just target NGDP and let the long run and/or markets and/or governments sort out the balance. It is not the role of central banks to be the arbiter in this debate about the shares of inflation and real growth in nominal growth. Central banks should merely maintain nominal stability to prevent low nominal income (or GDP) expectations, given sticky wages, being the problem they so often are. All else is noise.

Section 4 sets up a model that shows how precisely executed inflation targeting or a modified Taylor rule work, not only well, but perfectly. Just like the French contribution to the debate that we have already highlighted, but they are far from being precisely executed. Discretion ruins the theory in practice.

NGDP expectations targeting is far more likely to work well and not get hijacked by inflation or macropru “nutters”, using their discretion to follow their own, unintentionally anti-prosperity, ends.

The summary is fairly balanced:

From the ECB’s point of view, nominal income targeting is a feasible regime, but probably with as many drawbacks as advantages. On the positive side: it is easily understood, it accommodates beneficial supply shocks, provides stronger responses in bad times, and is a more efficient rule when supply responses are limited or structural reform is needed.

The “on the other hand” bit that follows is quite weak, as we have just shown.

The drawbacks are: inflexibility, problematic policy responses when prices and output react at different speeds, it may overreact or destabilise, and is robust to real time measurement errors. In addition, it appears to be less effective than the flexible form of Taylor rule that the ECB now uses. Nominal income targeting may be feasible, but probably not desirable.

The idea that “it appears to be less effective than the flexible form of Taylor rule that the ECB now uses” is just so remarkably optimistic, idealistic even. The evidence is primarily in the appalling track record of the ECB with its two bouts of disastrous rate rises in 2008 and 2011. Further evidence is the potential tragedy being played out in real time due to the ECB being so trapped by its rigid, and completely inflexible, ceiling of its “close to, but not above, 2%” inflation target. Draghi struggles heroically to offset the trap with huge amounts of QE and we and the markets watch with dread fascination how it will play out.

While it is really welcome to see the French team and Hughes Hallett taking an interest in NGDP Targeting, even if a somewhat critical one, these issues are just too important to be left to ivory tower academics alone.

The U.S. Dollar Is Soaring. Fed Prepares Rate Hike.

A Benjamin Cole post

A round robin of the world’s major central banks suggests that the U.S. Federal Reserve, already out–of-step, will on December 16 become a misfit loner, an active menace to U.S. manufacturing and tourism industries, and a threat to global financial stability.

December 16 has been all but pre-ordained as Day One of  “Lift Off,” when the Federal Open Market Committee (FOMC), which has been passively tightening for more than a year, will actively raise the federal funds rate by 0.25%.

Yes, the U.S. PCE core inflation rate is sagging below target of 2%, the economy is sluggish, and the dollar has been soaring for the last 18 months. So what? The Fed, and Chairwoman Janet Yellen, have somehow painted themselves into a corner and all but promised a rate hike. So now, institutional credibility is on the line. More quantitative easing (QE), or lowering interest of excess reserves (IOER), is not even up for discussion.

BC Broad Index

As you can see from chart above, the dollar has been spiking since mid-2014—a sign the Fed is tightening. Only a prelude? Probably. After all, the Bank of Japan is conducting quantitative easing at $50 billion a month; the ECB has a $1.2 trillion and extended QE program underway, and interest rates have gone negative on the continent; the People’s Bank of China has been loosening for months and letting the yuan fall; and even the Reserve Bank of India has been taking stimulative steps.

Dollar Spike, And Recession?

Given the sluggish global economy, and the actions of other central banks, it seems likely, perhaps even inevitable, that the U.S. dollar will appreciate further in coming months.

Already U.S. manufacturing, a bright spot that helped slowly pull the U.S. out of the 2008 economic debacle, is suffering from a too-high dollar. Next will be tourism, as the U.S., with its decidedly unfriendly borders, becomes too expensive for foreign guests. Here is a pinch from The Wall Street Journal, perhaps a taste of what is to come:

“U.S. factory activity in November fell to the lowest level since the end of the recession, as weak global demand and a strong dollar continued to buffet the manufacturing sector. The Institute for Supply Management said Tuesday that its gauge of manufacturing activity fell to 48.6 last month from 50.1 in October, slipping into contraction territory for the first time since the end of 2012 and notching the weakest reading since the final month of the recession in June 2009.”

Though it is beyond the ken of this post, many financial observers say a higher U.S. dollar will suck “hot money” and capital out of emerging markets, setting off asset plunges and economic havoc there. Just a little side-benefit a higher exchange rate for the dollar.


The Fed should be pondering a rate cut, or a reduction of interest of excess reserves, or a steady QE program, as is underway in Japan. Instead, the Fed is hidebound, backward-looking, fearful and self-reverential, and gravely maneuvering to the trap of a rate hike.

The Fed is choosing the “safest” course politically, perhaps. But dangerous for American prosperity.



Germany vs the Euro 18

A James Alexander post

Almost alone among economic commentators we do actually look at Nominal GDP data as it is released. Full Euro Area NGDP data for third quarter 2015 was released this week alongside the 2nd estimate of Real GDP.

We have already posted here and here on the good news as three of the “big 4” Euro Area countries, making up 75% of the Euro Area economy, had seen accelerating NGDP. The not so good news is that the little countries saw less acceleration; in fact, it looks as though they saw slower growth. It is a bit hard to be exactly precise as the Irish GDP data, both nominal and real does not appear to conform to Eurostat norms. Ireland appears to have been growing NGDP at between 5% and 10% for a couple of years now.



The result is that Euro Area NGDP, according to the first estimate for this figure, is still picking up but 3Q in total showed growth flattening. It is still below the average growth rate for the last twenty years, a period including the last disastrous seven years. RGDP is growing marginally above this trend.



The question of trends is important. If we took the trend from 1996 to 2007 then the current Euro Area NGDP and RGDP growth rates looks awful. What should be unquestionable is the dangers of too low NGDP growth, the only unanimous conclusion of fifty years of macroeconomics. Low or negative NGDP growth causes unemployment and welfare loss – as we are seeing now occurring in Switzerland and have seen in many monetary areas since 2007.

What is too low NGDP growth? Perhaps around 2% given long-run productivity growth of over 2%. Economies work best when they have decent flexibility to allow relatively declining economic sectors the ability to decline gently via declining real returns. And economies work very poorly when there is there is an ever-present threat of negative NGDP growth. It is very hard to see what is wrong with at least a 4% NGDP level target. Prosperity must be a more important goal than inflation.

Have we spotted the reason for stiffening German opposition to more QE?

Another way of understanding the dynamics of the Euro Area and its monetary policy is to look at the performance of Germany, 29% of total GDP, and the most nationalistic and selfish country within the Area when it comes to monetary policy. We have seen time and again that what Germany considers right for itself it considers right for the entire Area. Maybe they are right not to care as they are now nearly 30% of the total. But here we see the essence of the current problem: narrow and often wrong-headed national interest. The Centre for European Reform has proposed an interesting reform of ECB governance to deal with just this issue via a removal of national central bank influence on the board.



German NGDP is growing above trend again, as is its RGDP. Twice Germany was growing so fast it authorised and encouraged the “inflation-nutter” Trichet to his satisfy his mania and crash the Euro Area economy. There are clear signs the Germans are ratcheting up this pressure again.

Fortunately, Draghi is no inflation-nutter. However, he is still trapping himself with the insanely restrictive “close to, but below, 2%” non-flexible inflation target or ceiling. One that only huge amounts of QE can even partially offset.

The natural, normal, “good Europeans”, thing for Germany to do would be to enjoy faster nominal growth than other Euro member states and gradually see itself become less competitive and gradually fall back to relatively less strong growth for a while. Surely, this relative decline would be more in Germany’s longer-run self-interest, rather than crashing the Euro Area economy as a whole again, and probably growing more slowly than it would have done otherwise.