Tyler Cowen and Fiat-Money Independent Central Banks

A Benjamin Cole post

The globe’s major fiat-money central banks are considered “independent,” those being the Bank of Japan, the U.S. Federal Reserve and the European Central Bank.

The ostensible reason for the independent status is so that central bankers can “do the right thing” and not cave in to political or popular demands, almost invariably described as “printing money.”

But if inflation everywhere and always is a monetary phenomenon, then so too must be disinflation and deflation. After obtaining the former in the 1980-1990, the major central banks have obtained the latter in the late 2000s over much of the globe, and the U.S. is but one recession away from deflation also.

Tyler Cowen

Tyler Cowen, the brilliant blogging polymath from George Mason, recently posited it is politics and the labor class that is pushing the Fed to chronic tight-money, in his recent and welcome endorsement of nominal GDP level targeting by central banks, or NGDPLT.

By Cowen’s reckoning, the central banks are independent, except they are cowed by a working class that does not want to see wage cuts through inflation.

Does the AFL-CIO stand athwart of Fed desires for NGDPLT, and the attendant moderate rates of inflation?


I rather suspect it is strident right-wing academia, think-tankers, punditry and bloggers, and related party politics that have contorted an eagerly compliant Fed into a supine posture now conducive to a deflationary perma-recession.

It is rare to see true happiness in this world, but the beam on a central banker’s face when announcing a rate-hike is the best place to look.

The Fed has leaned to deflation for decades, and is on the doorstep now. It is benighted, second-rate mythology that the Fed has been “easy” or “held rates low.” If the Fed has been easy, how to explain the 35-year decline in inflation and interest rates?


Glad we are to accept a Tyler Cowen into the NGDPLT camp. Maybe for politesse, Cowen must identify the anti-inflation zealots as laborites. So be it.

There is still a real danger to American prosperity, even if the Fed adopts NGDPLT, and that is the Fedsters will select a straitjacket tight version of NGDPLT, or chronically miss LT on the low side, as they do with the IT (inflation targeting).

The idea of an independent fiat-money central bank may be proving a bad one. In the modern-era, such institutions generally asphyxiate economic growth.

The Reserve Bank of Australia is becoming ‘conventional’


The Reserve Bank of Australia has lowered the cash rate to 1.5% in an effort to stimulate growth, boost inflation and encourage a fall in the Australian dollar.

The cut of 25 basis points from 1.75% is the last decision from outgoing RBA Governor Glenn Stevens. In a statement on the rate decision he says:

“Low interest rates have been supporting domestic demand and the lower exchange rate since 2013 is helping the traded sector. Financial institutions are in a position to lend for worthwhile purposes.”

In addition:

In his statement, Glenn Stevens also addressed the concerns around Australia’s property market. He noted Australia’s banks have been cautious in lending to certain sectors like the property market and despite the possibility of a considerable supply of apartments emerging over the next few years, lending for housing has slowed this year.

It seems the RBA has ‘unlearned’ the lessons of 2008. Then it did not suffer a recession because, contrary to what most major central banks, it did not allow NGDP to tank.

What supported domestic demand was an adequate monetary policy that kept spending growing close to a stable trend path. Maybe because of worries about house prices, monetary policy has been overly tight for the past two years, despite the drop in the policy interest rate.

Australia Aug16_1

Australia Aug16_2

Australia´s monetary policy statement says:

In determining monetary policy, the Bank has a duty to maintain price stability, full employment, and the economic prosperity and welfare of the Australian people. To achieve these statutory objectives, the Bank has an ‘inflation target’ and seeks to keep consumer price inflation in the economy to 2–3 per cent, on average, over the medium term.

The chart shows that since 1992, when the target was set, inflation has averaged 2.5%. The RBA couldn´t have done better! Soon we´ll hear Steven Williamson say “Told you so; interest rates are falling and so is inflation. If rates continue to fall and remain low, you´ll get deflation”!

Australia Aug16_3

If only the RBA had continued to pay attention to NGDP!

The chart shows that the house price boom ended, without tears, more than 10 years ago.

Australia Aug16_4

At the FOMC, anything goes!

They haven´t yet figured out that it´s the data that is Fed-dependent:

Federal Reserve Bank of San Francisco President John Williams played down a “low” reading on second-quarter U.S. growth and said the economy could still warrant as many as two interest-rate increases this yearor none.

“There’s definitely a data stream that could come through in the next couple of months that I think would be supportive of two rate increases,” Williams told reporters Friday after speaking in Cambridge, Massachusetts. “There’s data that we could get that wouldn’t be supportive of that — it could be one, maybe, or none. Time will tell.

Dallas Fed President Rob Kaplan, who also spoke Friday, echoed Williams’ wait-and-see attitude, saying he wouldn’t “overreact to one data point,” particularly because the report showed consumer spending continued to be strong.

“We’re still hopeful for solid GDP growth this year, and the basis for that is the consumer,” Kaplan told reporters at an event in Albuquerque, New Mexico,

For the past two years, both the nominal and real economy have been weakening. All the while, inflation has been “dead in the water”.

Anything Goes

The Fed Will Fail

A Benjamin Cole post

House prices feed heavily into U.S. inflation rates as measured, and as pointed out by Kevin Erdmann of the excellent blog Idiosyncratic Whisk, there is hardly inflation at all but for housing costs.

The matters little for U.S. Federal Reserve officials or the gaggle of inflationistas who monomaniacally jibber-jabber about prices. At every juncture, monetary policy is about the perils of inflation and the need to raise rates.

But, as noted by many, from here the Fed cannot tighten its way to higher long-term interest rates. The United States is in that monetary zone long ago noted by Milton Friedman: Interest rates are low as a consequence of tight money.

The present-day reality is this: Easy money for years on end does not lead to sub-2% 10-year US Treasuries, which we see in the market now.

And Fed policy gets more confounding.  If the Fed raises rates, it will only succeed on the short-end of the curve. As money is already tight, long-term rates will sag, and that includes long-term mortgage rates.

Okay, so lower long-term mortgages rates, ceteris paribus, lead to higher house prices and thus higher rents, as rents are tried to house prices.

Of course, the real solution to high housing costs in the United States is twofold, involving aggressive upzoning or dezoning of property in high-cost cities, and a looser money policy and extension of credit to home-building industries and buyers.

An aggressive pro-growth monetary policy might actually result in prosperity and higher long-term rates. Oddly enough, the higher mortgage rates might somewhat depress house prices and related rents, which feed into reported inflation.

As it stands, there is little the Fed can do about property zoning, which is a local prerogative. At the last Fed shindig in Jackson Hole, every panel discussion was about inflation, but none mentioned property zoning. I would call this a blind-spot, but that would suggest the Fed has eyes.

In any event, the U.S. property-owning class in each city seems content to zone out competition, and is politically powerful. In the real world, prosperity in the United States will incur moderate inflation, in large part due to housing costs.

The Fed’s chosen solution is to prevent prosperity, but that is a central banker’s fix and not a good one. The Fed’s better recourse from here is to shoot for higher long-term growth and interest rates, and moderate inflation, by any means necessary, including helicopter drops.

Of course, the best course is targeting NGDPLT.

The Fed is likely to enter the next recession with interest rates near the zero-bound and inflation dead. Then what?

“Headwinds”: Code for “Fed”

Ms. Yellen has said headwinds are holding back the economy. Right! The Fed is working full-time to that end. And, if they continue their quixotic search for the “neutral rate”; if they continue to believe inflation will climb to target sometime in an unknown future date; if they continue to believe the labor market is “strong”; they will be surprised to see the fed funds rate remaining unchanged for “years to come”!

When low unemployment was meaningful

From the BLS today: 38K Payroll and 4.7% unemployment!

Will the Parrots at the FOMC continue to think the labor market is “overstretched”? Or will they revise their views to contemplate that their monetary policy is totally inadequate?

They could learn something from a historical comparison. In the “good days”, this same low rate of unemployment went hand in hand with about the same low rate of inflation. However, the growth rate of real output was in a very different league!

Those were the days

Update: And the Fed knows why!

Those were the days_1

“Playing the fiddle while Rome Burns”


As James Alexander wrote in the previous post, according to the London Times:

The Bank of England has cut its growth forecasts and signalled that interest rates may rise earlier than expected.

Higher savings levels as families grapple with their debts and weaker productivity than the Bank was projecting three months ago weighed on the outlook for the economy, also hitting jobs.

However, the Bank said inflation would overshoot its 2 per cent target within two years, putting an early interest rate rise on the table.

The MPC must be “MWI” (that´s “meeting while intoxicated”) because the story told by the following pictures is a very sad one!

After more than 15 years of great nominal stability (only more recent period shown), the BoE, like the majority of central banks, thought that nominal spending (NGDP) had to be “jerked down”.


For the past two years it has been trying to “jerk-it-down” even more.


No wonder real output growth “acknowledges” the “jerking-down”


And what about inflation? After a spell at zero it is just positive, but the “farsighted jerks” think that in two years’ time it will likely be “2.1%” and so “we have to act shortly”!


Australia falling prey to bad (interest rate oriented) monetary policy

In recent news we read:

Australians must urgently confront the danger that the Reserve Bank of Australia is nearing the very limits of its powers and risks stumbling into the same zero-interest rate trap that has neutered European and Japanese central banks, say two high-profile economists.

Saul Eslake, one of the nation’s most experienced economists, and the ANZ Bank’s top analyst, Richard Yetsenga, say the examples of major central banks around the world don’t provide much hope that ever-more intensive monetary policy stimulus can resurrect inflation.

“The evidence is that even aggressive monetary policy action doesn’t seem to be driving up inflation, so far,” Mr Yetsenga told AFR Weekend.

Calls for a national debate on the eve of the Federal election about how the central bank operates come after the Reserve Bank issued the weakest inflation outlook since introducing its 2-3 per cent target range in the early 1990s. It also comes a day after Phillip Lowe was announced as the replacement for RBA Governor Glenn Stevens.

“Aggressive monetary policy action”? Quite the opposite. Australia weathered the international crisis of 2008-09 because, differently from most other central banks, it managed to avoid letting NGDP to fall below trend, quickly reversing the initial fall in spending, as the two charts indicate.

Australia Falters_1

By identifying the stance of monetary policy with the level of its policy rate, it has allowed NGDP growth to fall continuously, and that has taken the level of spending below the long-term trend.

Meanwhile, inflation has fallen somewhat below the 2%-3% target range, something that is not novel. Since the start of the “IT” regime in 1992 Australia´s inflation, both headline and core measures of the CPI, have averaged 2.5%, and that´s certainly a most satisfactory outcome.

Australia Falters_2

The RBA´s goal should be clear. Work to put NGDP back on the level trend it was at!

Output Gap targeting is voodoo economics too

A James Alexander post

We have already outlined why inflation targeting is voodoo economics. The juxtaposition of two articles in Saturday’s FT (which I pay for in hard copy, but are behind a paywall) neatly illustrate why targeting NGDP expectations is so important. Debt is nominal but you need nominal growth to pay it back. Especially if you have a smaller nominal economy than expected you will have problems with that debt – and much else besides.

We had already issued an alert about George Osborne’s likely problem from not targeting NGDP growth, and so it comes to pass as the FT reported: 

Paul Johnson, director of the Institute for Fiscal Studies, says the bad news on nominal GDP is much more serious for the public finances than the small headline reductions in real growth forecasts. “The cash coming into the exchequer will be lower, and . . . freezing benefits and increasing pay by just 1 per cent turn out to be less of a real [spending] cut than intended,” Mr Johnson says.

With £18bn knocked off the level of nominal GDP, standard calculations would suggest that if the chancellor kept policy unchanged, this would feed through to a cut in tax revenues of about £9bn every year, enough to wipe out the projected surplus in 2019-20.

The last Labour government learnt how quickly public finances can deteriorate when nominal GDP undershoots. Julian McCrae, deputy director of the Institute for Government, recalls that when he was in the prime minister’s strategy unit in 2008, “we kept nominal [public] spending the same, but that meant huge increases in real terms”.

The second article reported a new and important study that showed why targeting either inflation as the Bank of England says it targets, or real GDP as it actually does, is so dangerous. They also illustrate that while the Output Gap is a valid concept it is unmeasurable, so targeting it is a form of voodoo economics, just like inflation-targeting.

Essentially, because inflation is not measurable, real (inflation-adjusted) output is not measurable either. And thus the output gap between actual real output and “theoretically optimal” real output is just pie in the sky too. All we have is total nominal output (or income or expenditure). Real measures of output (income or expenditure) are just not good enough quality given the challenges of correctly calculating an inflation index with which to deflate actual, nominal, figures to the supposedly underlying real, ones.

An important new survey

Support for this view, as reported by the FT, has come from the recently released exhaustive review into UK economic statistics conducted by Charles Bean The review makes many excellent points. Some opponents of NGDP Targeting, and even some sympathisers, dislike the idea because of the supposedly more often revised NGDP figures. We have dealt with those very weak, lacking-knowledge, criticisms already.

Bean goes through some of the obvious points about the lack of hedonic adjustments in the price indices. Even in the US hedonics is not that widely used. And as I have explained, without a transparent, specific, index for quality adjustments the inflation index itself does not really make sense.

A  choice section is where the high cost of making hedonic adjustments is cited by the UK’s Office of National Statistics (ONS) as a reason for not doing them. So we just have to live with highly unsatisfactory data instead. Or rather we have to live with the awful consequences of a wrong-headed pursuit of wrong numbers by central banks, ie inflation-targeting.

JA Gap Vodoo The section on the lack of any quality adjustments to services is equally damning.

Quality change is not unique to physical goods. Non-tangible characteristics, such as service reliability, effectiveness, or customer satisfaction can vary over time, which means that the quality will not be constant. However, quantifying movements in quality without clearly defined characteristics can nevertheless prove conceptually much more difficult when compared to physical goods.

To be fair, an additional area of challenge to GDP measurement as whole, not just to the deflators comes from intra-firm transactions by multi-nationals, usually with an eye to minimising tax burdens, but other issues can drive these too such as regulatory arbitrage by banks.

This section explored two potential rationales for inter-subsidiary transfers, redomiciling and intellectual property transactions. But these issues are not exhaustive and the challenges from intra-MNE transfers are more diverse. Transfer pricing can also be used to distort non-intellectual property transfers and debt can be shifted around the arms of a company creating distortions through interest rate payments.

Continued integration of global markets is expected to perpetuate the trend to greater foreign asset ownership – of both foreign ownership of UK assets and UK ownership of foreign assets. Therefore intra-MNE transactions of the sort discussed above may increase, worsening potential statistical measurement problems.

These issues make the Ireland and Luxemburg GDP number particularly hard to compile and, frankly, to believe. It is no wonder that these two developed countries are always the last to be accepted by EuroStat into the Euro Area GDP calculations, if at all.

The genuine challenges of measuring actual or nominal GDP should be recognised. Market Monetarists believe nominal stable growth in NGDP is all important to prevent downturns becoming dangerous, unemployment-creating recessions, due to the sticky wages problem. Targeting nominal growth expectations, and keeping those stable is thus far superior to targeting actual NGDP growth. This is partly because it is inevitably backward-looking, but also due to these genuine issues on measurement. If mistakes are made in NGDP looking back, it won’t matter, bygones are bygones.

And it must be so much worse to target things as hard to grasp and calculate as either Real GDP or its ugly sister, inflation. This is to say nothing of which inflation measure to target – either its very overestimated form the CPI (HICP in Europe) or its merely overestimated form the GDP Deflator as in the US.

The  pursuit of the “Output Gap” as voodoo – or worse than voodoo

And then on top of all this pile of uncertainty is added a theoretical amount of real output that economists claim they think should be produced. OK, I understand the concept.

But what to make of pursuing the difference between a theoretically amount of optimal real output and the essentially unmeasurable amount of real output? The pursuit of the output gap or, more colloquially, “slack”.

The dolls used in voodoo are real dolls, but they have no actual physical link with the people they are supposed to represent. Sticking pins in the dolls will not harm the individual. Unfortunately, pursuing unmeasurable concepts like “slack” or “inflation” could well harm people. In some sense, targeting the output gap or inflation is worse than voodoo. Medical doctors first have to take the Socratic Oath: do no harm. If only inflation hawks and slack-hunters took the same vow.

It is, of course, absolutely right that the gap or slack should be minimised but how anyone can have any confidence in the number is beyond belief. Hundreds, perhaps thousands or PhD theses and articles have been written on such an impossible to actually quantify number. What a waste of effort!

Just target nominal growth expectations and avoid sticky-wages caused unemployment and recession. Then leave it to the non-monetary experts, the politicians and the public to argue about what is really going on, ex-inflation and how to make things better if necessary. But please don’t get distracted from the main task of providing nominal stability.

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!