The Fed creates the “Ugly Duckling”

Ugly Duckling_1

Tim Worstall writes:

The reason this time is different is because, well, this time is different.

Let´s be more precise. The reason this “time is different” is because monetary policy has acted very differently, compressing spending growth thus, turning the 2007 cycle into the “Ugly Duckling”!

Ugly Duckling_2

PS BTW, The Atlanta Fed GDPNow nailed it. The average of it´s 13 successive Q1 RGDP forecasts (annualized) was 0.58%!

Must be lively in the FOMC these days

A James Alexander post

As expected the FOMC made no change to its target rate. But we still think that the discussions at the FOMC are much more lively than they have been. Somehow, the “normalization” program pressed by the Fedborg and championed by the anti-prosperity inflation hawks has been delayed. Hooray!

We reckon that some of the newbies on the FOMC, particularly Neel Kashkari are shaking things up a bit. In an internal interview released the other day he made the refreshingly honest statement:

“Clearly what happens in global financial markets, as an example, will affect the U.S. economy. We can’t be blind to the fact that actions we take could affect global economic developments, which in turn will have an effect on our economy. We need to think about those feedback loops, and I believe that we do. It is one of the many inputs that we look at as we decide the optimum course of monetary policy.”

It is such a change from the stance of the Fed until recently that believes it operates somehow independently of the real world rather than a participant. Sure in the long run money is neutral, but in the short run, in fact for the last eight years, it has not been neutral. Monetary policy was way too tight in 2008 and thus caused the recession. And policy has continued way too tight so that the US has had a very prolonged recovery from that recession. And may now be so tight again as to cause a new recession.

Obsession with keeping projected inflation below 2% means a sword of damocles of potential monetary tightening has consistently hung over the market and made economic growth like pushing water uphill. And since mid-2014 the US has had passive tightening, and after December 2015 actual tightening.

The Fedborg is not responding well to the uppity newbies on the FOMC. It is spitting out bizarre statements like today’s “Labor market conditions have improved further …” when it’s own Changes in Labour Market Conditions Index clearly shows them worsening.

It tries to highlight  that although nominal wage growth has cooled, real wages are much better.

“Growth in household spending has moderated, although households’ real income has risen at a solid rate”

Hasn’t it heard of the sticky wages problem? We had always thought that this key insight, perhaps the only insight, macroeconomics has had is rather a problem. Naively pointing to real wage growth in a deflation has long been regarded as a basic error – one which would lose a lot of marks if spotted in any undergraduate economics essay.

The Fedborg wants rates up because it believes rates are the tool for the implementation of monetary policy. Market Monetarists, like the market itself, believe expectations about future policy are the tool. The Fedborg doesn’t like expectations as it thinks they are harder to control, based on market consensus rather than a hard price like the Fed Funds Target Rate. Consensus is dangerously democratic or even anarchistic in that it may be different from the Fedborg’s own, autocratic, view of the world.

At least today the Fedborg has been shut up. We fear it won’t remain quiet forever and that any sustained market momentum will put it back on top. Hopefully, Kashkari and others might realise that this is also a feedback loop:

[market-strengthening -> Fed tightening talk -> market weakening -> Fed backing off -> market strengthening -> Fed tightening talk -> … ]

And a loop that needs breaking in order to achieve sustainable and stable growth – by a shift away from inflation targeting and towards nominal income growth targeting.

UK NGDP turns up a little but still dragging down RGDP

A James Alexander post

First release of UK RGDP for 1Q16 today was in line with expectations. This is not saying much at it is just 2.1% up on the year ago quarter and trending down.

Much worse news was that Nominal Gross Value Added (or “GVA at Current Prices”, a close proxy of the not-released-for-another-4 -weeks NGDP) is still limping along below 2% per annum and will continue to depress real growth. Households will continue to feel there is no growth while the economy appears so lacklustre. Real growth (RGDP) will continue to be dragged down by weak nominal growth (NGDP).


The crucial point missed by mainstream macro is that economies need micro-flexibility to promote efficient allocation of labour amongst different companies and sectors without some companies hitting downwardly sticky wages and thus forcing mass lay-offs. With 5% nominal growth gentle reallocations can occur via money illusion, as some employees in relatively declining industries or companies can lose real income but not lose their jobs. With 2% or less nominal growth nominal weakness in revenues forces nominal cuts in expenses and thus real job losses – and lost real GDP.

There has to be a huge caveat on these first release nominal GVA/GDP figures given large errors in the series seen in recent quarters on top of the inevitably large adjustments made as more data on the quarter is collected. To be fair, the trend NGDP had looked worse even  but the really bad figures have now been revised up a little.

Although Nominal GVA was reported at 1.9% and thus a small increase on the 1.4%  in 4Q15 the figure implies the official implied deflator, and the best measure of inflation we have, is still negative. That is, you have to inflate Nominal GDP to get Real GDP, rather than the usual deflating of Nominal to get Real. Confusing? Well, that is the actual deflationary world we live in these days for you.

What does and does not make sense?

In “Explaining the last 10 years”, Simon Wren-Lewis starts off:

The Great Recession was larger than any previous post WWII recession. But that is not what it will be mainly remembered for. Unlike previous recessions, it appears to have led to, or coincided with, a permanent reduction in the productive potential of the economy relative to previous trends.

According to measures of potential output put out by the CBO, the coincidence is clear, with a marked kink in the level of potential output occurring concomitant with the “Great Recession”. If that´s true, as the chart shows the economy has essentially closed the “gap”.

Greater Depression_1

However, according to a deterministic trend, estimated from 1955 to 1997 and projected forward, the “gap” has been rising given that real output growth, after dropping hard during the “GR” has never “bothered” to grow sufficiently to close the “gap”.

Greater Depression_2

The first case indicates that the apostles of the “Great Stagnation” thesis have a point. The second view says that the economy is, in the words of Brad Delong from almost 2 years ago, in a “Greater Depression”:

First it was the 2007 financial crisis. Then it became the 2008 financial crisis. Next it was the downturn of 2008-2009. Finally, in mid-2009, it was dubbed the “Great Recession.” And, with the business cycle’s shift onto an upward trajectory in late 2009, the world breathed a collective a sigh of relief. We would not, it was believed, have to move on to the next label, which would inevitably contain the dreaded D-word.

But the sense of relief was premature. Contrary to the claims of politicians and their senior aides that the “summer of recovery” had arrived, the United States did not experience a V-shaped pattern of economic revival, as it did after the recessions of the late 1970s and early 1980s. And the US economy remained far below its previous growth trend.


A year and a half ago, those who expected a return by 2017 to the path of potential output – whatever that would be – estimated that the Great Recession would ultimately cost the North Atlantic economy about 80% of one year’s GDP, or $13 trillion, in lost production. If such a five-year recovery began now – a highly optimistic scenario – it would mean losses of about $20 trillion. If, as seems more likely, the economy performs over the next five years as it has for the last two, then takes another five years to recover, a massive $35 trillion worth of wealth would be lost.

When do we admit that it is time to call what is happening by its true name?

Simon Wren Lewis goes on to indicate that:

If we stick to the more plausible idea that this is all somehow the result of the financial crisis and recession, we can again split explanations into two types: those that focus on the financial crisis and argue that crises of this type (rather than other types of recession) impact on potential output, and those that look at the impact of the recession itself. The distinction is important in understanding the impact of austerity. If the length and depth of the recession has permanently hit potential output, as Fatas and Summers suggest, then the cost of austerity is much greater than we could have imagined.

But I believe that´s the wrong focus. The charts show that the economy was “suffocated” not by austerity, but from a highly inadequate monetary policy, as indicated by the behavior of aggregate spending or NGDP.

Greater Depression_3

Greater Depression_4

And that wrong-headed monetary policy remains in place today!

Don Trump: Meek Inheritor Of The Forgotten Reagan Protectionist Legacy?

A Benjamin Cole post

When it comes to trade and protectionism, President Ronald Reagan (1980-1988) dwarfed in real life anything GOP candidate Don Trump has imaginatively proposed.

Trump wants a 45% tariff on China goods?

Hoo-haw. President Reagan slapped a 100% tariff on Japanese consumer electronics. And a 50% tariff on Japanese heavy motorcycles, as a favor to Harley Davidson, hog-makers. Forgotten today, Harley was about to go under. Reagan rode to the rescue, and Harley Davidson survives to this day. I guess if you like American-built huge motorcycles, protectionism has its merits.

Little was safe from Reagan’s protectionism, including sugar, textiles, roller bearings, machine tools, autos from Japan (limited by amount, not tariff. But that was OK because it went by the name of “Voluntary Export Restraint”!), steel, garments, lumber, forklifts, color TV tubes, and other items.

Sheldon Richman, writing for Cato Institute in 1988 (before latter-day hagiographers), reported, “Treasury Secretary James A. Baker III boasted last September (1987) that the administration ‘has granted more import relief to United States industry than any of [its] predecessors in more than half a century.’”

Richman concluded, “Ronald Reagan by his actions has become the most protectionist president since Herbert Hoover, the heavyweight champion of protectionists.”

The number of nations hit by trade restrictions reached into the dozens. Indeed, Reagan was such a ferocious protectionist that Milton Friedman wrote that the one-time actor was “making Smoot-Hawley look positively benign.”

William A. Niskanen, who was for a while acting chairman of President Reagan’s Council of Economic Advisers, reported, “The share of U.S. imports subject to some form of trade restraint increased from 12% in 1980 to 23% in 1988.”

Trump in contrast, has suggested tariffs on just one nation, and that as bargaining position.

Forgotten today is that Reagan conducted a global trade-war.

Plaza Accords

Moreover, Reagan didn’t just go crazy with tariffs—he repeatedly pressured other nations into increasing the value of their currencies, or, put it mildly, sought to cheapen the dollar.

As in September 1985, when the Reaganauts engineered the “Plaza Accord,” an international monetary straitjacket which mechanically depreciated the U.S. dollar against the Japanese yen and German mark.


Today, the punditry is in full-shriek mode at Trump-o-nomics. We are lectured The Donald’s trade policies will result in snowballing recessions or economic Armageddon.

But in the 1980s, the United States flourished behind rising walls of aggressive Reagan protectionism, much more pervasive than anything proposed by Trump.

Did Reagan’s wide-ranging trade-killing measures improve the domestic economy (in addition to saving Harley Davidson’s big motorcycles)?

It does not seem likely, but today Reagan is lionized by many, and the 1980s remembered as a period of prosperity.

Draghi gives a Monetary Economics 101 class

A James Alexander post

ECB President Draghi was on far better form in his press conference after the April ECB Council meeting  than the one in March.

It was great to hear the German journalists having the special pleading of their insurance companies, pension funds and savers slapped down time and time again by Draghi. They are only one country in the Eurozone, like it or lump it. The ECB sets policy for the whole monetary area.

German leaders and economists also do those special interests a massive disservice by not helping them to understand the direction of causality when it comes to monetary policy. Low rates are a sign of tight money, not loose, or ultra-loose as so many supposedly clever commentators like to mistakenly opine. High rates are a sign of loose policy.

In a splendidly clear answer to one journalist, about 38 minutes in, Draghi stated:

Low interest rates are a symptom of low growth and low inflation. It’s not the monetary policy consequence … as I’ve said before, if we want to return to higher interest rates we have to return to higher growth and higher inflation to do so we need the current monetary policy, that’s the necessary condition [for a recovery].

Hear, hear!

UK NGDP growth weakening. Blame it on Carney, not ‘Brexit’

A James Alexander post

The chickens continue to come home to roost for the Bank of England and its masters at the UK Treasury. The pathetic attempt of the a UK government minister to blame Brexit worries for the UK economic slowdown was truly breath-taking in its cheek. George Osborne recognises the problems caused by weak nominal growth but has failed persistently to show political leadership to do anything about, allowing the Bank of England to wallow in its hawkery about non-existent inflation threats.

Mark Carney tightened monetary policy throughout 2015, first by declaring that the next move in rates would be up and then in July confidently declaring that rate rises “will likely come into sharper relief around the turn of this year (2015)”. He has attempted to back pedal a few times since then over precise timing, but his tightening bias has been reiterated, most notably when he declared in February all members of his MPC believed the next move in rates would be up.

Ever since Carney sat on his laurels at the end of UK’s QE, and especially since his fatal Summer speechifying, UK nominal and real growth has been decelerating. We don’t have an Atlanta Fed-style “nowcast” for UK GDP but we can make a pretty good guess how badly things are turning out ahead of the release of 1Q16 data next week.

  • We already have Carney’s constant tightening bias.
  • We know the trend in NGDP is really poor.
  • This week we have seen retail sales growth slow (hitting the largest component of GDP) and the other side of the coin, personal income in the form of wage growth, also slow.

JA Brexit_1


JA Brexit_2

Although quite volatile, the nominal wage growth figures had shown some encouraging trends up to 2Q15 until Carney put a dramatic stop to any real return to prosperity with his hawkishness.

It would be absurd to suggest that Brexit uncertainty is having no impact on the economy. It has hit the currency after all. But any currency weakness will actually work as nice countercyclical aid  to any potential economic damage from Brexit.

By far the biggest problem is the stance of UK monetary policy in the face of collapsing nominal growth. Carney follows most other central bankers and the economics consensus in believing that low interest rates mean easy money. Clearly, it cannot be true when actual (even if 4Q15 was revised up a bit) and expected nominal growth is so incredibly low.

JA Brexit_3


Helicopters Drops: The Last Resort—But Why Not Chopper First?

A Benjamin Cole post

There has been some blog chatter of late on helicopter drops, that is the central bank printing money to toss on the population, or to finance government operations, or to compensate government for tax cuts.

Kentucky economist David Beckworth is open to helicopter drops as income tax cuts married to QE. The highly-regarded economist Michael Woodford of Columbia allows for something similar, in his oblique fashion.

Of late, former Fed chief Ben Bernanke suggested that when times are really tough, he would hold his nose and pilot helicopter drops, which he dubs “money financed fiscal programs” or MFFPs.  Bernanke’s blogpost appears to have cattle-prodded George Masonite scholar and top-blogger Scott Sumner onto the “last resort” whirlybirds, with many a hem, haw and harrumph.

So heavy hitters all say helicopter drops will work. In fact, Bernanke and Sumner go with the “nuke” analogy—printing money to run government will almost certainly work to boost the economy, but must only to be used to avert economic doomsday.

Why Wait?

But is the “Helicopter Drops=A-bombs” analogy really accurate?

Who says the analogy is not, “Keep your best power-hitter on the bench, until you really need him to win the game?”

In other words, monetary macroeconomists may be poor managers. They prefer to hit singles with rate cuts, or IOER or not, or negative interest rates, or limited QE.

But what would have been the impact in 2008, if the Fed and federal government had gone straight to serious helicopter drops?

In truth, it is difficult to decipher certain finer points of what is a helicopter drop and what is not. The federal government after 2008 ran big deficits and the Federal Reserve simultaneously bought a few trillion dollars of U.S. Treasuries.

It sure looks to me like post-2008, the federal government in fact had a Bernanke-style MFFP going. Bernanke evidently contends that because post-2008 the Treasury issued bonds and the Fed printed money and bought the bonds (which they have kept on their balance sheet ever since), that post-2008 was not an MFFP.

Bernanke says MFFP happens only if the Fed prints money and hands it directly to the Treasury. The fig-leaf of the Treasury issuing bonds means post-2008 federal policy was only QE, not a chopper-drop.

But the key point is no one in the private sector had to give up cash (through bond purchases) to finance the federal deficit post-2008. The Fed printed the money that financed the government deficit.

Let’s call it a “whirlybird offload.”

Conclusion And Prophylactic Expansionism

There is traditional, institutional and professional reticence about helicopter drops in the macroeconomics profession, as revealed in Bernanke’s tortured nomenclature and use of acronyms to describe a central bank printing money and handing to the federal government. MFFP!

There may be sound political reasons for skepticism regarding helicopter drops—as in, the U.S. Congress might learn to love the choppers a little too much, and we would finally see the Inflation Bogeyman.

But in the next recession why not fly the money-choppers ASAP—in fact, send in the B-52s. Why diddle around?

And could there be a justification for modest-scale chopper-drops now? What would be the harm of the Fed printing up $200 billion and sending it across the street to the Treasury, and President Obama cutting federal taxes by a like amount?

Why does the Fed (or other central banks) always have to wait for a recession before acting? How about monetary prophylactic expansionism?

The “Monetary Policy Normalization” Syndrome

It has been the force behind US monetary policy for at least the past two years. It can be captured by the behavior of the 1-year ahead expected FF rate, which coincides with the intensification of the “rate rise talk”.

The chart below is a representative example, showing how policy started tightening long before the December/15 rate increase.

Mp Normalization_1

The same is true if you chart inflation expectations, industrial production growth, stock market returns or oil prices alongside the FF future rate.

The “summary statistic” for the policy tightening stance is given by the declining behavior of NGDP (and RGDP) growth since mid-14.

Mp Normalization_2

The fact is that the Fed has “abandoned” the inflation target, or is really content with the low inflation that has materialized in large measure as a consequence of the effective policy tightening.

Mp Normalization_3

Not to be ‘blindsided’, some in the Eurozone have also begun to appeal for monetary policy normalization. An example is given by the recent CEPS study which argues for adopting the GDP deflator as the target, minimizing the worries about deflation captured by the CPI, concluding:

“It is time for a normalization of global monetary policy.”

Mp Normalization_4

No wander the “recession talk” has been on the rise!

“This crazy world…is coming undone”

Or, and this from a prominent former FOMCer Narayana Kocherlakota, “When Discredited Policies Make Sense”:

Presidential candidates Donald Trump and Bernie Sanders have proposed policies that run counter to literally centuries of economic thought. In the current environment of extremely low interest rates and low inflation, however, they might make more sense than most economists recognize.

The Federal Reserve faces a big challenge: It wants to get inflation up to its 2-percent target, but so far its stimulus efforts have failed to reach that goal. So there’s a good chance it will keep interest rates low, even if inflation pressures pick up a bit. This likely passivity of monetary policy creates a highly unusual situation, in which certain much-discussed economic initiatives could have an unusually positive effect.

So, monetary policy has been “passively” tightening. Market Monetarists agree with that. Kocherlakota hopes (in vain) that monetary policy will remain “passive”, but in “stimulating fashion”.

For example, he argues:

  • Increasing the minimum wage. What if Congress decided to increase the federal minimum wage by 10 percent a year over the next five years? Typically, economists would be concerned about the impact on employment: Higher wages might lead businesses to employ fewer workers. With monetary policy out of the picture, though, the move might actually help. The expectation of higher wages would cause consumers to expect more inflation over the next few years, leading them to buy more goods and services now, before prices went up. To meet this added demand, businesses would have to boost production and hiring.

Similar reasoning for other ‘favorited” measures:

Increasing import tariffs, and Imposing restrictions on immigration.

Recognizing that:

The Fed’s response is crucial in all these cases. Typically, the central bank reacts to increases in inflation by raising interest rates sharply — a move that would choke off any demand that the policy measures might generate. With inflation running well below target, however, it’s appropriate for the Fed to hold rates low even if it sees a modest increase in inflationary pressures. It’s this subdued reaction function that allows the policy initiatives to have more positive effects.

It´s the sort of argument that will be eagerly embraced by the “End the Fed crowd”!