Toying with business cycle dating

In this year´s ASSA Annual Meeting in January, Christina & David Romer (R&R) presented “NBER Business Cycle Dating: Retrospect and Prospect”:

“…Our most substantial proposal is that the NBER continue this evolution by modifying its definition of a recession to emphasize increases in economic slack [Deviations from potential output and/or unemployment] rather than declines in economic activity…”

“…Throughout the paper, we make use of Hamilton´s (1989) Markov switching model as a framework for investigating and assessing the NBER dates. Though judgement will surely never be (and should not be) eliminated from the NBER business cycle dating process, it is useful to see what standard statistical analysis suggests and can contribute.”

On page 32, they move to Application: The implications of a two-regime model using slack for dating US business cycle since 1949:

“We have argued that a two-regime model provides insights into short-run fluctuations. And we have argued for potentially refining the definition of a recession to emphasize large and rapid increases in economic slack rather than declines in economic activity. Here, we combine the two approaches by applying Hamilton´s two-regime model to estimates of slack and exploring the implications for the dating of postwar recessions.”

According to R&R (page 34):

“The largest disagreement between the two regimes estimates using slack and the NBER occurs at the start of the Great Recession. The NBER identifies both 2008Q1 and 2008Q2 as part of the recession (with the peak occurring in 2007Q4), while our estimates (see table 1) put the probability of recession as just 21% in 2008Q1 and 43% in 2008Q2.”

Table 1 Economic Performance going into the Great Recession

Quarter NBER Date

In Recession?

Agreement of 2-Regime Model Shortfall of GDP from Potential Unemployment minus Nat Rate
2007Q4 No 97% -0.6% 0.6%
2008Q1 Yes 21% 4.2% 0.9%
2008Q2 Yes 43% -0.2% 1.4%
2008Q3 Yes 91% 3.9% 2.7%

It is somewhat confusing! The 2-Regime model only “fully” agrees with the NBER that the economy was in a recession from 200Q3. The GDP gap roams all over the place, while the unemployment gap is increasing consistently over time.

Although R&R suggest the NBER emphasize measures of slack, those measures are very imprecise. This is clear given the CBO systematic revisions of potential output in the chart below.

Since I´m “toying” with dates, I´ll try using the NGDP Level target yardstick to see what it says about the Great Recession. (Useful recent primers on Nominal GDP Level Targeting are David Beckworth and Steve Ambler).

In the years preceding the Great Recession, there were many things happening. There was the oil shock that began in 2004 and gathered force in subsequent years. There was the bursting of the house price bubble that peaked in mid-2006 and, from early 2007, the problems with the financial system began, first affecting mortgage finance houses but soon extending to banks, culminating in the Lehmann fiasco ofSeptember 2008.

The next chart  the oil and house price shocks.

The predictable effect of an oil (or supply) shock is to reduce the real growth rate and increase inflation (at least that of the headline variety). The charts indicate that was what happened.

The chart below shows that when real growth fell due to the supply shock, real output (RGDP) dropped below the long-term trend (“potential”?). Does this mean the economy is in a recession? If that were true, the recession would have begun in 2006!

In that situation, how should monetary policy behave? Bernanke was quite aware of this problem. Ten years before, for example, Bernanke et al published Systematic Monetary Policy and the Effects of Oil Price Shocks”. (1997)

In the conclusion, they state:

“Substantively, our results suggest that an important part of the effect of oil price shocks on the economy results not from the change in oil prices, per se, but from the resulting tightening of monetary policy. This finding may help to explain the apparently large effects of oil price changes found by Hamilton and many others.”

In the chart below, we observe that during his first two years as Chair, Bernanke seems to have “listened to himself” because NGDP remained very close to the target level path all the way through the end of 2007.

With NGDP kept on target, the effects of the supply shock are “optimized”. Headline inflation, as we saw previously will rise, but if there is little or no change in NGDP growth, core measures of inflation will remain contained.

During the first quarter of 2008, NGDP was somewhat constrained. This likely reflects the FOMC´s worries with inflation. RGDP growth dropped further, but during the second quarter of 2008, the Fed seemed to be trying to get NGDP back to trend. RGDP growth responded as expected and core inflation remained subdued.

At that point, June 2008, it appears Bernanke reverted to focus almost singly on inflation, maybe remembering what he had written 81/2 years before in What Happens when Greenspan is gone? (Jan 2000):

“U .S. monetary policy has been remarkably successful during Alan Greenspan’s 121/2 years as Federal Reserve chairman. But although President Clinton yesterday reappointed the 73-year-old Mr. Greenspan to a new term ending in 2004, the chairman will not be around forever. To ensure that monetary policy stays on track after Mr. Greenspan, the Fed should be thinking through its approach to monetary policy now. The Fed needs an approach that consolidates the gains of the Greenspan years and ensures that those successful policies will continue; even if future Fed chairmen are less skillful or less committed to price stability than Mr. Greenspan has been.

We think the best bet lies in a framework known as inflation targeting, which has been employed with great success in recent years by most of the world’s biggest economies, except for Japan. Inflation targeting is a monetary-policy framework that commits the central bank to a forward-looking pursuit of low inflation; the source of the Fed’s current great performance; but also promotes a more open and accountable policy-making process. More transparency and accountability would help keep the Fed on track, and a more open Fed would be good for financial markets and more consistent with our democratic political system.”

This is evident in his summary of the FOMC Meeting June 2008 (page 97), where Bernanke says:

“My bottom line is that I think the tail risks on the growth and financial side have moderated. I do think, however, that they remain significant. We cannot ignore them. I’m also becoming concerned about the inflation side, and I think our rhetoric, our statement, and our body language at this point need to reflect that concern. We need to begin to prepare ourselves to respond through policy to the inflation risk; but we need to pick our moment, and we cannot be halfhearted. When the time comes, we need to make that decision and move that way because a halfhearted approach is going to give us the worst of both worlds. It’s going to give us financial stress without any benefits on inflation. So we have a very difficult problem here, and we are going to have to work together cooperatively to achieve what we want to achieve.”

From that point on, things derailed and a recession becomes clear in the data. It appears the NGDP Level Targeting framework agrees with Hamilton´s 2-regime model that the recession was a fixture of 2008Q3.

If NGDP had not begun to tank in 2008Q3, a recession might, later, have been called before 2008Q3, but it would never have been dubbed “Great”, more likely being short & shallow.

The takeaway, I believe, is that the usual blames placed on the bursting of the house price bubble, which led to the GFC and then to the GR is misplaced. Central banks love that narrative because it makes them the “guys who saved the day” (avoided another GD) when, in fact, they were the main culprits!

PS: The “guiltless” Fed is not a new thing. Back in 1937, John Williams (no relation to the New York Fed namesake), Chief-Economist of the Fed, Board Member and professor at Harvard (so unimpeachable qualifications, said about the 1937 downturn:

If action is taken now it will be rationalized that, in the event of recovery, the action was what was needed and the System was the cause of the downturn. It makes a bad record and confused thinking. I am convinced that the thing is primarily non-monetary and I would like to see it through on that ground. There is no good reason now for a major depression and that being the case there is a good chance of a non-monetary program working out and I would rather not muddy the record with action that might be misinterpreted.

The usefulness of underlying, or core, rates

It is the case, instead, of not missing the trees for the forest. The case for core inflation, for example, is well established, but not always understood. The charts below show that sometimes the qualitative information given by “trees & forests” or core and headline rates is the same, but at other times, “trees & forests” look very different.  In 2007-08, the Fed took drastic and wrong actions because it only looked at the “forest” and missed the “health of the trees”.

The next chart shows the effect of the “sudden drop shock” brought on by Covid19. With economic activity “dumped”, temporary lay-offs skyrocketed.

Temporary lay-offs have since decreased, bringing headline unemployment down. Should we be “thrilled” by the falling headline unemployment, or are we missing the more durable effects of the wild swings in temporary lay-offs? In effect, these lay-offs may increase again following the pick-up in infections since the last data collection period for the employment report.

In order to have a better understanding of what´s happening to the trend in unemployment, we have to strip-out this highly (and distorting) volatile element. Our measure of core unemployment includes those called marginally attached (which are not in the labor force but want to work) and excludes those defined as on temporary lay-offs. In practice, it defines core unemployment by subtracting temporary lay-offs from the U-5 definition of unemployment.

The chart below shows that for most of the time, headline & core unemployment gave out the same information about unemployment. Even during the deep recession of 2008-09, there was not much divergence.

Since the Covid19 “sudden drop shock”, however, they diverge “majestically” even showing opposite trends.

The underlying unemployment trend is rising at an increasing rate. Therefore, it may be premature to indicate, as many have been doing, that the economy is improving or even showing signs of recovery!

Contrasting Inflation Targeting with NGDP Level Targeting

Given the recent increase in the number of articles or blog posts on NGDP level targeting (see, for example, here, here, here or here), I thought it would be useful to post an essay I wrote at the end of 2014 that compared NGDP-LT to inflation targeting. The piece is empirical, but I think the visual evidence is compelling,

Which is more reliable-1

Recession & Recovery: Is a rebound likely?

From March 12, 2009

Recently there was a heated debate involving, on one side Greg Mankiw and, on the other, Krugman and Brad DeLong. The spat revolved around the CEA deficit projection based on the prediction of relatively fast growth down the road. According to the CEA: “A key fact is that recessions are followed by rebounds. Indeed, if periods of lower-than-normal growth were not followed by periods of higher-than-normal growth, the unemployment rate would never return to normal”.

Implicitly, the CEA (and DeLong and Krugman) is supposing that “trend” (or “potential”) GDP and “normal” (or “natural”) unemployment are constant and that fluctuations in output (and employment) represent temporary deviations from “trend”.

Figure illustrates the concept.

What Mankiw is saying is that the “trend” itself may change. If, for example, the “trend” falls as a consequence of the recession we should not observe a strong rebound in the future exactly because “potential” GDP has fallen.

Based on his constant “trend” view of the process, Krugman asks: “How can you fail to acknowledge that there´s huge slack capacity in the economy right now? And yes, we can expect fast growth if and when that capacity comes back in to use”. The “slack capacity” is given by the distance between the level of “potential” GDP and actual GDP.

DeLong illustrates the argument for a strong rebound following a recession by showing (figure 2) that “those post recession periods of falling unemployment are also times of rapid output growth”. But figure 3 shows that if we remove points from the 1981-83 period, the positive correlation between higher unemployment and future growth disappears!

Maybe there´s something “special” about the 1981-82 recession? To find out I describe three alternative views of “potential” output and compare two periods; 1979-84 and 2002-08.

Figure 4 describes “potential” output according to the CBO estimate, figure 5 measures “potential” by applying the Hodrick-Prescott Filter (H-P) to the real GDP series and figure 6 calculates “potential” from a regression of real GDP on real consumption of non durables and services.

This last measure is based on work by John Cochrane (1994), who suggested that consumption might be useful to track movements in “trend” GDP. The idea behind this measure of “trend” or “potential” is based on the Friedman´s Permanent Income Hypothesis (PIH) coupled with Rational Expectations, according to which consumption primarily reflects the expectation of private households about long-term movements in income (GDP). Therefore, consumption should provide a reasonably good measure of “trend” GDP.

In the pictures, the yellow shaded areas designate periods when the economy was in recession. The dotted green lines on figure 6 indicate moments when “trend” growth appears to have changed.

What is notable is that in figures 4 and 5 “potential” GDP is much smoother (“linear”) than in figure 6. Note that in figures 4 and 5, for example, “potential” GDP doesn´t budge at the time of the second (and significant) oil shock in 1979-80. Intuition and theory are more consistent with the observation on figure 6 that shows that “potential” GDP falls temporarily.

The 1981-82 recession was severe. From peak to trough, GDP fell by almost 3% and unemployment reached almost 11%. From figure 6, however, we see that even before the recession was officially over “potential” GDP increased so that when the economy picked up the “distance” between “potential” GDP and actual GDP had increased even more, giving rise to a robust rebound.

Figure 6 indicates that “potential” or “trend” GDP does not evolve at a constant rate. During the 1981-82 recession, important structural changes were taking place. At that time Volker succeeded in controlling inflation (with gains in credibility) and Reagan convinced economic agents that economic policy (redirected towards “smaller” government) changed favorably “perceptions of the future”[1].  These changes increased “potential” GDP, which had the effect of increasing actual GDP growth. Therefore, the strong rebound in GDP growth was not the consequence of a high rate of unemployment, but was more likely due to the structural changes that increased the level of “potential” GDP. This is consistent with the finding that if we ignore those points in figure 2 the positive correlation between unemployment and future growth disappears.

Another marked difference between figures 4 & 5 on the one hand and figure 6 on the other, is that in the latter we observe one break in “potential” GDP in early 2007 (when the first signs of the subprime crisis showed up) and a reversal of “trend” in mid 2008. Apparently, the “intermediation shock” and the policy reactions to it this time around worsened agents “perceptions of the future”, reducing “potential” GDP and increasing the “natural” or “normal” rate of unemployment (here also, the behavior of the stock market may be regarded as a ”blanket” indicator, with the S&P showing a decrease of around 30% since election day)[2].

An article in the NYT (March 7) argues in favor of some kind of structural change: “… The acceleration [of unemployment] has convinced some economist that, far from an ordinary downturn after which jobs will return, the contraction under way reflects a fundamental restructuring of the American economy. In crucial industries – particularly manufacturing, financial services and retail – many companies have opted to abandon whole areas of business…”

According to figure 6, at the moment the level of GDP is just at “potential” meaning, opposite to what Krugman argues, that there is no “slack” – large or small – in the economy as indicated by, for example, figure 4. In this situation a strong rebound, underlying the CEA predictions, is quite unlikely!

 

PS June 25, 2020

What I didn´t fully grasp at that time was the importance of monetary policy in ‘determining’ the level of the trend growth path.

With the Fed laser-focused on inflation, something confirmed by Bernanke himself in the June 08 FOMC meeting:

“My bottom line is that I think the tail risks on the growth and financial side have moderated. I do think, however, that they remain significant. We cannot ignore them. I’m also becoming concerned about the inflation side, and I think our rhetoric, our statement, and our body language at this point need to reflect that concern. We need to begin to prepare ourselves to respond through policy to the inflation risk; but we need to pick our moment, and we cannot be halfhearted.”

“Agents perceptions of the future were worsened”, with the economy evolving along a ‘depressed growth path’.

The danger at present is that the Fed will fall short in ‘reviving’ agents perceptions of the future, in which case a rebound will be incomplete and the economy will remain in an even deeper depressed mode!

[1] The behavior of the stock market corroborates this observation. After spending the previous 17 years fluctuating around 850 points, in mid 1982 the Dow (and S&P) begin a long boom period that would take the Dow from 850 points to 12 thousand points 17 years later!

[2] Otherwise the qualitative information given by the 3 pictures don´t differ. Notable is the fact that in the more recent period (something that is in fact observable since 1984) the economy evolves very close to “potential”. This has been named “The Great Moderation”.

The Longest Expansion: A post mortem

According to the NBER´s Business Cycle Dating Committee (BCDC), the expansion that began in June 2009 ended in February 2020, having lasted 128 months, eight months more than the March 1991 – March 2001 expansion.

A comparative analysis of these two long expansions should be useful. I´ll fudge the dates of the 1991 – 2001 expansion, extending it to the end of the next cycle that began in November 2001 and ran through December 2007. The only reason behind this extension is to bring out the importance of a stable level path of NGDP. [Note: The 2001 recession was more like a growth retrenchment, with year-on-year real growth never turning negative. Also, the popular rule of thumb of negative real growth in two successive quarters never materialized].

What separated these two long expansions was the deep and longest post war recession that went on from December 2007 to June 2009 (18 months), being known as the Great Recession.

The main statistics (average over periods) for the two expansions is illustrated below:

The charts are telling. In order to have all the data on a monthly basis, for RGDP & NGDP I use the monthly estimates of those variables (available from January 1992) provided by Macroeconomic Advisers.

The first panel illustrates the behavior of NGDP & RGDP relative to the Great Moderation trend level path.

During the first expansion, both NGDP & RGDP hug close to the trend for much of the time. During 1998-03, there is some instability in NGDP, which is mirrored in RGDP instability. Note that towards the end of the first expansion, although NGDP remains close to trend, RGDP falls significantly below trend. What is going on?

In the second expansion, both NGDP & RGDP remain on a stable level trend path that has been permanently lowered! Later I will examine the ‘transition’ from the high to the low trend path brought about by the Great Recession.

The next panel shows the behavior of prices, both the headline and core versions of the PCE during the two expansions.

During the first expansion, both headline & core prices remained close to the 2% trend line from 1992. Towards the end of this expansion, just as RGDP fell below trend, headline PCE rises above trend. The fall in RGDP growth & rise in inflation implied by those moves is consistent with predictions of the dynamic AS/AD model in the case of a supply (oil price in this case) shock.

During the second expansion, after 2014, when oil prices dropped significantly, headline PCE shifted down and never “recovered”. Core PCE has remained significantly below the 2% trend and has risen at a rate below 2%.

The real and nominal output growth panel (and the price panel) indicate the two expansion phases were characterized by nominal stability. The differing characteristic is that during the recent long expansion, nominal stability followed a lower trend level path with lower growth.

To see how the economy transited from the “high” to the “low” path, I examine the details of the last years of the first expansion.

Those years were marked by oil shocks. As the dynamic AS/AD model tells us, growth slows and inflation rises. The best monetary policy can do in those instances is to keep aggregate nominal spending (NGDP) growth stable along the level trend path.

As the next charts indicate, the results are ‘model consistent’. An oil shock happened:

As predicted by the model, RGDP dropped below trend (real growth fell) and headline PCE shifted up (headline inflation increased):

NGDP, however, remained close to the trend level path, while Core PCE remained below the 2% level path, with core inflation remaining subdued:

The fall in real growth and the rise in headline inflation were the unavoidable consequence of the oil shock. Apparently, both Greenspan during his last year as Fed Chairman and Bernanke during his first two years as Chairman recognized this fact, keeping monetary policy on an ‘even keel’ (evolving close to the trend level path).

After that point, things unraveled. In the first six months of 2008, oil prices climbed an additional 44%. Headline PCE (and inflation) followed suit.

It is rare that a policymaker has the chance of putting his academic knowledge into practice. In 1997, Bernanke, with co-authors Gertler & Watson, published a paper titled:

“Systematic Monetary Policy and the Effects of Oil Price Shocks”. 

In the conclusion, they state:

“Substantively, our results suggest that an important part of the effect of oil price shocks on the economy results not from the change in oil prices, per se, but from the resulting tightening of monetary policy. This finding may help to explain the apparently large effects of oil price changes found by Hamilton and many others.”

At that point, June 2008, monetary policy was “crunched”, with NGDP growth turning negative! No wonder the “effects of the oil price changes became large”, and the recession became “Great”.

The problem, I believe, is that Bernanke´s mind became increasingly focused on inflation. In that same year (1997) he had published a paper (coauthored with Frederick Mishkin) titled:

Inflation Targeting: A New Framework for Monetary Policy?

At that time he was still “flexible”, concluding that IT “construed as a framework for making monetary policy, rather than rigid rule, has a number of advantages…”

It seems “rigidity” set in because eleven years later, concluding the June 2008 FOMC Meeting, Bernanke states:

 “My bottom line is that I think the tail risks on the growth and financial side have moderated. I do think, however, that they remain significant. We cannot ignore them. I’m also becoming concerned about the inflation side, and I think our rhetoric, our statement, and our body language at this point need to reflect that concern. We need to begin to prepare ourselves to respond through policy to the inflation risk; but we need to pick our moment, and we cannot be halfhearted.”

Bernanke´s timing could not be worse because at that point, June 2008, a recovery appeared to be incipient. The rest, as they say, is history. The economy never recovered so the “longest expansion” should never be hailed or become a paradigm.

Appendix:

As the charts below indicate, the US economy has always recovered from deep recessions, even from the “Great Depression”. By recovery, I mean that the economy climbs back to where it should have been if not for the recession/depression. As the bottom right chart indicates, the economy never recovered from the Great Recession.

A big problem is that monetary Policy is “guided” by unobservable variables. The concept of “potential” output, for example, says that if real output is above “potential”, monetary policy should be tightened, because otherwise inflation will rise. Conversely, if real output is below “potential”, monetary policy should be loosened, otherwise inflation will fall.

The fact is that when guided by unobservable variables, monetary policy becomes a “matching game”.

The charts below indicate that when actual output is above the initial estimate of “potential”, “potential” output is systematically revised up until it “matches” actual output. The opposite happens when actual output is below initial estimates of “potential”. Note that in the first case, inflation, instead of rising was falling and remained low thereafter, while in the second case it remained low throughout.

This imparts a tightening bias to monetary policy. In the “longest expansion”, this bias proved “mortal”.

PS: Note that I make no mention of the house price bust or financial troubles, usually pinned as “causes” of the Great Recession. I believe those were minor actors in the “movie”. The “movie was a box-office bust” because monetary policy, the “leading actor”, forgot its lines!

Getting down to business

A James Alexander, Benjamin Cole, Justin Irving, Marcus Nunes post

After a six-year run, during which Historinhas helped spread the Market Monetarist approach, this blog will undergo a metamorphosis, becoming NGDP-Advisers. The blog will continue but be augmented by new products that will be available via subscription.”.

In watching the U.S. and global economy since 2008 (and before) it has become obvious there is a dearth of financial advice that is informed by Market Monetarism, or even close attention to nominal gross domestic product (NGDP).

A recent Economist magazine study of the International Monetary Fund’s national economic forecasts from 1999 to 2014 found, “Over the period, there were 220 instances in which an economy grew in one year before shrinking in the next.  In its April forecasts the IMF never once foresaw the contraction looming in the next year.” Not once! Something is wrong in economic forecasting.

NGDP-watching is not a forecasting cure-all. However, Historinhas and the Market Monetarists have time and again been proven right on macroeconomic matters when the establishment was wrong. When old-school monetarists feared hyperinflation from unconventional easing measures, Market Monetarists correctly saw the real risk was still tight money. When Keynesians predicted recession from cuts in government spending during the 2013 US fiscal cliff episode, Market Monetarists anticipated the monetary offset and were proven right. When central banks in Europe raised interest rates in 2011, Market Monetarists called this for the debacle that it became.

It is time to bring these insights from the world of blogging, into the realm of macro forecasting, time to unseat the hopeless “experts”.

The bedrock of our approach is a healthy fear of market efficiency, though our approach still has important advice for investors. Many have missed historic bond rallies since 2008, so certain were established advisers that an inflationary surge, or even hyperinflation, was pending. Equity investing is equally tricky.

Central bank monetary policy sometimes feels like a game of blackjack, random. Time and again in its history, the Fed has tried to tighten (in recent years), or loosen (in earlier eras), yet been beaten back when markets question their view of economic reality. It is hard to forecast how stubborn a central bank will be in such situations and when it will inevitably buckle, but our approach frames the issues correctly, allowing all investors to understand where their risk lies.

At NGDP Advisers, we hope not only to continue our examination of the global economy, but also to recognize realities and advise accordingly. We’ll yell from the cliff tops ‘what should be’, but we’ll also help you get ready for what ‘will be’.

Please join us at ngdp-advisers.com, the best is yet to come. The Historinhas blog will stay up but dormant, and recent and all future posts will be freely available here ngdp-advisers.com/blog/ 

Bernanke: interest rate junkie and inflation-targeting nutter

A James Alexander post

Seems like Ben Bernanke has tried to get the final word before the next FOMC meeting, as sort of ex officio member. In a blog post he strongly defends negative interest rates and rails against raising the inflation target as if people were proposing 10% inflation targets. It seems no more than 2% inflation or we are all doomed. He does mention NGDP targeting but misunderstands it badly.

His post is so full of errors that it has hard to know where to start.

Nominal interest rates are very low, and in a world of excess global saving, low inflation, and high demand for safe assets like government debt, there’s a good chance that they will be low for a long time.

What does “excess global saving” mean? In macroeconomics “saving” is part of an identity equal to “investment”. Like MV=PY. Saving can’t be in excess it has to equal investment.

Being generous, perhaps he means there is too much demand to hold money? In which case, central banks should supply more to bring demand and supply into balance; or threaten to do so until demand increases and more is spent.

Interest rates are my first love

When the next recession arrives, there may be limited room for the interest-rate cuts that have traditionally been central banks’ primary tool for sustaining employment and keeping inflation near target.

This is a very basic error. It is a view that sees interest rates as the primary tool, rather than a symptom of monetary policy. Interest rates react to nominal growth expectations and these are driven by central banks supplying more or less high-powered money. Interest rates are low in the US because nominal growth expectations are low. Yet US Base Money has been shrinking at between 3-6% for over a year now. Doesn’t he know this?

Gets the case for NGDP Targeting very wrong

Outside the United States, Mark Carney, governor of the Bank of England, has expressed openness to targeting nominal GDP (which essentially involves targeting a higher inflation rate when GDP growth is low)

Err, just no, that is not what it is. NGDP targeting asks for a stable growth of NGDP. It particularly targets expectations of growth as expectations drive action – just like in the theory of targeting inflation expectations. Targeting expectations also avoids near term noise in actual data, just like with inflation targeting. More generally, it provides nominal stability, thus preventing the occurrence of major demand shocks, especially those that flow from monetary policy reacting to supply shocks (like the one Bernanke himself presided over in 2008).

NGDP targeting does not target “higher inflation”. It is agnostic about inflation. Market Monetarists are often very sceptical that inflation can be accurately measured. And, they are certainly sceptical a central bank can target inflation. It is a sprite and it makes (Real) GDP equally hard to calculate, in real time or even forecast. People live and work in the nominal world, not the Real world.

Interest rates are best even when negative

The rest of the article is all about the pros and cons of negative interest rates (many pros) versus a higher inflation target (many cons).

The extended discussion on real rates leaves me cold. I don’t really understand what inflation is so I struggle to understand the meaning of a real interest rate and find it very hard to comprehend the neutral real rate.

I also know the public finds negative rates almost incomprehensible and regard such a policy as a total failure by “the authorities”, whoever they are. Bernanke’s strong support for negative rates shows just how out of touch he must be with real people. He claims Europeans and Japanese under these negative interest regimes are coping well. That is just not true.

He even suggests that negative rates are only temporary, and that everyone knows it, not realising that this renders them toothless, as it promises tightening around the corner.

Whoooo, don’t let the inflation genie out of the bottle

Higher inflation has costs of its own, of course, including making economic planning more difficult and impeding the functioning of markets. Some recent research suggests that these costs are smaller than we thought, particularly at comparatively modest inflation rates. More work is needed on this issue. Higher inflation may also bring with it financial stability risks, including distortions it creates in tax and accounting systems and the fact that an unexpected increase in inflation would impose capital losses on holders of long-term bonds, including banks, insurance companies, and pension funds.

It is hard to know what “higher inflation” he is talking about. 3%, 4%? The golden eras of the US economy usually had higher inflation than today. The lowflation, or rather low nominal growth, of the Great Stagnation he helped create is the thing making economic planning more difficult and impeding the functioning of markets. Economies need healthy nominal growth to be flexible enough in rewards to allow all to see growth in returns, some faster than others. At a crushing 3% or less nominal growth, at a depressed NGDP level (see chart below), this cannot happen.

ja-bernanke-junkie-nutter

Downwardly sticky wages are a massive problem causing recessions, but also constraining productivity growth  in a low nominal growth environment. Yet Bernanke calls for more work! What have the thousands of central bank-employed PhDs been doing all these years? Twiddling their thumbs.

Is Bernanke talking his own book and/or that of his employers?

Financial stability risks are worst in deflationary environments, no question, just look at the Great Recession or the Great Depression. Tax and accounting issues arise only when inflation is well above 10% or more, and then they are still quite theoretical rather than real. Bernanke seems to be fearing a return to the worst years of the 1970s. He can’t be serious.

And then he worries about his various new employers seeing capital losses from betting wrong on financial markets. Well, does he think they should be guaranteed winnings?

The article goes on and on with the familiar litany of worries about higher inflation hurting savers, needing political approval etc. etc. No one is proposing 10% inflation. Just 3 or 4%, or better still a commitment to a level target, an average target, and not constant undershooting. Or, better, a nominal income/NGDP level target.

He seems to be randomly firing at straw men. He even clutches at the idea of more fiscal activism, as if that could work without threatening the inflation target. He well knows the Fed would offset it at the first opportunity.

He never used to be quite this bad, as Scott Sumner tirelessly points out when Market Monetarists get fed up with these manias of the modern Bernanke.

Perhaps he’s worried about his lowflation legacy crumbling. It couldn’t happen soon enough for us. He seems to have become a caricature of things he may have ridiculed in the past: an interest rate junkie and an inflation-targeting nutter.

UK Monetary Policy Revolution

A James Alexander post

The great mid-2015 tightening

From the August 2015 Inflation Report opening remarks:

Policy outlook

The MPC’s projections are conditioned on Bank Rate following the gently rising path implied by
market yields. Under this assumption, demand growth is expected to be sufficient to return inflation to the target within two years. Inflation then moves slightly above the target in the third year of the forecast period as sustained growth leads to a degree of excess demand.
….
As the UK expansion progresses, speculation about the precise timing of the first move in Bank Rate is increasing. This is understandable and is another welcome sign of the economy returning to normal. The likely timing of the first Bank rate increase is drawing closer.

The great mid-2016 loosening

From the August 2016 Inflation Report opening remarks  :

Policy trade-off

The MPC’s Remit recognises that when the effects of shocks persist over an extended period, the MPC is likely to face an exceptional trade-off between returning inflation to target promptly and stabilising output.
When this is the case, the Remit requires the MPC to explain how it has balanced that trade-off, including the horizon over which it aims to return inflation to target.

Fully offsetting the persistent effects of sterling’s depreciation on inflation would require exerting further downward pressure on domestic costs. And that would mean even more lost output and a total disregard for higher unemployment.
In the Committee’s judgement, such outcomes would be undesirable in themselves and, moreover, would be unlikely to generate a sustainable return of inflation to the target beyond its three-year forecast period.

As a result, in order to mitigate some of the adverse effects of the shock on growth, the MPC is setting policy so that inflation settles at its target over a longer period than the usual 18-24 months.

ja-uk-mp-revolution

Kashkari should have joined the Treasury, not the Fed!

The title of his speech is revealing: Nomonetary Problems: Diagnosing and Treating the Slow Recovery, where he says:

I must acknowledge up front that most of the policy prescriptions I will identify are outside the scope of monetary policy. Monetary policy is largely doing what it can to support a robust recovery, and what remains are fiscal and regulatory policies. If we are able to apply our research expertise to identify potential solutions, I believe it is appropriate to do so and then leave it to other branches of government to decide whether or not to pursue them

If, as he says “I joined the Federal Reserve because I want to help tackle the most important economic policy challenges we face as a country”, he´s wasting his time at the Fed!

The view of central bankers that the problems they face are “nonmonetary” is prevalent. Just to give one example (among many):

Throughout the “Great Inflation” Arthur Burns argued that inflation was a nonmonetary phenomenon (Unions, Oligopolies, Oil Producers, etc.).

Now, the view remains the same “throughout the “Great Stagnation”!