The blameless crowd

They are masters in shifting responsibility.  See “ECB’s Nowotny: Don’t Blame Central Bankers for Low Rates”:

The low interest rate environment has more to do with economic developments, rather than the autonomous actions of central banks, said European Central Bank Governing Council member Ewald Nowotny in a speech Thursday. He added that in this environment it was difficult for a central bank to set interest rates on its own.

Speaking at a conference in Alpbach, Austria, Mr. Nowotny said that one of the factors keeping inflation down is globalization. Low prices are “an advantage for consumers, but puts pressure on wages,” he noted.

Moreover, growth is also relatively low. “We have a trend of long-term, low growth rates, which is not easy to interpret,” he said.

In his pre-Jackson Hole ‘manifesto’:   John Williams shows this chart


And writes:

The underlying determinants for these declines are related to the global supply and demand for funds, including shifting demographics, slower trend productivity and economic growth, emerging markets seeking large reserves of safe assets, and a more general global savings glut.

Although the main reason was starring him in the face, it is never acknowledged. And that reason is the simultaneous crash in NGDP, resulting from sweeping the monetary policy framework pursued during the great moderation under the rug, first by the Fed, immediately followed by the other nincompoops.


The Fed, by tightening, is reducing “slack”!

Speaking at a conference in Beijing, Boston Fed President Eric Rosengren said it has been appropriate to be patient about normalizing interest rates, given that growth “has continued to underwhelm.” But the Fed’s mandated goals – stable prices and maximum sustainable employment – are likely to be achieved relatively soon, and “keeping interest rates low for a long time is not without risks.”

As a result, important questions confront monetary policymakers in the United States, including when and how quickly to continue normalizing interest rates.

Why are they so worried if inflation, as measured by the PCE-Core has remained below the 2% target level for almost the whole time since end-2008, even if “full employment” is all around us?


What they don´t realize is that “slack” has been diminishing because they are keeping the economy ever more subdued. The idea of “potential” is risible because actual NGDP seems to be the strongest determinant of “potential” NGDP.

In the chart you can see that while for the years prior to 2013 potential NGDP in the latest vintage (August 2016) was revised slightly up, compared to the 2011 vintage (the earliest available in Alfred), for the past two years it was revised down significantly.



Now, note that´s exactly the period during which NGDP growth has tumbled down, the outcome of all the tightening talk going on at the FOMC!


The Fed’s logic is faulty but may yet end up with the right answer

A James Alexander post

The last blog post was a great analysis of the last thirty years of US monetary policy as the Fed focused on Core PCE inflation and unemployment and for most of the time accidentally got NGDP growing on target. When the Fed switched rigidly to focusing on its own projections for Core PCE things started to go awry, both with unemployment and NGDP.

Still focusing on those projections since 2009 it has got things right in fits and starts only. Unemployment has ever so gradually returned to 5%, a record slow recovery. That said, there is still tons of labor market slack as evidenced by the participation ratios, ultra-low nominal wage growth and low quit rates. These factors mean there is very little productivity growth as the labor market is so lacking in energy. Core PCE keeps missing Fed projections of a return to 2%.

This troubled but not yet terrible situation is summed up by, actually caused by, the dreadful growth rate and level of NGDP.

So why does the Fed want to raise rates?

Trying to put myself in the mind of the average FOMC member I came up with this “logic”, although it is not logical – perhaps because it reflects so many competing views and not just one human brain:

1. The Fed wants to raise rates to give it the room to cut them when the data goes bad – even though we know the data will go bad due to the raising of rates, or the constant threat of raising rates.

2. The Fed is thus stuck as it really doesn’t want to:

a. use negative rates because the banks, insurance companies, money market mutual funds and savers will complain very loudly;


b. do more/wider QE because too many politicians, internet Austrians/goldbugs, alt-right, progressives, socialists, etc. will all            complain about the Fed creating winners and losers “and may require legislation” as Yellen said;


c. do helicopter money, defined here as directly new-money financed fiscal expenditure as it is bound to run up against any unaltered Core PCE inflation target projections

3. While the Fed needs rate-cutting firepower it is unlikely to have been able to raise before the data goes really bad

4. So the Fed has to look at more innovative alternatives than negative rates or more/wider QE. Thus it is tentatively looking at a higher inflation target or even level targets for inflation or nominal growth, instead as a sort of last resort back-up plan.

The Fed is causing this confusion becausthe logic is confused. It has the wrong targets and they are both causing and storing up trouble. Changing the targets would be the right thing to do, even if for all the wrong reasons.


The Great (Monetary) Unraveling

In “Years of Fed Missteps Fueled Disillusion with the Economy and Washington”, Jon Hilsenrath gives his contribution to the “Great Unraveling” series. He starts off writing:

In the past decade Federal Reserve officials have been flummoxed by a housing bubble that cratered the financial system, a long stretch of slow growth they failed to foresee and inflation persistently undershooting their goal. In response they engineered unpopular financial rescues, launched start-and-stop bond buying and delayed planned interest-rate boosts.

“There are a lot of things that we thought we knew that haven’t turned out quite as we expected,” said Eric Rosengren, president of the Federal Reserve Bank of Boston. “The economy and financial markets are not as stable as we previously assumed.”

In the 1990s, a period known in economics as the “Great Moderation,” it seemed the Fed could do no wrong. Policy makers and voters saw it as a machine, with buttons officials could push to heat or cool the economy as needed. Now, after more than a decade of economic disappointment, the central bank confronts hardened public skepticism and growing self-doubt about its own understanding of how the U.S. economy works.

For anyone seeking to explain one of the most unpredictable political seasons in modern history, with the rise of Donald Trump and Bernie Sanders, a prime suspect is public dismay in institutions guiding the economy and government. The Fed in particular is a case study in how the conventional wisdom of the late 1990s on a wide range of economic issues, including trade, technology and central banking, has since slowly unraveled.

During the Great Moderation, the Fed did do wrong. It just didn´t fail utterly! I believe the chart tells a convincing story.

Great Monetary Unraveling_1

Note that during the Great Moderation – the Greenspan years – NGDP growth was relatively stable. In 1990-91, the story is the Fed engineered a “strategic Disinflation”, with inflation coming down from the 4% level to 2%. In 2000-02 the Fed, worried about the low (4%) rate of unemployment and what it would do to inflation, erred, allowing NGDP growth to fall significantly. This mistake was subsequently corrected.

In level terms we see that NGDP remained close to its “target level”.

Great Monetary Unraveling_2

In the first two years of his mandate, Bernanke managed to keep NGDP close to its “target level”. Inflation remained very close to target and unemployment low and stable.

Great Monetary Unraveling_3

The follow-up in 2008-09, however, was a disaster. The Fed allowed NGDP growth to take a beating. The result was a massive increase in unemployment (given wage stickiness) with inflation dropping below target.

Great Monetary Unraveling_4

This outcome is very closely linked to the Fed´s renewed obsession with the likelihood of inflation shooting up on the heels of an oil shock. This is somewhat surprising given that 10 years earlier, in 1997, Bernanke and co-authors had published a paper “Systematic Monetary Policy and the Effects of Oil Price Shocks” (now gated), which was summarized by Business Insider in March 2011, at the time the ECB was considering hiking rates because of the oil price rise.

Earlier we mentioned a Ben Bernanke paper from 1997 titled, Systematic Monetary Policy and the Effects of Oil Price Shocks and while the full thing is definitely worth a read, we have a breakdown for you right here.

CNBC is talking about it today, too, in light of the ECB’s talk of higher rates.

The thesis is that it is central bank monetary policy in reaction to oil price spikes that creates economic downturns, not the oil price spike itself.

On the other hand, a rate hike ends up causing problems for years, reducing output.

The implication of this is that Federal Reserve Chair Ben Bernanke has no interest in raising rate for a commodity or oil spike, so long as prices remain within Fed range, because it has a damaging impact on output that could send unemployment higher.

In 2008, however, the Bernanke Fed was very worried about the inflationary impact of oil. Although the Fed didn´t raise rates (they didn’t lower them either between April and September 2008), all the FOMC talk, as gleaned from the 2008 Transcripts, was about the risk of inflation and how the next rate move would likely be up!

“Fed talk” is monetary policy, and it gets transmitted through the expectations channel. You get the idea about how monetary policy was severely tightened during 2008, in addition to looking at the behavior of NGDP growth, that tanked, by looking at how the dollar strengthened, how the stock market plunged, and how long-term interest rates dropped.

Great Monetary Unraveling_5

In mid-2009 the economy began to recover, with NGDP growth reversing course. QE1 had a positive impact.

Great Monetary Unraveling_6

During this policy easing, the dollar fell while stocks and long-term bond yields rose.

Great Monetary Unraveling_7

For some reason, by mid-2010 the Fed decided that “enough was enough”. QE1 ended and NGDP growth was stabilized initially at 4%. In other words, unlike after the 2000-03 when NGDP fell below trend but was brought back to trend, this time around the Fed decided that a lower trend path was the way to go.

Great Monetary Unraveling_8

For the past two years, even with inflation remaining below target, through its raise hike talk the Fed has been tightening monetary policy. NGDP growth is coming down, the stock market has remained sideways while the dollar has boomed, oil prices have tanked and long-term bond yields are coming back down. It seems the Yellen Fed is guided by the unemployment rate.

Great Monetary Unraveling_9

It is, therefore, not surprising that the level chart for the Bernanke/Yellen period contrasts sharply with the one observed during the Greenspan years ( I would have imagined that would give useful pointers for the “design of a new monetary framework”)

Great Monetary Unraveling_10

The Jackson Hole Conference had an encouraging title: “Designing Resilient Monetary Policy Frameworks for the Future”. Unfortunately, they mostly talked about the nuts & bolts of policy implementation. Furthermore, while Yellen signalled one rate rise this year, her number 2 Stan Fischer said he “roots” for two. And Bullard said once in the next two years!

It was certainly a missed opportunity for the Fed to regain some modicum of credibility.

While they discuss about economy “overheating”, the economy is “overcooling”

Stan Fischer:

The Federal Reserve’s governors are debating what is going on in the U.S. economy and how to set policy, the Fed’s No. 2 official said on Thursday.

“The issue of overheating of the economy is being discussed within the Fed board,” Fed Vice Chair Stanley Fischer told a room of labor activists who met with Fed officials to press them not to raise interest rates.

“Everything that’s being argued here is being argued in the board as well,” said Fischer.

But reality “stinks”!


The Fed Is Artificially Budging Rates—But Higher Not Lower Does Fiat-Money Central Banking Lead to Deflation?

A Benjamin Cole post

At the always interesting Alt-M website is a post by highly regarded monetary scholar Gerald P. O’Driscoll, pondering if the Fed can raise rates even if it wants to, whether Fed presently is artificially pumping up short-term rates.

O’Driscoll notes that today 20 central banks globally have negative interest rates in place.  Were now an activist Fed to jack-up the Fed funds rate and the interest on excess reserves (IOER) by another 25 basis points, the spread between U.S. rates and global rates would widen even more.

O’Driscoll points out such an action will attract capital to the U.S., thus raising the exchange rate of the U.S. dollar, slowing domestic business activity when the economy barely growing anyway.

Moreover, the Fed appears to be struggling to even keep short-term rates as high as they are. As O’Driscoll notes, in December 2015 the Fed raised interest on excess reserves from 25 to 50 basis points and also posted an offering rate of 25 basis points on reverse repurchase agreements. The Fed’s mysterious reverse-repo program has expanded to $321 billion at recent count, as it tries to sop up enough cash to prevent even lower rates.

But the Fed is battling the tide. O’Driscoll notes interest rates on short-term treasury bills (4 weeks) have recently traded down close to or even below 25 basis points.

Of course, long-term rates are primarily set by market forces, and 10-year Treasuries have been yielding near record-lows, now offering about 1.50% interest.

“There are real questions as to whether further hikes in what are administered (not market) interest rates will move market interest rates as desired. We have no experience on which to base such a forecast,” intones O’Driscoll.

There is much to admire in O’Driscoll’s blogging, but perhaps I quibble with his non-conclusion, which is that, “Fed policymakers are still mostly stuck in closed economy thinking. But, so, too, are most advocates of monetary reform. New thinking is needed all around.”

Well, bring it on, I say. Like what?

The Alt-M Outlook

In the past O’Driscoll has called for free banking, or a gold standard, and noted that modern-day central banks are aligned with nationalist malignancies of financing wars, empire-building, welfare-ism, oppressive state seizure of private assets and inflation.

Maybe all true in the past, but what about inflation since 1982 or so?

In the last 35 years the direction of interest rates and inflation internationally has been down, under globalist central-bank management. Indeed, much of the planet is now in deflation, and the U.S. but one recession away from joining the world. As Milton Friedman noted, you don’t get to chronically low interest rates through chronically easy money. For 30 years we have heard doom from inflation-mongers, and now we have global deflation.

If central banks have an inflationist agenda, they are even more incompetent than we suspect. The admirable Alt-M team still discusses fiat-money central banking as having statist-inflationary agenda. Yet the Alt-M perspective appears out of date, by a few decades.


Maybe free banking or a gold standard will work better than globalist central banking.

But unlike O’Driscoll, I think the problem is globalist fiat-money central bankers are obsessed with inflation and not economic growth. The ECB, for example, appears intent on crushing nations, not promoting statism.

Indeed, for now it would be better if a modern-day Korekiyo Takahashi (Japan’s central banker who ended the Great Depression on the islands) seized the Fed and sent in the helicopters. Darken the skies, and don’t stop until we see robust real growth and inflation north of 4%.

Of course, Market Monetarists contend the practical path forward is central-bank NGDPLT. It may actually happen.

The Alt-M crowd offers plenty of food for thought, but perhaps some updating is needed.

Is Growth Moderate or mediocre?

A James Alexander post

No wonder the Federal Reserve has challenges with its communication these days. They say they are data-dependent but when the data comes in they still can’t agree on what it represents.

Data point: 2Q 2016 RGDP growth of 1.2% QoQ annualised and 1.2% YoY, coincidentally.

Minutes of the Federal Open Market Committee July 26–27, 2016:

“Staff Review of the Economic Situation: The information reviewed for the July 26–27 meeting indicated that labor market conditions generally improved in June and that growth in real gross domestic product (GDP) was moderate in the second quarter.”

Vice Chairman Stanley Fischer, at the “Program on the World Economy” a conference sponsored by The Aspen Institute, Aspen, Colorado, August 21, 2016, Remarks on the U.S. Economy :

“Output growth has been much less impressive. Over the four quarters ending this spring, real GDP is now estimated to have increased only 1-1/4 percent. This pace likely understates the underlying momentum in aggregate demand, in part because of a sizable inventory correction that began early last year; even so, GDP growth has been mediocre at best.”

It’s no surprise that the Fed is confused when Fischer goes on to say stuff like “the frustratingly slow pace of real wage gains seen during the recent expansion likely partly reflects the slow growth in productivity”. But immediately caveats with a footnote that says the exact opposite: “An alternative explanation is that productivity growth has been slow because wage growth has been slow; that is, faced with only tepid rises in labor costs, firms have had less incentive to invest in labor-saving technologies.”

Of course, we favour the latter explanation, and it is moderately encouraging to see Fischer or someone important reading his speech has inserted the caveat.

The bulk of Fischer’s speech is very traditional central-banker speak passing the buck for their poor nominal growth management to politicians. So they call on politicians to engage in greater fiscal activism and structural reform to counter the RGDP slowdown, just like we often hear in Europe or Japan. The unspoken assumption is that if the politicians do engage in fiscal activism such that it (inevitably) raises inflation expectations the central bankers will offset it.

Central bankers who cannot escape from Inflation Target ceilings, and politicians who don’t assist them are doomed to be trapped by them. Inflation will never reach the targets and nominal growth will be squeezed no matter how low interest rates go or how big is the QE. This fatal mistake is repeated by many outside central banks in mainstream macro. The call to use Helicopter Money is another variant. HM will not be used while Inflation Target ceilings are in place.

It seems so obvious that if you move the Inflation Target to a higher plane, to a Level Target or an NGDP LT, then interest rates will naturally move higher as the expectations channel that drives down inflation works in the opposite direction, rendering QE or HM unnecessary.

Inflation Target ceilings will cause growth to remain moderate to mediocre for some time unless the Fed can figure out some alternative targets that allow greater nominal growth – even if it means temporarily busting current inflation targets.

It’s complicated

A James Alexander post

We were rightly excited by John Williams letter from San Francisco on Monday as we had already detected stirrings. We and many others were also equally right to wonder what was going on when JW reverted to type on Thursday.

The JW-induced downward move in the USD Index stuck. The move down was against all major currencies but specifically against the JPY where it fell through Y100 to the USD for a while on Tuesday and more persistently on Thursday.


The Japanese were repeatedly browbeaten by the US Treasury when their currency versus the USD had traded up to Y120. They did what they were told, pulling back from more QE. However, the US Treasury campaign still culminated in the creation of the ignominious “monitoring list” in April this year.

Now the Japanese find themselves with an even stronger currency than in April and overnight we see reported “plunging foreign trade“. In July export volumes were down 2.5% and imports down 4% – despite the new buying power. Exports by value were down 14% and imports by value were down 25%. AD is suffering.

Even more USD weakness to come?

The reaction to the idea of further reform of US monetary policy by John Williams ahead of the “Designing … Frameworks For The Future” brainstorming at Jackson Hole was pretty swift. Japanese currency chief called journalists into his office in Tokyo and issued a public warning.

William Dudley and his market-monitoring colleagues on the NY Fed frontline must have either had a call from Tokyo or felt compelled to react first or both. The NY Fed President’s hastily arranged a five minute interview on CNBC attempted to put a floor on this new USD weakness. Very significantly, he failed. Maybe Dudley failed because he looked so ashen-faced. On such things markets move, or rather refuse to move. John Williams’ latest public speech was very much back-to-business as usual for him, but also failed to raise the USD.

However, the NGDP Level Targeting bandwagon may be hard to stop as widely-read commentators as diverse as Larry Summers and Stephen King both weighed into the debate in favour.

Central banks do not act in isolation from one another. The US monetary tightening since mid-2014 has been causing a global slowdown. The active tightening in December 2015 caused global markets mayhem by early 2016. The rowing back from that tightening caused the USD to weaken, particularly against the JPY.[See chart above]

Ironically, if the US were to adopt NGDP Level Targeting it would lead to a stronger US economy and alleviate the pressure on the currency. The markets do not see it that way at the moment, though.

Most of the world’s central banks have had to pull back from their post-2009 tightening, the Federal Reserve probably will be no different. But it will cause a lot of major ripples, no doubt. Things are complicated. 

Screwed-up minds at the Fed

San Francisco Fed president John Williams on August 15:

Central banks and governments around the world must be able to adapt policy to changing economic circumstances. The time has come to critically reassess prevailing policy frameworks and consider adjustments to handle new challenges, specifically those related to a low natural real rate of interest. While price level or nominal GDP targeting by monetary authorities are options, fiscal and other policies must also take on some of the burden to help sustain economic growth and stability.

Then the same individual three days later:

Federal Reserve Bank of San Francisco President John Williams said the U.S. economy is strong enough to warrant an increase in interest rates soon, warning that waiting too long risks high inflation or asset bubbles that would cripple growth.

“In the context of a strong domestic economy with good momentum, it makes sense to get back to a pace of gradual rate increases, preferably sooner rather than later,” Williams said Thursday in the text of a speech in Anchorage, Alaska. “An earlier start to raising rates would allow a smoother, more gradual process of normalization.”

First he talks about “adapting” the policy framework. Then, he says the framework of “policy (rate) normalization” is still “the way to go”!

To this tweet:

Jeanna SmialekVerified account‏@jeannasmialek

Williams is still gunning for a rate hike, despite his essay earlier this week urging a re-think in the longer term.

David Beckworth answered:

David Beckworth ‏@DavidBeckworth 

Very clever. Gun for a rate hike now=>cause economic stress=>blame current system=>get monetary policy reform now.

No wonder the economy is a mess.

Is there an NGDP Targeting bandwagon rolling here? Maybe

A James Alexander post

As recently as the late July John Williams, “an influential centrist” FOMC member and President of the San Francisco Fed, was mouthing the usual threats that have become so common about implementing more rate rises than the market expects:

“The Federal Reserve could raise interest rates up to two times before year end, a top Fed official said on Friday as he downplayed data that showed the U.S. economy grew far less than expected in the last quarter.”

Since then we have had a flurry of comments and speeches suggesting the Fed was engaged in a re-think of its monetary policy. Heck, as we said yesterday, just look a the title of the upcoming Jackson Hole Symposium: Designing Resilient Monetary Policy Frameworks for the Future  .

Now President Williams in a sort of official blog post seems to have completely changed his tune:

“Second, inflation targeting could be replaced by a flexible price-level or nominal GDP targeting framework, where the central bank targets a steadily growing level of prices or nominal GDP, rather than the rate of inflation. These approaches have a number of potential advantages over standard inflation targeting. For one, they may be better suited to periods when the lower bound constrains interest rates because they automatically deliver the “lower for longer” policy prescription the situation calls for (Eggertsson and Woodford 2003).

In addition, nominal GDP targeting has a built-in protection against debt deflation (Koenig 2013, Sheedy 2014). Finally, in a nominal GDP targeting regime, a decline in r-star caused by slower trend growth automatically leads to a higher rate of trend inflation, providing a larger buffer to respond to economic downturns. Of course, these approaches also have potential disadvantages and must be carefully scrutinized when considering their relative costs and benefits.

In stressing the need to study and consider new approaches to fiscal and monetary policy, I am not advocating an abrupt reversal of course; after all, you don’t change horses in the middle of a stream. And in monetary policy, “abrupt” and “disrupt” have more than merely resonance of sound in common. But now is the time for experts and policymakers around the world to carefully investigate the pros and cons of these proposals.”

It’s a shame he doesn’t mention Scott Sumner, the tireless campaigner for NGDP Targeting, but the blogosphere knows where the idea has come from even if a Federal Reserve President can’t be open about the fact.

But a Federal Reserve President who concludes by quoting Machiavelli probably knows a lot more about successful politicking than a mere blogger once of Bentley University.

“Conclusion – Economics rarely has the benefit of a crystal ball. But in this case, we are seeing the future now and have the opportunity to prepare for the challenges related to persistently low natural real rates of interest. Thoroughly reviewing the key aspects of inflation targeting is certainly necessary, and could go a long way towards mitigating the obstructions posed by low r-star. But that is where monetary policy meets the boundaries of its influence. We’ve come to the point on the path where central banks must share responsibilities. There are limits to what monetary policy can and, indeed, should do. The burden must also fall on fiscal and other policies to do their part to help create conditions conducive to economic stability.

Policymakers don’t often cite Machiavelli, but in this instance, the analogy is potent (and, perhaps, a portent). In The Prince, fortune is compared to a river; in times of turbulence it wreaks havoc, flooding and destroying everything in its way. But in calm and sedate weather, people can build dams and stem the tide of destruction. In other words, we can wait for the next storm and hope for better outcomes or prepare for them now and be ready.”

Yesterday we said that there had been little obvious reaction in markets. Well, today there has been a little more. Specifically in the USD, which weakened overnight on the back of the “influential centrist” changing his views. Bond markets do not agree as the yield curve remains flat and low. Bonds seem to be responding more to a perception of incipient economic weakness than a revolution in monetary policy. As true Market Monetarists will only know there has been a revolution when the Fisher effect (aka expectations effect) swamps the liquidity effect as bond prices crash in anticipation of higher nominal GDP growth.