Hiding behind “Secular Stagnation”

Scott Sumner comments on a post by Edward Hugh:

The focus of Hugh’s piece is Finland.  He points to the very weak recovery, and suggests that structural factors are involved. Perhaps so, but some of the data he cites point in exactly the opposite direction.  Finnish unemployment has been rising, and at 9.2% is at the highest rate in more than a decade.  Meanwhile Hugh’s post shows inflation in Finland falling to zero. Those data points suggest a lack of aggregate demand, not structural problems.

EH shows several charts to further his “secular stagnation” claims. One chart he doesn´t show is a comparative chart of nominal spending (NGDP) relative to trend. I do so below and add Austria and Spain as “evidence” of the degree of the AD shortfall in Finland.


Every country in the world could do with some structural reforms, some more, some less, but the big problem with most of those economies, as exemplified by the charts for the three countries above, where all are subject to the same monetary policy, is differing degrees of  aggregate demand shortfall.

Yellen faces the “Iron Ladies” in the FOMC

It seems Esther George (EG) and Loretta Mester (LM) are stand-ins for the departed Fisher and Plosser! Since they can´t play the role of “Inspector Clouseau”, let´s call them “Maggies in Drag”.


This balanced approach framework supports taking steps to remove the extraordinary amount of monetary accommodation currently in place. The next phase in this process is to move the federal funds rate off its near-zero setting. While the FOMC has made no decisions about the timing of this action, I continue to support liftoff towards the middle of this year due to improvement in the labor market, expectations of firmer inflation, and the balance of risks over the medium and longer run.


Most times in life, moving from extraordinary to ordinary is considered a bad thing.  In the case of monetary policy, such a move should be viewed as a good thingbecause it means conditions are in place for a sustainable economic expansion with maximum employment and price stability.

The Chair tries to “sooth them”:


I would be uncomfortable raising the federal funds rate if readings of wage growth, core consumer prices, and other indicators of underlying inflation pressures were to weaken, if market-based measures of inflation compensation were to fall appreciably further, or if survey-based measures were to begin to decline noticeably.”

The underlying economy has been “quite weak by historical standards” and thus in need of low interest rates to sustain progress on unemployment; inflation remains very low; the risk that because of a stagnant global economy, the U.S. might not be able to bear very high interest rates in the future; the experiences of other countries with early rate increases, such as Japan and Sweden, point to caution; it pays for the Fed to take out “insurance” against a return to exceptionally low inflation and high unemployment by making sure with sustained low rates that the economy gets on a stronger track.

The chart shows important Yellen concerns. Core inflation and expected long-term inflation have mostly stayed well below target for the past seven years. Even the volatile headline measure has underperformed!

Iron Ladies_1

For the past five years, after “emerging” from the “Great Recession”, the economy  has yet to find a “stronger track”.

Iron Ladies_2

When will they ever learn about love NGDP-LT

The “(Stan) Fischer Effect”

In 1995, while a managing director of the IMF, Stanley Fischer wrote an essay titled: “Modern Central Banking”, where he ardently defends “Inflation Targeting” (The NBER version is here):

…The issue of a target price level (PLT) versus target inflation rate (IT) nonetheless remains. Compare the goal of being close to a target price level that is growing at 2% per annum from a given date, say 1995, with the goal of achieving a 2% inflation rate each year from 1995 on.

With a target price path (PLT), the monetary authority attempts to offset past errors, thus creating more uncertainty about short-term inflation rates than with an inflation target (IT). The gain is more certainty about the long-term price level.

My present view is that the inflation target with its greater short-term inflation rate certainty is preferable, despite its greater long-term price level uncertainty.

I thought that view was “narrow-minded”, in particular given that important firm and individual decisions tend to be longer term ones. Does Fischer still hold those views from 20 years ago?

By 2011 he had come to favor a flexible IT regime:

“A central bank should aim to maintain price stability and support other goals, particularly growth and employment. So long as medium-term price stability — over the course of a year or two or even three — is preserved.”

Price stability means 2% inflation. But for at least six years inflation (as measured by PCE Core prices) has been well below target except for a fleeting moment in early 2012, coinciding with the moment the 2% target was made official. Barring people like Bullard who think the “Core is rotten”, most people think core prices provide a better indication of the inflation trend. (The chart indicates how fickle the Fed would be if it targeted headline inflation at 2%!)

Stan Fischer Preferences_0

So by Fischer´s own definition we haven´t experienced “price stability” for several years, implying a lot of uncertainty about “short-term inflation rate certainty”.

In fact, “long-term price level uncertainty has been lower than short-term inflation uncertainty”, especially if you associate the price level with the core measure of the PCE.

As the panel below shows, core prices evolved very close to trend until 2012, after which they fall a little short. The headline price level was impacted by the persistent oil shocks during 2003-08. More recently, the negative oil shocks have brought it back to trend. Meanwhile, core inflation has spent most of the time below the target (initially implicit) level.

From a PLT perspective, the Fed is doing OK. From an IT perspective, it is doing a pretty awful job. But note that trying to “correct” inflation (bring it to target) will likely “disturb” the PLT (at least the headline price level). But the Fed doesn´t target the price level!

In 2008 the Fed botched the job because it became “afraid” of the increase in headline inflation that was rising on the heels of oil prices. That shows the main deficiency of both IT and PLT. Both are sensitive to real or supply shocks. Since the Core measure of the price level is much less sensitive to supply shocks, the fall in the core price level below trend over the past few years is an indication, contrary to FOMC conventional wisdom, that the drop in inflation is due to more than recently falling oil prices! Would that be related to a monetary policy that is implicitly tight?

On that score, the panel also shows that the major factor behind both the depth of the recession and the weak recovery was the Fed letting nominal spending drop way below trend and then not allowing it to climb back towards trend, i.e. keeping monetary policy too tight!

The NGDP & Trend chart is also evidence that the prevalent view that monetary policy was “too easy” in 2002-05 is misguided. With the FF rate at 1%, in August 2003 the FOMC decided to undertake forward guidance. All measures of inflation were below the target, and so was the NGDP level. It was effective in bringing both NGDP and core inflation back to target (headline was impacted by oil, and that shouldn´t concern the stance of monetary policy).

Bernanke took over with a “clean slate”! And proceeded to botch the job!

Stan Fischer Preferences

Unfortunately, those responsible for monetary policy simply won´t recognize the need for an overhaul in how monetary policy is conducted. Simply “endowing” the inflation target with more flexibility, imposing interest rate rules (aka “Taylor-type” rules) or even adopting a PLT won´t cut it. One of the consequences of this “hard-headedness” will be increasing claims for the use of distortionary fiscal policies (“stimulus”).

Unfortunately as he has made abundantly clear over the years, Stanley Fischer is quite against it, although he left a door open in a 2011 speech called “Central Bank Lessons from the Global Crisis”:

During and after the Great Depression, many central bankers and economists concluded that monetary policy could not be used to stimulate economic activity in a situation in which the interest rate was essentially zero, as it was in the United States during the 1930s – a situation that later became known as the liquidity trap.  In the United States it was also a situation in which the financial system was grievously damaged.  It was only in 1963, with the publication of Friedman and Schwartz’s Monetary History of the UnitedStates that the profession as a whole1 began to accept the contrary view, that “The contraction is in fact a testimonial to the importance of monetary forces.”

In this lecture, I present preliminary lessons – nine of them – for monetary and financial policy from the Great Recession.  I do this with some trepidation, since it is possible that there will later be a tenth lesson: that given that it took fifty years for the profession to develop its current understanding of the monetary policy transmission mechanism during the Great Depression, just two years after the Lehmann Brothers bankruptcy is too early to be drawing even preliminary lessons from the Great Recession.  But let me join the crowd and begin doing so.


The ninth:

In a crisis, central bankers (and no doubt other policymakers) will often find themselves implementing policy actions that they never thought they would have to undertake – and these are frequently policy actions that they would prefer not to have to undertake. Hence, some final advice for central bankers :

Never say never

Greg Ip´s “tantalizing signs” of a turn in the inflation cycle

GI writes “The Inflation Cycle May Have Turned”:

Central banks around the world have been alarmed at how inflation has plummeted in the last year, in many cases into negative territory. Though much of that is due to oil prices, core inflation, which excludes energy and food, has also been disturbingly low.

But there are tantalizing signs that the cycle has turned. In February, U.S. consumer prices rose 0.2% from January, which pulled the annual inflation rate out of negative territory; it’s now zero. More important, core prices rose 0.16%, which nudged the annual rate up to 1.7% from 1.6%. It was the second upside surprise to core inflation in a row. The driver in January was firmer service prices, this month it was goods.

Looking at the chart for short (1 yr), medium (5 yr) and long (10 yr) inflation expectations estimated by the Cleveland Fed, I couldn´t suppress a laugh!

Tantalizing Signs

Note the much higher volatility of short term expectations, very much influenced by oil price gyrations!

Keep on dreaming…

Clive Crook writes “Dreaming of ‘Normal’ Monetary Policy”:

The U.S. Federal Reserve wants to get monetary policy back to normal without scaring or surprising the financial markets. Now, try defining “normal,” and you can see it’s going to be difficult.

A vital instrument of abnormal monetary policy has been the promise to keep interest rates at (roughly) zero for an extended period. Once rates have been raised off that floor, this kind of time-based commitment no longer works.


In a previous post, I mentioned that a Taylor-type rule for monetary policy could help in presenting Fed decisions, even if it wasn’t used to dictate them. Taylor-type rules explicitly link interest rates to inflation and the amount of slack in the economy. Fischer and Haldane both touched on the idea.


Starting-point, baseline, whatever. Policy rules shouldn’t be followed slavishly. Nonetheless, taking them more seriously — and being seen to do so — would help to make markets more comfortable with data-driven policy.

With all the “dreaming” going on, I was reminded of this passage in an old Scott Sumner post:

[R]ecessions are predictions of bad policy.  That’s what Michael Woodford thinks, and I agree.  Not all recessions.  In 2001 economists didn’t even see a recession coming until about September, and the recession was over by November.  I’m talking about severe recessions, those where there is the feeling of going over the crest in a roller coaster, then that “uh-oh moment,” followed by a sickening plunge.  Like 1920-21, 1929-30, 1937-38, 1981-82, 2008-09.  Can policy address the problem once it has occurred?  Yes and no.  Technically it can, but it is very unlikely to work in practiceprecisely because it is very unlikely to be tried. 

So I hope Becky Hargrove´s “dream” one day will come true:

What are the chances for an NGDP level target to be adopted in the near future? It’s hard to say. But one thing is for certain: once this happens, it will be like a breath of fresh air. Everyone will finally be able to concentrate on the kinds of supply side reforms which mean real economic growth, for all concerned. Hey, it doesn’t hurt to dream a little. Here’s hoping that this week’s Cato event goes well.

Footnote: Why do journalists in general and Clive Crook in particular, have short memories? Almost 4 years ago he wrote: “Fed must fix on a fresh target”:

Move to a nominal GDP regime and let the markets know, in Fed-speak, that this is what the intention is.

Related: From the FT:

Britain’s monetary thought leaders have used the arrival of deflation as an excuse for a public argument about the next move in interest rates. Mark Carney, governor of the BoE, spoke of the foolishness of cutting rates, which inspired Andrew Haldane, his chief economist, to muse about that very possibility, a viewpoint latersquashed by his colleague David Miles.

These squabbles display a perverse ability to complicate what should be a simple matter. The real culprit, however, is the inflation target, which obliges the BoE to target something it only partially controls. Monetary policy more directly affects nominal spending, only bringing about a certain level of inflation after interacting with the supply side. On this measure, Mr Carney has performed admirably, keeping demand growing somewhat faster than before his arrival in 2012, albeit slower than what was normal before the crisis. Fluctuations in headline inflation stem from matters beyond his control, such as the recent sharp fall in the international oil price.

Remembering 1937

When the “Great Recession” hit, many comparisons were made with the “Great Depression” (see Eichengreen and O´Rourke Vox columns which according to the editor shattered all Vox readership records with over 450,000 views). Eight years after the 2007 peak, now there are “reminders” of 1937, also eight years after the 1929 peak!

Robert Samuelson has a piece:

How fast should the Federal Reserve tighten monetary policy? Should it tighten at all? I recently wrote about these issues but didn’t have the space to explore a fascinating aspect of the debate: the mostly forgotten 1937-38 recession. To many, it’s a cautionary tale against adopting tighter policies too soon. The latest to sound the alarm is Ray Dalio, the respected founder of Bridgewater Associates, a huge hedge fund group. His recent memo to clients inspired a Page 1 story in the Financial Times, headlined “Dalio warns Fed of 1937-style rate risk.”

And goes on to discuss what may have “caused” that event. The “best” candidate:

A final explanation involves gold. Since 1934, the United States had been receiving large gold inflows — reflecting fears of political instability or war in Europe — that stimulated economic expansion. The reason was simple. When the gold arrived here, it had to be sold to the government for dollars. Those dollars were then spent or lent, giving the economy a boost. But in late 1936, the Treasury — again, to quash incipient inflation — decided to offset this boost by draining money from the economy. In economic jargon, the gold flows were “sterilized.”

This turned out to be a massive miscalculation. The sterilization created a “pronounced monetary shock,” argues a paper by Dartmouth economist Douglas Irwin. Growth in the money supply, which had been rapid, halted. Stock prices fell, and interest rates rose. After the Treasury reversed its policy on sterilization in 1938, the economy recovered.

A nominal visual of the period following the Depression trough in March 1933:





Footnote: Orphanides has an enlightening article on the Fed during the Great Depression. Following the downturn in 1937 we read:

Though the extent of the sharp decline in activity was not immediately evident, by Fall it became fully clear to the Committee that the economy was thrown back to a severe recession, once again.

The following evaluation of the situation by (John) Williams at the November 1937 meeting is informative, both for offering a frank admission that the FOMC apparently wished for a slowdown to occur and also for outlining the case that the recession, nonetheless, had nothing to do with the monetary tightening that preceded it.

Particularly enlightening is the reasoning offered by Williams as to why a reversal of the earlier tightening action would be ill advised. We all know how it developed. There was a feeling last spring that things were going pretty fast … we had about six months of incipient boom conditions with rapid rise of prices, price and wage spirals and forward buying and you will recall that last spring there were dangers of a run-away situation which would bring the recovery prematurely to a close. We all felt, as a result of that, that some recession was desirable … We have had continued ease of money all through the depression. We have never had a recovery like that. It follows from that that we can’t count upon a policy of monetary ease as a major corrective. …[Doesn´t that sound familiar?]

In response to an inquiry by Mr. Davis as to how the increase in reserve requirements has been in the picture, Mr. Williams stated that it was not the cause but rather the occasion for the change. … It is a coincidence in time. …

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. (FOMC Meeting, November 29, 1937. Transcript of notes taken on the statement by Mr. Williams.)

Coincidentally, at present there´s also a John Williams at the FOMC!

Looking At U.S. Unit Labor Costs

A Benjamin Cole post

From the fourth quarter of 2008 to the fourth quarter of 2014 (the last measure), unit labor costs in the United States have increased by 1.39%.

No, that is not annually compounded. That is it. In six years, unit labor costs have barely budged, while the monetary myrmidons moaned inflation every moment.

Yet, the St. Louis Fed informs us the nonfarm business unit labor cost index hiked from 103.479 to 104.913 in that time frame (no, I do not know why the St. Louis Fed publishes indices three places past the decimal point).

But is that six-year period a “cherry pick”? After all, it marks the worst recession in postwar history.

Okay, let go back a full 10 years. In that period, unit labor costs have increased by 11.4%, or a little more than 1% annually compounded.

Egads. Unit labor costs are dead. They are not contributing to overall price inflation, which is nearly dead.

The Fed

Yet we have Fed Chair Janet Yellen telling the world that the Fed is “highly accommodative.” We have pundits—and some FOMC members—in sweat-drenched hysterics about inflation or even hyperinflation.

The quiet observer must conclude monetary policy makes no sense.

By the lights of many, monetary policy was way too loose thus prompting the 2008 real estate boom-bust, and has been way-way too loose ever since. For a decade, monetary policy has been ultra-loose, hyper-accommodative—and yet unit labor costs are nearly dead flat for 10 years.

Judging from results, I guess the U.S. needs to go to a “ginormous super-duper king-size loose, XXXL” monetary growth model.

Long-term, the “hyper-accommodative” monetary stance is just too tight.

Well, judging from results. Maybe we should judge by a theory instead.

Crap from “FOMC´ers”

Scott Sumner is his diplomatic self:

Stanley Fischer is one of the world’s most thoughtful monetary economists. And now he is also vice chairman of the Federal Reserve Board. He recently gave a speech on monetary policy, which as you’d expect contained many wise observations. However I was also deeply troubled by some of his comments.

And than proceeds to “trash” him:

However, I was also deeply troubled by some of his comments.

One “troubling” comment:

For over six years, the federal funds rate has, effectively, been zero. However it is widely expected that the rate will lift off before the end of this year, as the normalization of monetary policy gets underway.

The approach of liftoff reflects the significant progress we have made toward our objectives of maximum employment and price stability. The extraordinary monetary policy accommodation that the Federal Reserve has undertaken in response to the crisis has contributed importantly to the economic recovery, though the recovery has taken longer than we expected. The unemployment rate, at 5.5 percent in February, is nearing estimates of its natural rate, and we expect that inflation will gradually rise toward the Fed’s target of 2 percent. Beginning the normalization of policy will be a significant step toward the restoration of the economy’s normal dynamics, allowing monetary policy to respond to shocks without recourse to unconventional tools.

Stanley Fischer has been the Governor of the Bank of Israel, a country that managed to altogether avoid a recession in 2008-09 for the simple reason that, just like Australia, it was following a de facto NGDP level target. But as I have argued here, that was “luck”! Just before stepping down from the BoI Fischer made a speech:

In my work as a central banker, I have made much use of my knowledge of central banking history around the world. Many of the events that are taking place today remind me of events from the past, and knowing the lessons from the past helps us develop policy in the present.

A prominent example of this is that of Ben Bernanke, who learned the lessons and the mistakes in handling the Great Depression of the 1930s during his research, and knew how to deal with the most recent financial crisis differently and more efficiently than how they tried to handle the situation in the 1930s.

We, the central bankers, thought at the outset of the crisis that we were about to experience another great depression like in the 1930s, when the unemployment rate in the US reached 25 percent. I am not here to claim that the current situation is good, but during the current crisis, US unemployment rate hit 10 percent and then began to decline, and I am sure that the situation would have been very different had Bernanke not acted according to the knowledge that he acquired in the course of his research.

Apparently, learning was only partial and selective because he also said:

There are those who support setting a nominal GDP target. I think that this is very impractical. The data that we receive on nominal GDP are very unstable.  There are changes of whole percentage points between the various estimates of GDP. For this reason, I think that there is no reason to use nominal GDP as a target.

Maybe he thinks inflation, output gaps and natural rates are precisely defined and known!

So much for the Fed´s Vice-Chairman monetary policy “abilities”.

Another voting member this year is also “dying” to vote for a rate rise. This is SF Fed president John Williams:

NEW YORK–Federal Reserve Bank of San Francisco President John Williams reiterated on Monday his belief that central bankers should consider raising rates some time this summer.

Things are looking better–in fact, they’re looking downright good,” the official said in a speech to be delivered to an audience in Sydney and Melbourne via video.

Given how much the economy has improved and is likely to continue to gain ground, “I think that by mid-year it will be the time to have a discussion about starting to raise rates,” Mr. Williams said.

The strength of the U.S. dollar against a “broad index” of currencies is not an impediment to the U.S. economy reaching real GDP growth of 2.5% this year, he said .

“The U.S. economy has good momentum…even with what is a rather large appreciation of the U.S. dollar,” Mr. Williams said.

Fischer wants to raise rates to “restore(!) the economy´s normal dynamics”. Williams thinks things are looking “downright good”! So much crap with a straight face. Only FOMCers can do that and get away with it!

The charts illustrate what “significant progress”, “extraordinary monetary accommodation” “economy looking downright good” and “gradual climb of inflation to 2%” looks like.

FOMC Crap_1

FOMC Crap_2

Now, think for a moment while contemplating the charts above and the next one. If the Fed managed to keep NGDP growing at such a stable (3.95%) rate for the past five years, after the economy “lifted-off” from the depths of the “Great Recession”, don´t you think it would also be capable (if it wanted) to:

1. Give nominal spending an initial boost (6%-7%) for it to regain “height” and

2. Then “levelled ” it off at a 5% growth rate (or 4% if you prefer)?

FOMC Crap_3

Ask yourselves:

1. Would inflation be closer to target?

2. Would RGDP growth be closer to 3+%?

3. Would employment be so “structurally” constrained?

The dollar back in vogue

Every time the dollar makes “Strong” moves, up or down, there are “lamentations” and “concerns”. Take, for example, this post from 2011 “The myth of the strong dollar”, where I discussed the “debate” that was generated by a David Malpass piece in the WSJ “Weak Dollar, Weak Economy”:

The combination of super-low interest rates and trillions in leveraged Federal Reserve debt constitutes a semi-official weak-dollar policy. It has driven gold to a record high and made the dollar one of the world’s weakest currencies. The dollar index has fallen 38% since 2002 (to 75 from 120) despite cynical statements by officials that a “strong dollar is in our national interest.” To protect themselves from the weakening dollar, investors and corporations are shifting growth capital from U.S. businesses into foreign infrastructure and jobs, a process that is dismantling decades of U.S. wealth creation.

My conclusion then:

The last figure “proves” the myth of the “strong” dollar. It shows the real trade weighted exchange rate of the major currencies against the dollar. At present, in real terms, the dollar trades at levels that correspond to the minimum over the floating exchange rate history. Anybody cares to take a guess of its future direction? Will it turn up in “typical” cyclical fashion or will it brake through its “historic” floor?

The dollar_1

Fast forward almost four years and the dollar is being “debated” again. The NYT did a “foursome” with Desmond Lachman, Jeffrey Frankel, Scott Sumner and Erin Nakamura:

Desmond Lachman:

Among the more striking international economic developments over the past six months has been the 15 percent appreciation of the U.S. dollar. U.S. policymakers would be ignoring this development at their peril.

Jeffrey Frankel:

Any movement in the exchange rate has pros and cons. When the dollar appreciates as much as it has over the last year, the obvious disadvantage is that the loss in competitiveness by U.S. producers hits exports and the trade balance. But if the dollar had fallen by a similar amount, there would be lamentations over the debasing of the currency.

Scott Sumner:

In the past few months, the euro has fallen from roughly $1.35 to $1.08, triggering concern that the dollar is becoming overvalued. Some economists have suggested that the Fed should ease monetary policy by printing money or holding down interest rates, in order to weaken the dollar in the foreign exchange markets.

Emi Nakamura:

It may not actually be bad news that the dollar is strengthening. The dollar tends to strengthen when the U.S. economy is doing well. The last two times when the U.S. real exchange rate reached comparable levels were the late-1990s and the mid-1980s. Those were good times for the U.S. economy.

The chart shows what transpired in the intervening period. The dollar turned back in “typical” cyclical fashion. It may still climb, but the real question is: So what?

The dollar_2