“Entre les deux, mon coeur balance”

This is the imaginary scale that hangs over the center of the FOMC´s meeting table.

Entre les deux

Unemployment and inflation are the two objects on the scale. The Fed wants to keep the scale “balanced”. For that purpose, it has a policy framework best described as “gradual normalization”.

As Janet Yellen said last September, telegraphing a rate increase in the near future:

“But we are getting closer. The labor market has improved. And as I’ve said in the past we don’t want to wait until we’ve fully met both of our objectives to begin the process of tightening policy given the lags in the operation of monetary policy.”

In other words, it wants to be able to “normalize gradually”. The “link” between the two plates of the scale is the Phillips Curve/NAIRU subscribed by several FOMC members, according to which, “too little” rate of unemployment will shift the inflation plate up, maybe abruptly, forcing the FOMC to abandon the “gradual” half of the framework!

But there are tensions. According to this Binyamin Appelbaum piece in the NYT:

One wing of the Fed sees an undiminished case for raising rates.

Esther L. George, president of the Federal Reserve Bank of Kansas City and one of the 10 Fed officials voting on the direction of policy this year, said this week that the Fed “should continue the gradual adjustment of moving rates higher to keep them aligned with economic activity and inflation.”

She also played down concerns about the economic impact of recent market volatility. “While taking a signal from such volatility is warranted,” she said, “monetary policy cannot respond to every blip in financial markets.”

Loretta J. Mester, president of the Federal Reserve Bank of Cleveland and another voter, said on Thursday in New York that it was “premature” to change her economic outlook.

“At this point, solid labor market indicators, including strong payroll growth, and healthy growth in real disposable income, suggest that underlying U.S. economic fundamentals remain sound,” Ms. Mester said. “Until we see further evidence to the contrary, my expectation is that the U.S. economy will work through the latest episode of market turbulence and soft patch to regain its footing for moderate growth.”

Other Fed officials, however, say the volatility has given them pause.

William C. Dudley, president of the Federal Reserve Bank of New York and a close adviser to Ms. Yellen, said in an interview with Market News International this week that he was worried about the economic impact of jittery markets.

“If those financial conditions were to remain in place by the time we get to the March meeting, we would have to take that into consideration in terms of that monetary policy decision,” Mr. Dudley said.

And Lael Brainard, a Fed governor who has been particularly outspoken in warning that global pressures will weigh on domestic growth, told The Wall Street Journal this week that “recent developments reinforce the case for watchful waiting.”

Investors, oddly, have walked away from this debate feeling confident that the Fed will not raise rates in March. Indeed, asset prices tied to expectations about the future level of short-term interest imply only about a 50 percent chance of any rate increase this year.

That contrasts sharply with the Fed’s own prediction in December that it planned to raise rates by about one percentage point in 2016, most likely in four discrete steps.

Many analysts have taken a more measured position, predicting that the Fed is less likely to move in March, but that it will still raise rates two or three times this year.

Michael Gapen, chief United States economist at Barclays, said on Friday he now expected the Fed to raise rates twice, instead of three times, and to start in June, instead of March.

Michael Feroli, chief United States economist at JPMorgan Chase, said the continuation of low inflation probably meant Fed policy makers would hesitate at their next session.

“Were the meeting held tomorrow, we still think the Fed would stay on hold — primarily because of concerns about inflation and inflation expectations,” he said. “But it would be an uncomfortable hold.

Uncomfortable, indeed! But that has to do with the policy framework adopted.

Soon meteorology will be required credit for economic majors

In the first quarter of last year and the year before, “unusually bad weather” was deemed responsible for the negative growth surprises.

The “weather factor” is becoming more common.

Example 1:

In addition to seasonal effects, abnormal weather can also affect month-to-month fluctuations in job growth. In my paper “Weather Adjusting Economic Data” I and my coauthor Michael Boldin implement a statistical methodology for adjusting employment data for the effects of deviations in weather from seasonal norms. We use several indicators of weather, including temperature and snowfall.

Example 2:

As for the slight slowdown in consumption at the end of 2015, December was both the warmest and the wettest on record. The warmth reduced spending on heating; the wet may have kept people indoors. Spending at restaurants fell by 1.7%, notes Paul Ashworth of Capital Economics, a consultancy. Now that the heavens have closed, wallets should reopen.

Agree that sometimes it´s a fun read!

The Fed & the Unemployment Rate

Yellen on labor market (Sept 2015):

As I said, although we’re close to many participants and the median estimate of the longer-run normal rate of unemployment, at least my own judgment – and this has been true for a long time – is that there are additional margins of slack, particularly relating to very high levels of part-time involuntary employment, and labor force participation that suggests that at least to some extent the standard unemployment rate understates the degree of slack in the labor market.

“But we are getting closer. The labor market has improved. And as I’ve said in the past we don’t want to wait until we’ve fully met both of our objectives to begin the process of tightening policy given the lags in the operation of monetary policy.”

In fact, she´s a long way from meeting both objectives! No one has any doubt about the distance we are from the 2% inflation target. On the other hand, with unemployment down to 4.9%, many could assume that we´re even “overstepped” it!

The best way to look at the unemployment rate is to analyze it from the perspective of its two constituents: The employment population ratio (EPR) and the labor force participation rate (LFPR).

That´s because the unemployment rate (UR) is, by definition, equal to [1-(EPR/LFPR)]*100. Therefore, a rise in the EPR, normally associated with a robust economy, will reduce the unemployment rate. On the other hand, a rise in the LFPR, something also usually associated with a growing economy (controlling for demographic factors, that change slowly), will increase the unemployment rate.

From this perspective, even in a strong economy the rate of unemployment could be rising (a little at least) if the rise in LFPR is higher than the rise in the EPR.

The charts below make the importance of looking at the rate of unemployment together with its determinants clear.

In the “Golden 60s” and in the “roaring 90s”, we see the unemployment rate falling with rising EPR and LFPR, with the EPR rising faster than the LFPR.



Over the last 10 years, and especially since 2008, we see unemployment first jumping from the steep drop in the EPR and then monotonically falling with the fall in the LFPR together with a reasonably level EPR.


The suddenness of the fall in the EPR and coincident falling trend of the LFPR is difficult to ascribe to sudden and big demographic changes. But they are consistent with the initially gradual and then sudden drop in NGDP growth, which even turned significantly negative (a rare event indeed).


It doesn’t look like that the labor market has in some sense, improved. What is more likely is that the perverse monetary policy of the last several years has changed its nature, maybe through hysteresis effects.

That has been the outcome of the Fed´s policy framework, which Kocherlakota aptly named “gradual normalization”. That policy framework has been instrumental in providing monetary policy tightening!

To undo the hysteresis effect on the labor market the Fed has to change the policy framework. The best alternative, and one that would do the most to reverse those effects, is for the Fed to establish a higher nominal spending target. To reach it, nominal spending growth (NGDP) would be temporarily higher, providing the right incentives for an increase in both the EPR and LFPR.

The Fed is more like the ECB 2011 than Fed 1937

A James Alexander post

Ja-net Yel-len, Ja-net Yel-len, are you Tri-chet in dis-guise?

At football matches in England there is always a particularly hurtful chant that goes up around the ground when a team, a player or a referee is doing badly. They are very often compared to some team or referee or player whom everyone knows is far worse. It is sung to the tune of a famous hymn, like many football songs, “Guide me, O thou great redeemer”. Janet Yellen’s record so far as Chairman of the Fed reminds of this chant, and particularly Jean-Claude Trichet’s penultimate year (mis)guiding the ECB.

13th July 2011 should go down as a day of infamy in the Euro Area. It was date of the second rate rise by the ECB that year, that tanked markets and led more or less directly to a dramatic liquidity squeeze for Euro Area banks, and caused the plunge into the second part of the Area’s double dip recession.


We all now know that Euro Area troubles started in 2008 when the world was plunged into the Great Recession by pro-cyclical monetary tightening by various central banks, just as NGDP growth expectations were falling rapidly at the time of the Lehman default. A lot of other stuff was going on, for sure, but it was noise compared to the core monetary story.

The US and Europe had already spent two hard years escaping from the consequences of the 2008 tightening. Then, in an attempt to out-macho the US and impress the selfish German establishment, the ECB under Trichet decided to stamp on headline inflation hitting nearly 3% in early 2011, while core remained solidly below 2%. The ECB therefore directly smashed the early stages of recovery with a heavy tightening bias and two rate rises. The different paths of the two big currency blocs has been very well documented here with a good summary here.

Trichet and those two ECB 2011 rate rises

The first of the rate rises that year on 3th April 2011 did not cause undue damage. 1Q11 Euro Area NGDP had almost hit the dizzying 3.9% YoY. Within the Area German NGDP was at 6.4% YoY that quarter. This was too strong for Germany and so they pressed for a tightening and Trichet was only too happy to oblige, forgetting about the rest of the Euro Area, especially the periphery. In that quarter Spain and Portugal were already enduring marginally negative NGDP growth. Yes, they were in outright deflation but had their monetary policy tightened substantially – it seems really crazy the more you think about it. Greece had very negative NGDP YoY at -9%.

Never mind, the selfish, almost anti-European, old DM/German bloc anti-growth bias had to be appeased. Actually, it was even worse, Trichet was actually rather fanatical in thinking he was doing the right thing for the Euro Area as a whole. It was his final goodbye press conference that made me rethink my priors. He was forced to defend what havoc he’d caused by trying to claim credit for giving the Euro Area a lower inflation rate than Germany had experienced prior to the Euro – and hang the consequences of a double dip recession. It was all deeply personal and subjective. Central bankers can do no wrong and certainly cannot take criticism.

Well, the rest is history. The Euro Area slowed during 2Q11, as you’d expect from such a tightening of monetary policy. Although the Euro Area stock markets merely drifted, NGDP growth fell to 2.9%. The stock market drift may have lulled Trichet and his ECB into a false sense of confidence.

As expectations for NGDP growth dropped further, they made their second fateful move. Stocks tanked within days, the banking crisis re-erupted, engulfing the French bank SocGen in particular. NGDP fell to 2.4% during 3Q and carried out on down. It was too late, the damage had been done and the cycle was hard to turn.

Market response to April 2011 ECB rate similar to December 2015 Fed rise

We often see articles and blogs wondering whether the US rate rise in late 2015 will end up forcing the country to re-live the great 1937 stumble in the recovery from the Great Depression when monetary policy was tightened too early. The Euro Area from 2011 seems far more apt, and fresh in our memories. A slow recovery, with a few hot spots, was stamped on by two rate rises amidst a severe tightening bias. Rates ended up falling, of course. The first rate rise was seen by the markets as almost manageable, or rather it was met with a degree of sang froid. The second seemed mad given where NGDP expectations had tumbled.

The December 2015 rate rise seemed to be met with a similar sang froid, after all it had been expected for months. Some, particularly market Monetarists, had warned of the dangers of the monetary tightening and thought actual and expected NGDP growth too weak to cope. The market sang froid was probably mistaken by the Fed as an acceptance that its full-blown “normalisation” programme could proceed as they planned. Vice-Chairman Stanley Fischer’s now notorious 6th January interview on CNBC, especially his articulation that four more rate rises this year was “in the ballpark”.

Economic news has been poor since then, reflecting the impact of the 2015 monetary tightening, and now expectations are falling. The question remains: Is Janet Yellen Jean-Claude Trichet in disguise? Will she take some market tranquillity as a justification for a second rate rise? Maybe. Just how much does she fear inflation rising to the Fed’s forecast of 2%, how stubborn will she be in pursuing her “normalisation” programme come what may?

“You don’t know what you’re doing”

When the team, referee or player continue to invite really bad comparisons the football fans often switch to an even more hurtful chant, “you don’t know what you’re doing, you don’t know what you’re doing”. It is sung to the tune of “Que sera, sera” (whatever will be, will be). Fatalistic, but apt.

Sounds good, but it´s not!

Draghi Warns on Risks of Low Inflation:

European Central Bank President Mario Draghi hit back at a warning from Germany’s Bundesbank that the ECB shouldn’t overreact to a sharp drop in oil prices, underlining his readiness to launch additional stimulus to shore up ultralow inflation.

In a speech at the Bundesbank’s home in Frankfurt, Mr. Draghi warned that central banks “cannot be relaxed” in the face of a series of shocks to commodity prices.

“The longer inflation stays too low, the greater the risk that inflation does not return automatically to target,” Mr. Draghi said.

Cheaper oil and other “forces in the global economy” that are holding down consumer prices “should not lead to a permanently lower inflation rate,” he said. “They do not justify inaction.”

The comments come a week after Bundesbank President Jens Weidmann urged central bankers to look through an oil-price driven drop in inflation, arguing that they shouldn’t fixate on current price levels like a “rabbit staring at a snake.”

The back-and-forth between two of Europe’s most influential central bankers underlines the debate within the ECB about how urgently the bank should respond to sharply lower oil prices.

It´s a mirror image of what happened in 2007-08, when oil prices were rising and central bankers felt “compelled” to tighten lest inflation permanently rose!

This is one more evidence against “Inflation Targeting”. It also shows how, in practice, central banks have an “asymmetric view” of the target!



Will it be enough if there are no rate hikes in 2016?

Janet Yellen and the Federal Reserve are on another planet:

That’s the message from global investors who are sending the Fed a big distress call to come back to earth.

The Fed is still predicting four interest rate hikes this year, but the market now forecasts zero hikes in 2016.

The closely watched Fed Futures market now has a nearly 60% probability of no rate hikes at all this year.

It’s a dramatic U-turn from only a month ago when the market was pricing in a 75% probability the Fed would increase rates at least once in 2016.

New York Fed Dudley said:

New York Fed President William C. Dudley said in an interview with Market News International that policy makers are “acknowledging that things have happened in financial markets and in the flow of the economic data that may be in the process of altering the outlook for growth and the risk to the outlook for growth going forward.”

Only “may be”? Much more is needed, especially since lately we´ve had the Fed and the ECB/BoJ pulling in opposite directions. Some policy coordination would greatly increase their productivity!

I believe that even if there are no rate hikes in 2016, that will not be near enough to get the economy “unstuck”!

What´s needed is a reversal of nominal growth expectations that translates into a reversal of actual nominal growth. For the past year and a half, this has been sliding down and if the Fed remains hostage to its policy framework of “gradual normalization” underpinned by “Phillips Curve thinking”, the outcome will be dire!

Fed Wrong

Dudley is the markets man on the FOMC, a small mercy

A James Alexander post

The role of the President of the NY Fed is to be the lightning conductor of market sentiment to the FOMC. The NY Fed is the operating arm of the FOMC, conducting the open market operations. Because of this importance the President of the NY Fed gets a permanent vote at the FOMC, alongside the senior Fed staffers like Yellen and Fischer. What the NY Fed President says is important, often more so than the Vice-Chairman of the Fed, currently Fischer, or sometimes even than the Fed Governor themselves.

While Dudley has always physically looked uncomfortable passively tightening monetary policy and also actively doing so, he is incredibly loyal too. Twenty years at Goldman Sachs would have taught him that. He said nothing in public or officially dissented to any of the moves. Today we get this:

In addition, the weakening outlook for the global economy and any further strengthening of the dollar could have “significant consequences” for the health of the U.S. economy, William Dudley, president of the Federal Reserve Bank of New York, told MNSI in an interview.

“One thing I think we can say with more confidence is that financial conditions are considerably tighter than they were at the time of the December meeting,” said Dudley, a permanent voter on the Federal Open Market Committee, the Fed’s monetary policy arm.

“So if those financial conditions were to remain in place by the time we get to the March meeting, we would have to take that into consideration in terms of that monetary policy decision,” he said.

But how can he and his colleagues be so obtuse as to think that the tighter financial conditions are not a direct response to their own active tightening of monetary policy? It is this obtuseness, this stubbornness, that is of major concern, and makes monetary policy so unpredictable at times. Humans make errors

Predicting when the humans will recognise their errors, if ever, is all too subjective. When will the FOMC reverse course: the S&P hits 1500, unemployment at 8%, an inverted yield curve? All of them? We know they will change their minds, the question is whether market players can stay solvent until they do.

UK NGDP growth flashing red

A James Alexander post

Back in late October we highlighted the collapse in growth of UK NGDP as proxied by the release of the 3Q15 Nominal Gross Value Added (GVA) figure. Things have now worsened. Growth has dropped from 2% YoY to less than 1%. Where is the Bank of England? Where are their political masters, the UK Treasury? Are they all asleep at the wheel? Hello? Wakey, wakey!

It is not just the risk of falling revenues leading expense reductions combining with the usual “sticky wages problem” forcing employers to cut staff, although this should be alarming enough on its own. It is the huge hole in tax revenues that will open up that should alarm the UK Treasury. They need nominal growth to reduce the deficit, and slow the growth in national debt. They are happy enough, and possibly right, to attempt to constrain public sector spending, but a recession will mean years of hard work washed away in an instant. NGDP growth should be their top priority, for both issues.

The figures are alarming

In it’s first estimate of RGDP the UK’s Office of National Statistics is unable to give us a figure for Nominal GDP. This situation is highly unsatisfactory for what should be the key measure of monetary policy. They don’t devote a lot for resources to its proxy either as the initial 4Q15 GVA figure contained a bad and obvious error (spotted by yours truly) and had to be withdrawn for a few days before reissue.

The reissued had no bad or obvious error, it just looked bad. UK NGDP growth had been running at a too slow 4%, before crashing down over the last 4 or 5 quarters to 2% and now less than 1%. There is some stuff going on in the wider world, but in common with the US central bank, the Bank of England has been talking the tightening talk for a year, and has now reaped the consequences.


Carney is only chasing the game

Of course, Mark Carney is no Meryvn King or Trichet-like dogmatist and can react to markets, but the damage has been done. Ask any sports team manager and you´ll hear that chasing the game is a lot tougher than leading the game. And Carney is chasing the game.

However interesting, try not to dissect the output data

Nerdily-speaking, GVA is about 90% of the GDP figure, the other 10% is the rather mysterious “Basic Prices Adjustment” (BPA), to add a large slug of taxes on production that are paid by final buyers of that output (less a miniscule amount of subsidies on production). BPA is a very stable number.

More nerdily, GVA is the building block for the output version of GDP, the prime method in the UK for measuring GDP. The other two methods are expenditure and income, but are usually adjusted” to the output result. In contrast, the US gives primacy to the expenditure method, and adjusts the other two to it. It is rather irrelevant as the main issue is speed of deliver. The O, I and E measures should all equal each other. They often use similar fundamental data anyway, just released at different times, and at the micro level are used to check the reliability of each data set.

Even more nerdily, and as an example, wage income and gross profits in the media sector should equal money spent on media products by consumers (films, games and TV etc) and should equal the value-added of output too (calculated, using similar data sets, as all sales less sales to other producers, i.e. intermediate sales).

One can look at the industry breakdown of UK GDP, via the industry-by-industry contributions to GVA. For monetary policy it doesn’t make any difference, tight money is tight money as evidenced by weak NGDP growth – please stop looking at the level of interest rates and the amount of QE, they tell us little about the stance of policy. Indeed, rates are usually high when monetary policy is loose and NGDP is growing fast.

There will still be relative winners and losers in an economy whatever the stance of monetary policy, and analyzing individual industries performance can easily mislead policy makers into thinking it is the fault of the relative losing industry dragging down growth when its monetary policy.

The output data is probably as good as it can be, but still not much use

That said, there appears to be some underlying changes still working through the economy. Manufacturing is in relative decline versus the services sector. But so what. In any case the “service sector” is so huge and poorly understood that it is impossible to really see the drivers of the switch from manufacturing. IT is in services and growing, but should it really be in manufacturing? Consultancies likewise, aren’t they just outsourced management?

The ONS, like most other national statistics authorities, collects agricultural, extraction and manufacturing industry output in minute detail, with around 61 separate categories of data – yet these sectors account for just 20% of national output. There are only 51 data points for the 80% represented by services. The ONS is steadily working to rectify this problem via a number of initiatives, but it is very hard work indeed.

It is highly entertaining to read all the wordy, earnest, discussions about productivity when so little is known about 80% of the economy. Still, discussing the productivity crisis (or miracle) is nice work if you can get it.

One oddity is that while the manufacturing sector is in recession, the extraction sector is apparently growing in real terms but crashing in nominal terms. Mmm.

Stanley Fischer has no idea about what tight monetary policy means!

In early January, he thought four rate hikes in 2016 was in the “ballpark”.

In a speech yesterday he was less sanguine, but still believes monetary policy remains accommodative.

The framework under which the Fed operates, which Kocherlakota, who knows what he´s talking about, clearly set out recently, permeates the Fischer´s speech: “gradual” and “normalize”.

According to Fischer:

“[M]y colleagues and I anticipate that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate, and that the federal funds rate is likely to remain, for some time, below the levels that we expect to prevail in the longer run” [the normal level].

The saddest thing is to see that to Fischer, as well as to many other FOMC members, what informs monetary policy is employment/unemployment and oil/commodity prices! Within that framework, inflation will climb back to 2% when oil prices stabilize and unemployment falls a bit more!

In a recent post, using the federal funds future rate, David Beckworth has argued that monetary policy has been tightening since mid-2014. That´s quite true as the chart indicates.

Stan Fischer mistakes_1

More generally, that reflects the fact that NGDP growth, the best measure of the stance of monetary policy, has turned down since that time. This fall in AD growth has been accompanied by “negative” trends in most indicators of economic activity and sentiment, including oil prices and the broad dollar index.

Stan Fischer mistakes_0

Only when a recession is announced by the NBER will the Fed realize it has been on a tightening spree!