The FOMC or the Market?

James Bullard just gave a presentation in China: “Slow Normalization or No Normalization?”. The conclusion:

  • The FOMC median projection for the policy rate suggests a gradual pace of rate increases over the next several years.
  • The market-based expectation for the FOMC policy rate is much shallower, implying only a few increases over the forecast horizon—almost no normalization.
  • US. evidence from labor markets, actual inflation readings and global influences suggests the FOMC median projection may be more nearly correct.
  • US. evidence from recent readings on GDP growth and market-based inflation expectations suggests the market view of the path of the policy rate may be more nearly correct.

Ladies & Gentlemen, place your bets!

PS Note how monetary policy has been downgraded to establishing a “normal” level of the FF rate. And by “devine coincidence” that “normal” level will provide the “target” rate of inflation. It´s a double “reasoning from a price change”!

NAIRU: The “Holy Grail”

Tim Duy, the quintessential “Fed Watcher”, has a detailed discussion of the FOMC Minutes: This Is Not A Drill. This Is The Real Thing.  He then gives his thoughts, the last of which summarizes them:

E.) Of all the divisive points above, I think the most important is the debate over the level of full employment. The ability of the doves to slow the pace of subsequent rate hikes will hinge on their willingness to push for below NAIRU unemployment to alleviate underemployment.

Which puts the Fed in a very bad light, square in the Phillips Curve camp, with the long discredited NAIRU being the “holy grail” in determining Fed policy!

If monetary policy could have avoided it, “Secular Stagnation” is a direct consequence of monetary policy!

Larry White has a very interesting post at Alt-M, where he uses Michael Darby´s 1976 analytical apparatus to do “Some Simple Monetarist Arithmetic of the Great Recession and Recovery” (you should read the post to enjoy the simplicity of the “apparatus”):

Monetarist theory sharply distinguishes real from nominal variables.  Nominal shocks (changes in the path of the money stock or its velocity) have only transitory effects on real variables like real GDP. Accordingly, an account of the path of real GDP in the long run (and 6+ years of recovery should be enough time to reach the long run) must be explained by real and not merely by nominal factors.  An account of the path of nominal GDP, by contrast, cannot avoid reference to nominal factors.  So we need distinct (but compatible) accounts of the two paths.

A downward displacement of the steady-state path of nominal GDP, due to a contractionary money supply or velocity shock, can bring a transitory decline in real GDP.  As is familiar, people try to remedy a felt deficiency in money balances by reducing their spending.  In the face of sticky prices, reduced spending generates unsold inventories and hence cutbacks in production and layoffs until prices fully adjust.  As Market Monetarists have long argued, the Federal Reserve could have avoided the downward displacement of the path of nominal GDP if policy-makers had immediately recognized and met the rise in fluidity (the drop in velocity) with appropriately sized expansionary monetary policy. 

Although a one-time un-countered rise in desired fluidity [inverse of velocity] can temporarily knock real GDP below course, such a nominal shock should not persistently displace its growth path, as the first chart above indicates has happened.  We can expect monetary equilibrium to be roughly restored by appropriate adjustment in the price level relative to the nominal money stock, bringing real balances up to the newly desired level, within three or four years at most.  (In the data plot above, we see the GDP deflator shift to a lower path already in 2009.)  Real GDP should around the same time return to its steady-state path as determined by non-monetary factors (labor force size and skills, capital stock, total factor productivity as governed by technologic improvements, policy distortions, and so on).  To explain the continued low level of real GDP relative to estimated potential since 2011 or so, we need a persistent shock to the path of real GDP.

I suggest that real GDP has shifted to a lower path because of a shrinkage in the economy’s productive capital stock — a problem that better monetary policy (not feeding the boom) could have helped to avoid, but cannot now fix.

Some comments:

The two highlighted passages seem contradictory. In the first, monetary policy failed to offset the rise in fluidity (fall in velocity) giving rise to the steep fall in NGDP.

In the second, he goes back in time to say the problem was excessively expansionary monetary policy that fed the boom.

I have a lot of trouble with the second claim (see here). But if you assume that´s true it becomes a double critique of monetary policy, having got it wrong in sequence, first in one direction and then the other.

The hysteresis argument that bad monetary policy shrank the economy´s capital stock (permanently lowering the path of real output) is hard to accept. After all, during the great depression, real output over a long span of time climbed back to the previous trend level, despite a much larger” shrinkage in the productive capital stock”. It seems a “review” of monetary pólicy had a lot to do with that outcome.


The next charts are also shown by Larry White, but I want to go into a bit more detail.



The sequence is clear. Economic events (house price fall, troubles with financial firms, among others) induced a strong rise (jump) in fluidity (drop in velocity). Money supply did not rise by anything close to necessary to offset the fall in velocity. The result was a (almost unheard of) fall in NGDP to a much lower level.

Later, from the end of 2010 to late 2011, maybe due to the Eurozone crisis, fluidity had another “step increase”, also not fully matched by the rise in money. The NGDP path ticks down.

More recently, with the path of fluidity steepening somewhat and the money supply trend remaining stable/constant, NGDP growth seems to falter.

What the horrendous monetary policy of the past eight or nine years has accomplished is “momentous”. From the successive reductions in the level of potential output estimated by the CBO over the past years, it seems that instead of “Mohamed (actual RGDP) going to the mountain (Potential RGDP), the mountain is coming down to Mohamed”!


The “emptiness” of the Fed´s monetary policy

Dean Baker writes: “As talk grows of a June interest rate increase, where’s the data to support it?”:

Weak data had convinced many that the Federal Reserve was unlikely to raise interest rates in June, but in recent days multiple Fed policymakers have suggested that an increase should be on the table in the near future. What’s unclear is why.

Little new data have emerged to suggest that the economy is much better than it was six or nine months ago. Since interest rates were raised in December, in fact, the pace of economic improvement has slowed almost to a stall.

All that´s true, but Dean shouldn´t be surprised because the monetary strategy in place has absolutely nothing to do with the underlying economy, being guided only and exclusively by what they call “Gradual Normalization” (of interest rates, obviously).

And “gradual” cannot mean just once a year, but at least a couple of times. Remember that early this year the sages thought four times was a “good definition of gradual”!

Update: In addition to “empty” the Fed´s strategy (program) is infeasible because there´s a loop that doesn´t allow it to “terminate”:

 [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.

Central Bankers are in a “Permanent State of Readiness”

Sounds like they all attended the same “Military Academy”!

The latest:

SENDAI, Japan—Bank of Japan Gov. Haruhiko Kuroda said he would act quickly if the yen’s rise threatens his inflation goal, highlighting his caution over exchange rates ahead of a major international convention.

“Be it exchange rates or anything, if it has negative effects on our efforts to achieve our price-stability target, and from that perspective if we figure that action is necessary, we will undertake additional easing measures,” Mr. Kuroda told reporters Thursday.

The remarks by Mr. Kuroda come at a time of tension between the U.S. and Japan over whether the yen’s appreciation seen earlier this year is sharp enough to warrant intervention by authorities. Investors are closely watching whether Tokyo and Washington will continue to clash over yen policy during a meeting in northern Japan Friday and Saturday of finance chiefs from the Group of Seven leading industrialized nations.

A few other examples picked randomly:

Dovish Draghi drives down the euro after promising more QE ‘if necessary’

As consumer debt grows, Mark Carney says ready to act ‘if necessary’

Bernanke: Fed Remains Ready To Act, If Necessary

I´m being cute. Obviously central bankers must always be ready to act. I just wish that sometimes they really did! After all, the world economy situation is in such dire straits because of, on the one hand, from some lack of action and, on the other, from some bad ones.

And going on to the G7 meeting we travel back thirty odd years to another “time of tension between the US and Japan”. In short, it seems the Yen can never depreciate against the dollar, in what is one of the most blatant cases of “currency discrimination” the world has ever known.

If you don´t believe me, believe the data.

State of Readiness

In the first half of the 1980s, the dollar appreciated a lot against all currencies, except, you guess, the Yen! To make it visually clean, the chart compares the Yen and the DM against the dollar.

When the sages gathered at the Plaza to “talk the dollar down”, then, yes, the Yen could appreciate freely!

So, Mr Kuroda, never mind “hurting” the “feelings” of Secretary Lew. Just don´t let him force on you what Secretaries Donald Regan and James Baker forced on your predecessor in the 1980s!

Currency War: It won´t happen

Kocherlakota writes “Bring On the Currency War”:

The U.S. government seems concerned about what will happen if other big nations push down the value of their currencies against the dollar. Actually, it could be good for the global economy.

Ahead of this week’s meeting of finance ministers from the Group of Seven developed nations, Treasury Secretary Jacob Lew has warned that the U.S.’s counterparts — the three largest euro-area nations plus Canada, Japan and the U.K. — might undermine global growth if they engage in policies that cause their currencies to depreciate against the dollar. In my view, his concerns are misplaced.

That´s an obvious point, just look what happened to the countries that devalued (delinked from gold) in the early 1930s, but:

  1. The US has selectively (and Japan in the 1980s is the “representative” example) over time “warned” countries about letting their currencies depreciate against the dollar.
  2. The US position as a “monetary superpower” indicates that it dictates to a large extent the world´s currency “configuration”.

The charts below show, through some examples, how US monetary policy has ‘shaped’ the broad dollar index over time.

Currency War_1

Whenever US monetary policy is tightened (measured by an enlargement of the NGDP ‘gap’ relative to the “Great Moderation” trend, or a narrowing if coming from above), the dollar appreciates relative to a broad basket of currencies. If US monetary policy is “eased” (measured by the NGDP ‘gap’ narrowing, or enlarging if from above trend), the dollar depreciates.

Now, Japan is in the news. Actually, it´s described as “Elephant in the Room at This Week’s G-7 Is Sure to Be the Yen”:

When finance chiefs and central bankers from the Group of Seven countries gather this week at a hot springs resort in northern Japan, the official agenda has them focusing on ways to revitalize global growth and crack down on cross-border tax evasion.

Left off the discussion list is one of the most pressing concerns for the host nation: how to counter a 10 percent surge in the yen that’s squeezing an economy unable to escape a cycle of expansion and contraction. Cries for sympathy are likely to fall on deaf ears, given the tailwind corporate Japan got in the first years of the Abe administration from the currency’s sharp depreciation.

As the chart indicates, Abenomics was successful from inception because the expansionary monetary policy undertaken by Abe/Kuroda managed to depreciate the Yen by more than the Broad Dollar Index.

Currency War_2

But more recently, while Japan´s monetary policy has faltered, the US has relented on “tightening” (although this seems to have changed as indicated by the Minutes released yesterday). That was a “deadly” combination from Japan´s perspective.

In short, Japan did it to itself! If the US “tightening bias” is resumed and Japanese monetary policy makers rethink their strategy, the Yen will again depreciate. If the FOMC “lightens-up” again, as it did earlier this year, Japan´s monetary policy will have to be even “braver”!

“If I had a hammer” & “When will they ever learn”

From the FOMC Minutes

Most participants continued to expect that, with labor markets continuing to strengthen, the dollar no longer appreciating, and energy prices apparently having bottomed out, inflation would move up to the Committee’s 2 percent objective in the medium run.

Most participants judged that if incoming data were consistent with economic growth picking up in the second quarter, labor market conditions continuing to strengthen, and inflation making progress toward the Committee’s 2 percent objective, then it likely would be appropriate for the Committee to increase the target range for the federal funds rate in June.

Some participants were concerned that market participants may not have properly assessed the likelihood of an increase in the target range at the June meeting, and they emphasized the importance of communicating clearly over the intermeeting period how the Committee intends to respond to economic and financial developments.

They want markets to play Keynes´ “Beauty Contest Game”. However, market participants look at the same data that the Fed does. And markets don´t see objective reasons for the Fed to (explicitly) tighten.

The dollar, which reversed trend shortly after the April meeting, rose and will continue to rise to reflect the renewed passive tightening! When will they ever learn?

Why talk about the “living” when they´re handsomely compensated to elucubrate about the “dead”?

Walking dead_0

My partner James Alexander sent me something that gave me this idea…

And the “dead”, as you may have surmised, is Inflation!

As the chart depicting (from the Atlanta Fed Inflation Project) the flexible and sticky CPI YoY inflation makes very clear, inflation has been dead for at least a quarter century.

Walking dead_1

What the chart makes clear:

  1. An inflationary process, like during the “Great Inflation” of the 1970s, is characterized by increases in both the flexible and sticky components of the CPI (or any other price index)
  2. When you have price shocks like in the 00s, where between 2003 and 2008 oil shocks were prevalent, the flexible components “swing along” while the sticky components “stay put”. That´s the outcome when the Fed is successful in maintaining nominal stability (satisfactory NGDP growth along an adequate trend path).
  3. When, as in 2008, the Fed, suddenly fearful of price shocks that disturb the flexible components, engineers a massive demand shock (deep drop in NGDP) to quench “inflation”, the result is a long depression! Note that even the sticky prices are affected!

To justify their handsome remuneration, our sages at the Fed keep “talking-up” a problem that has long been dead. Much easier than worry about the (sometime barely) living!

Euro Area 1Q16 NGDP growth not so bad, better to come

A James Alexander post

We have already posted about our optimism for Euro Area economic growth due to the very strong growth in Base Money fuelled by the ECB’s “shock and awe” QE programme. We know it could be so much easier and so much better if they simply moved to properly flexible inflation targeting, price-level targeting or better still, NGDP level targeting. Unfortunately, central banks the world over just don’t seem brave enough to break with their peers on the issue. 2% projected inflation is the ceiling, de facto in the US, UK and Japan, de jure in the Euro Area.

However, out of the US, UK and Euro Area only in the latter is QE still growing strongly, and we remain encouraged by the plans for more.

While it will still be a few weeks until Eurostat releases 1Q16 NGDP figures we can estimate the result using those individual countries that have reported NGDP for 1Q16 like Germany and France plus the next four largest countries that have reported RGDP and “inflating” the figure to NGDP using their average GDP deflator over the past four quarters. It won’t be precisely right, but it will be good enough to get a feel of the first quarter trend.

The biggest six Euro Area countries account for 87% of Euro Area GDP and their estimated 1Q16 NGDP growth was 3.0% YoY, an uptick from the 2.9% seen in 4Q15. It is not quite as strong as the US at 3.2% YoY, but encouraging and actually in line with the longer run average. It was actually a really strong (for the Euro Area) 3.7% QoQ annualised – and the highest figure since 1Q11. But QoQ figures are noisy and we wouldn’t like the ECB to get any funny ideas about the strength of NGDP growth, especially as we know what followed 1Q11!


NGDP growth was driven by the strong NGDP growth figure for Germany at 4.1% YoY that helped offset a deceleration to 2.3% for France. Spain is still growing above 4% YoY and even Italy managed to maintain a decent result at 1.7%.

We could dwell on the mistakes of the past, the twin Trichet disasters of 2008 and 2011, and the failure of Draghi “to do what it takes” in 2013 when he let the TLROs run off with no replacement, thus crashing Base Money growth. But bygones are bygones. Now looking at current trends in QE and the effect on Base Money we are more encouraged and pleased to see the impact on Euro Area NGDP despite significant market and German scepticism. We are Market Monetarists but sometimes the markets can be rather obtuse, in my opinion. Still, all views are welcome and it’s what makes a market after all.