Do you believe in miracles?

From the WSJ:

“At a time when the global economy is doubting itself in the face of Brexit, the U.S. consumer is emerging with a smile on his face,” said Gregory Daco, head of U.S. macroeconomics at Oxford Economics.

I find it hard to see much reason for smiles! That´s not what the data show. The chart indicates that nominal consumption expenditure growth has come down over the past two years. The basic reason is the Fed tightening of monetary policy through the “rate hike talks”. On a smoother basis (12-month growth), it has fallen and has remained reasonably flat.


The chart below clearly illustrates that consumption is depressed! Both the spending level and the trend growth are below what they were. Maybe Gregory Daco is mistaking “open mouth” for “smile”!


What about the Fed´s inflation mandate? The Fed does not understand what inflation means! Sometimes they think it´s the “oil price”, sometimes the “foreign exchange” and sometimes, “other stuff”.

The fact is that for the past 20 years “inflation” has not been a problem. And given the (low) growth rate of spending, inflation will blossom only through a miracle!


The inflation bogeyman

Calculated Risk (Bill McBride) presents this chart

Inflation Bogeyman

And remarks:

Using these measures, inflation has been moving up, and most of these measures are at or above the Fed’s target (Core PCE is still below).

OMG! None of them are above the Fed´s target because none of them are targets, other than the PCE (advised by the much less volatile PCE-Core), which is below target!

And aren´t we lucky that none of those other measures of inflation are the target. Quite likely the outcome of yesterday´s FOMC Meeting would have been very different (and much more painful too!).

PS In addition to those measures of inflation, the Cleveland Fed also provides (CPI) inflation expectations. The chart shows how the 5 and 10 yr expected inflation have behaved for the past two years, since the Fed began the rate rising mantra!

Inflation Bogeyman_1

Inflation: A Schizophrenic Target!

In the US, many, like Blanchard and Krugman, have for long advocated a higher inflation target as a means of getting the economy ‘moving’.

However, if the Fed, just as the ECB, BoE or BoJ are having a hard time pushing inflation up to the 2% target, why should a higher target “solve” the problem?

Australia, on the other hand seems to be ‘flirting’ with the opposite tack: reduce the inflation target:

The RBA is likely to indicate that it remains wedded to the target, stressing that there is a high degree of flexibility for policy that goes with it.

But the target doubters argue that if low inflation is entrenched, there seems little sense in promoting a target that won’t be achieved without driving interest rates still lower and inviting financial sector stresses in the process. In other words, why risk the fallout from a domestic housing bubble by obsessing over a price target that global forces are keeping out of your reach?

Funny how central banks all over are quick to say they´re “powerless”. That´s just like a “forger” saying that he has no money to buy a new car!

What central banks miss is that inflation is low, not because of “structural” (or entrenched) reasons, but because they are conducting monetary policy to make it so!

Australia provides a good example of good monetary policy that has more recently turned bad.

The chart shows that since the IT regime was adopted, inflation has clocked 2.5% on average, for either the headline or core measures. That´s exactly the center of the 2% to 3% target band.

Australia IT Change_1

Meanwhile, monetary policy was mostly good, keeping NGDP evolving close to a level target path.

Australia IT Change_2

For the past two years, however, the RBA has been “sleeping at the helm”. NGDP has deviated systematically from the “target level”.

Australia IT Change_3

So, it´s not at all surprising that inflation, in either guise, is also trending below the target band!

Australia IT Change_4

The “solution” is not to have a higher or lower inflation target, but to “get a grip” on nominal spending (NGDP). If the RBA says it´s “powerless” to do so, bring in a “master forger” like Gideon Gono, the former head of Zimbabwe´s central bank.

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!

Group-think within and amongst central banks

A James Alexander post

A new book has just been released on problems with central banks. The best chapter looks like the one on group-think. John Taylor, one of the book’s editors describes it thus:

 “Kevin Warsh’s (ex-FOMC member) report on the lack of effective deliberations at the FOMC is one of the most surprising parts of the book. In his commentary Peter Fisher notes Warsh’s refreshing candor, and uses it to jump off on a critique of policy committees, including the unwillingness of committee members to change priors when presented with new arguments or data.”

It is not just within central banks that we see such group-think. Loretta Mester, a current FOMC member gave a speech this week drawing comfort that all central banks saw an uptick in inflation just around the corner.

JA Inflation_1

JA Inflation_2

We have already commented on just how happy central banks are with their current monetary stance, they are all on target with their central projections for inflation. Meanwhile, in the real world, anaemic economic growth is the result of low nominal growth, and recession is always and only a few active monetary tightenings away.

They just can’t see the group-think, either within their central banks or amongst them.


And a serious one when perpetrated by the IMF´s Chief-Economist with colleagues who write: Oil Prices and the Global Economy: It’s Complicated:

Even though oil is a less important production input than it was three decades ago, that reasoning should work in reverse when oil prices fall, leading to lower production costs, more hiring, and reduced inflation. But this channel causes a problem when central banks cannot lower interest rates. Because the policy interest rate cannot fall further, the decline in inflation (actual and expected) owing to lower production costs raises the real rate of interest, compressing demand and very possibly stifling any increase in output and employment. Indeed, those aggregates may both actually fall. Something like this may be going on at the present time in some economies. Chart 3 is suggestive of a depressing effect of low expected oil prices on expected inflation: it shows the strong recent direct relationship between U.S. oil futures prices and a market-based measure of long-term inflation expectations.


…Our claim is simply that when an oil importer’s macroeconomic conditions warrant a very low central bank interest rate, a fall in oil prices could move the real interest rate in a way that runs counter to the positive income effect.

But the “causation” they allude to, from oil prices to expected inflation is just a figment of their collective imagination!

If they only looked at a longer time period (beginning in 2003 when the inflation expectation became available), they would have difficulty establishing even a simple correlation.


What you do notice in the chart above is that oil prices and inflation expectations fall in tandem when there is a negative demand shock. That´s very clear in 2008/09. More recently, since mid-2014, there the Fed has also tightened monetary policy – a negative demand shock. The tightening was initially expressed through Fed words and has been reflected in NGDP growth slipping, expected one year ahead FF rate rising, the dollar index rising (dollar appreciation) in addition to the oil price fall, among other indications of monetary policy tightening!



“The Impossibility Theorem”

When your argument centers on interest rates and inflation, you´re bound to arrive at a wrong conclusion.

That´s happened to Ryan Avent´s article “No Exit – Global financial integration is tying central banks hands”, where he concludes:

The balance of risks suggests the Fed should tolerate rising inflation. A faster pace of increase in wages and prices would be a healthy development for the American economy. Inflation has been below 2% for four years; exceeding that level would affirm the Fed’s claim that 2% is a symmetrical target for inflation, rather than a ceiling. A temporarily higher inflation rate might be an annoyance for some Americans, but it is preferable to imploding portfolios and a risk of recession.

Even though Ms Brainard prevailed in March, the debate is sure to continue. The Fed is bound to raise rates again at some point, as inflation rises. Another torrent of mobile capital will then flood in, perhaps swamping the Fed’s attempts to go its own way. The world should brace for more financial storms.

There will be no “rising inflation” as long as the central bank constrains nominal spending (NGDP) growth (that´s the “impossibility theorem”). And if there´s no increase in inflation there will be no need, under the Fed´s operating procedure, to raise interest rates.

The chart indicates, with monthly data on a year over year basis, that from 1993 to 2006 NGDP growth averaged 5.5%; RGDP growth averaged 3.4% (exactly the same average as from 1947 to 1992) and Core-PCE inflation averaged 1.8% (just shy of the implicit (at the time) 2% target.

RA Havoc

From 2007 to the present, NGDP growth averaged only 2.9%; RGDP growth averaged 1.3% while Core-PCE inflation averaged 1.6%.

In the more recent period average 1.6% inflation is just equal average NGDP growth minus average RGDP growth (for the pre 2007 period while average inflation was 1.8%, NGDP growth minus RGDP growth was 2.1%. This may reflect the occurrence of a real positive (productivity) shock in the earlier period, which increases RGDP growth and reduces inflation, under a stable NGDP growth regime).

Much has been said about a supposed fall in “potential output”. I tend to believe that a significant part of that is due to the “demand downgrade”.

Anyway, what Ryan Avent should be writing about is not how an inevitable increase in rates will cause havoc, but how the markets are telling (not constraining, mind you) the Fed that it´s on the wrong track. If only the Fed would talk about a NGDP level target…

No Inflation In Texas: A Lesson There? We Miss Inspector Clouseau

A Benjamin Cole post

It is too bad in some regards that Richard “Inspector Clouseau” Fisher, the former president of the Federal Reserve Bank of Dallas, in no longer ensconced in that position. For one, he was always great copy. For seconds, he was one of the most infallible reverse indicators of Post War Era, and economic soothsayers could bet against a Fisherian proclamation with a rare calm.

Alack and alas, Fisher was replaced by Robert Kaplan in September, who so far seems content to avoid huge and regular public embarrassments.

Some may remember a jaw-dropping press conference Fisher held October 9, 2014 in the fair city of Dallas, where he proclaimed Texas wage inflation was a threat, soon to possibly envelop the nation—“there are concerns about getting it (wage growth) under control,” Fisher said. The former Dallas Fed Chief seemed especially agitated that wages were rising faster than prices, enough so to call reporters into his office.

BC Texas

Well, as we see from the chart above, inflation, even as measured by the CPI (which tends to overstate inflation), Dallas sunk into deflation after the Fisher proclamation. Sheesh, the CPI for Dallas was headed south even as Fisher spoke. The chart for Houston, the Lone Star state’s other big city, looks much the same.

A Serious Lesson?

Okay, taking potshots at Fat-Target Fisher is always good for a laugh, but is there a more-serious lesson in all of this? Probably. Texas boomed and did not suffer inflation.

Now, some will say, “Oh sure, but Texas can import labor, capital and services from surrounding states.”

But the U.S. imports goods, services, capital and labor from the world. More demand would result in more supply. See Texas. Besides, global supply lines are glutted with product and commodities.

If a seven-year national recovery, magnified in the red-hot energy state of Texas, results in deflation in Dallas, should the U.S. Federal Reserve continuously go weak at the knees whenever unemployment skates near 5%?

Probably not.

P.S. Housing

Fans of Kevin Erdmann, author of blog The Idiosyncratic Whisk, know that Dallas is what Erdmann defines as an open city, one in which housing can be readily built. Many of America’s largest and glamour cities, such as Los Angeles, San Francisco, New York, Boston, Seattle etc., have criminalized robust housing construction. Not only those cities, but surrounding suburbs and towns—building high-rise condos anywhere along the Southern California coast, from liberal Santa Monica to conservative Newport Beach, is not done.

The U.S. economy has structural impediments, and housing is a big one. Still, the Fed may wish to ponder if suffocating the national economy to avoid some housing inflation is a good trade-off.

Stanley Fischer speaks with forked tongue

A James Alexander post

In a speech this week Stanley Fischer, Vice Chair of the Fed, insisted on the existence of the Phillips Curve. It made little sense.

  1. Inflation and unemployment: Estimated Phillips curves appear to be flatter than they were estimated to be many years ago–in terms of the textbooks, Phillips curves appear to be closer to what used to be called the Keynesian case (flat Phillips curve) than to the classical case (vertical Phillips curve). Since the U.S. economy is now below our 2 percent inflation target, and since unemployment is in the vicinity of full employment, it is sometimes argued that the link between unemployment and inflation must have been broken. I don’t believe that. Rather the link has never been very strong, but it exists, and we may well at present be seeing the first stirrings of an increase in the inflation rate–something that we would like to happen

If, after more than 50 years since it’s invention the curve may be still be flat or horizontal then it would seem to non-economists that it is time to move on. He made many jokes and recalled many  supposedly wise sayings, but one appeared to me to demonstrate why the profession of economics is held in such disrepute.

But Paish also warned us that forecasting was difficult, and gave us the advice “Never look back at your forecasts–you may lose your nerve.” I pass that wisdom on to those of you who need it.

It seems to typify economics as a profession, never let your theories be tested. Real scientists would say if your forecasts are consistently proven wrong then your models are wrong.

The final comment in that Inflation and Unemployment section is what struck me as particularly disingenuous. How does the Fed demonstrate that they want to see the inflation rate increase? By actively tightening monetary policy in December 2015?  By having so publicly forecast and fretted about a rise in inflation for months beforehand, thus passively tightening monetary policy? It appears that Fischer says he wants something but all his actions and his fretting tells the market that he doesn’t actually want it.

Fischer’s Fed has consistently forecast a return to higher inflation as unemployment has fallen. It hasn’t happened, it will never happen if the Fed insists on tightening any time 2% is approached, either in real time or more importantly in the Fed’s own forecasts for inflation.

His attitude to inflation was quite revealing when he was asked in the Q&A, about 42 minutes in, whether raising the inflation target to 4% was a good idea.

He immediately responded by talking about other countries’ hyperinflation experiences. Great. Scare tactics. ‘If you touch the 2% target all hell would break loose.’ Really?

Then he worried about too much indexation at higher rates of inflation and how hard it was to undo that indexation once embedded. A fair point, but not very relevant in a free market economy. Indexation is a supply side issue, and not really one for central bankers to address, though they may have to react to it once it is established.

He then said that 2% is  about right, “clearly here”, according to Greenspan’s definition of not having people having to think about the rate of inflation in their daily work. And “4% is the other side of the line”. Is there really such a difference? Was the average of 2.5% PCEPI throughout the Great Moderation so bad?

And lastly he mentioned the “credibility problem of changing targets in mid-stream, because that’s easy”. It’s easy, perhaps because it’s right.

In a section on the ZLB and the effectiveness of monetary policy he stated:

Empirical work done at the Fed and elsewhere suggests that QE worked in the sense that it reduced interest rates other than the federal funds rate, and particularly seems to have succeeded in driving down longer-term rates, which are the rates most relevant to spending decisions.

The Fed has claimed that is the reason they did QE, to bring down longer-term rates, but they keep missing the Fisher effect. If QE is really working then it is raising longer term rates, reflating the economy. Fischer and the Fed have a truly massive blind spot here, one that makes their policy making hard to understand in the markets.

And that is what we saw when QE was working, and growth expectations rising, longer-term rates were rising too, not falling. From an old post:

JA Stan Fischer

At least Lael Brainard, on the same day, spoke  more sense. Is there a generational debate at the Fed? The old guard of inflation hawks and those younger types more in touch with the lack of prosperity in the US. We hope so, although age shouldn’t be the main gauge for hawkishness. There are lots of older Market Monetarists too!

CPI trending higher, NGDP growth lower – monetary policy must go easy

A James Alexander post

The echoes of 2008 became stronger last week as both headline and core US inflation as measured by the CPI rose faster than expected. It is a very dangerous cocktail when the claque sees inflation yet nominal growth expectations are weak. It caused the Great Recession when central banks misread the situation. Hopefully they will have learned their lesson, but the current tightening bias of the Fed doesn’t give us much confidence.

Go to Twitter and enter “core CPI” and you’d see a welter of inflation hawks trumpeting the now clear upward trend in CPI. These were typical:

“John P. Hussman‏@hussmanjp

Not to bust anyone’s NIRP bubble, but while YOY CPI inflation is 1.34% due to food & energy, YOY core inflation rose to 2.22% in January.

Michael Ashton‏@inflation_guy

I did NOT realize until just now that this month’s 0.29% rise in core CPI was the highest m/m since 2006.

Carl Quintanilla‏@carlquintanilla

Beating estimates in past 2 wks: * core CPI * core PPI * hourly wages * retail sales * Ind. Prod


It is hard to disagree with the charts over the short-term.


The longer term is a bit different, of course.


But does it mean the Fed should take act? The markets decided the new information content from the CPI data was virtually nil.

Why were markets so calm?

 1. The Fed looks at the far superior Personal Consumption Expenditure price index or deflator. It is composed of the dozens of individual price index estimates used to deflate nominal spending to derive a supposedly “real” level of spending for each category of goods and services purchased. Compiling these indexes is a task fraught with pitfalls. At least PCE uses actual data on expenditure rather than the CPI surveys of consumer expenditure as a starting point. It also includes items bought on behalf of consumers by their employers like healthcare and insurance. It also estimates the financial benefit of services not paid for, like banking.

PCE has historically run 0.5% lower than CPI and been far less prone to volatility. The PCE deflator much more quickly captures substitution effects, as consumers switch purchases from higher priced goods and services to lower ones, or like today (probably) switching spending from energy and goods sectors in deflation to housing, healthcare and education – increasing the pace of service sector inflation? Looking just at the service sector will be very misleading.

The housing element of CPI remains a minefield as Kevin Erdmann constantly reminds us. Artificial shortages abound and have significant effects. Artificial demand in education thanks to state-subsidised loans  also leads to price pressure, and we all know about restrictive practices in medicine.

 2. The Fed has made it clear since the market turbulence that it caused will be incorporated into its future actions.

 3. Nominal growth is still horribly weak. Core CPI may be trending up but nominal Personal Consumer Expenditure, i.e. not deflated, remains stuck in a 3% trend – down from the 4%-5% trend achieved towards the end of QE3 when nominal spending peaked at 4.96% in August 2014.

 I remain unconvinced that PCE will move up meaningfully towards any higher trend in CPI. Nominal growth, historic and expected, remains just too low. And, of course, active monetary policy is clearly biased towards tightening.

And here we may get a horrible echo of 2008 where nominal growth expectations are flat or falling but the claque of inflation hawks is fretting about cost-push inflation. The Fed should ignore the claque and laser-lie focus on nominal growth expectations, but will they?

The other echo of 2008 comes from the accounting identity that if inflation really is rising and nominal growth really is weakening then the counterpart has to be in weakening RGDP and weakening productivity. And this is precisely what we are seeing. RGDP is weak and so is productivity.

I am a bit more more sanguine about productivity, even if arithmetically it is shown to fall. It may not be falling as the deflator may be too high, underestimating real growth, and thus productivity growth. Why is this?

First, because it is so fiendishly difficult to directly measure productivity, especially in our service-sector dominated world. There are hardly any detailed temporal or cross-border studies of productivity by industry segment, just windy, useless, macro level stuff by country. Output of physical stuff is relatively easy to measure in both nominal and real terms, as long as the quality of the stuff doesn’t change too much: a bushel of wheat, a barrel of oil, a table. But think of a college degree, a cable subscription or a visit to the dental hygienist and things get trickier.

Quality issues are very, very tricky to gauge. It should be for economic historians and politicians to argue about the quality of the nominal growth, the balance between real and inflation within the nominal figure.

Second, it will have got very difficult with the rise of the web to really figure out what is happening to the real economy. It is important to figure it out, but is really hard. Diane Coyle wrote this thought-provoking piece on Digitally Disrupted GDP recently:

 Digital technologies are having dramatic impacts on consumers, businesses, and markets. These developments have reignited the debate over the definition and measurement of common economic statistics such as GDP. This column examines the measurement challenges posed by digital innovation on the economic landscape. It shows how existing approaches are unable to capture certain elements of the consumer surplus created by digital innovation. It further demonstrates how they can misrepresent market-level shifts, leading to false assessments of production and growth.

Third, we think it will rise once the nominal economy begins to run hot again. Why should businesses invest to economise on labour when labour is so plentiful? Why should businesses invest when sales are so weak and expected to remain so?