Jeffrey Lacker strongly mis contextualizes

In a recent interview, Jeffrey Lacker, when answering the question “So why haven’t we seen faster inflation?” said:

… the historical evidence suggests that there’s some lag before things accelerate as you reduce slack significantly. In 1966-67, we had unemployment at 5 percent, we pushed it to 4, and it was 1967 and 1968 when inflation took off. So there was a significant lag in the way that relationship seems to have worked in the past.

That only shows the degree of his ignorance about economic contexts. As Arthur Okun, an important player throughout the 1960s, and the economist that “invented” the concept of “potential output” reminisces:

“The strategy of economic policy was reformulated in the sixties. The revised strategy emphasized, as standard for judging economic performance, whether the economy was living up to its potential rather than merely whether it was advancing…the focus on the gap between potential and actual output provided a new scale for the evaluation of economic performance, replacing the dichotomized business cycle standard which viewed expansion as satisfactory and recession as unsatisfactory. This new scale of evaluation, in turn, led to greater activism in economic policy: As long as the economy was not realizing its potential, improvement was needed and government had a responsibility to promote it.

The objective was to promote brisk advance in order to make prosperity durable and self-sustaining…The adoption of these principles led to a more active stabilization policy. The activist strategy was the key that unlocked the door to sustained expansion in the 1960s”.

Furthermore, to the economists at the CEA:

The stimulus to the economy also reflected a unique partnership between fiscal and monetary policy. Basically, monetary policy was accommodative while fiscal policy was the active partner. The Federal Reserve allowed the demands for liquidity and credit generated by a rapidly expanding economy to be met at stable interest rates.

However, as Okun recognized:

The record of economic performance shows serious blemishes, particularly the inflation since 1966. To some degree, these reflect errors of analysis and prediction by economists; to a larger degree, however, they reflect errors of omission in failing to implement the activist strategy”.

Funny how often policymakers and commenters fall prey to the “it wasn´t enough” argument, in this case not “activist enough” or, more recently, “the 2009 fiscal stimulus wasn´t big enough” or was “reversed too soon”.

The above is far from being a description of the present context.

I think these points from Ryan Avent´s “Simple rules of thumb” are very relevant to the present context (just as they would have been 50 years ago). They are also consistent with my preference for “experimentation” instead of “estimation” (of all the “naturals” – interest rate, unemployment, output) to which much time and effort is devoted mostly in vain!

4) We know what an economy with way too much demand looks like. It has high and accelerating inflation.

5) We know what an economy with way too little demand looks like. It has high unemployment and deflation.

6) Within those two extremes, it can be tricky to identify exactly where an economy stands: how close or far away from potential output it is.

7) Both too much and too little demand are economically costly, but history suggests that too little demand is far more economically costly and politically risky than too much demand. So policy should err on the side of too much demand rather than too little.

How does “now” compare to the 1960s? For one thing, demand (NGDP) is growing at a relative trifling rate. The charts also indicate that the unemployment rate doesn´t add anything to the story, especially because the unemployment numbers are just not comparable.

Rules of Thumb_1

What happened between those two extremes? Following the 1960s, nominal aggregate demand growth (NGDP) took off at a rising rate (the scale in this chart is different from the others). Inflation was also up with spikes reflecting the oil shocks of the decade that reduced real growth and increased unemployment. Later, during the age of the “Great Moderation”, demand growth was just about right; inflation remained low and stable (with swings reflecting supply shocks).

Rules of Thumb_2

The images are telling us that the FOMC would be much more productive if, instead of eternally grumping about inflation, it moved on to experiment with level targeting nominal aggregate demand (NGDP).

Has Stan Fischer gone gaga?

After so many years as a top-notch academic in addition to a stint as head honcho at the Bank of Israel, how come he still reasons from a price change?:

A strong dollar is restraining U.S. inflation and exports, justifying a slower pace of interest-rate increases, but on balance the U.S. economy is riding out the effects fairly well, Federal Reserve Vice Chairman Stanley Fischer said Thursday.

He can´t see below the surface and misses the fact that the strengthening dollar (and low inflation) is a consequence of the tight policy his ‘bank’ has adopted!

Or, it could be smart blame shifting, as in “In spite of that the ‘bank’ has done quite well”!

Fischer Gaga

HT Dajeeps

An increase in the FF target rate is “a pill that must be swallowed”!

One think I know is that I will have fun reading comments on the GDP release. For example, “GDP Waves Yellow Flag at the Fed”:

The hope is that the inventory swing is just temporary, and that GDP will soon be moving along at a strong enough clip that the economy will have no problem swallowing a rate increase. The concern is that businesses cut inventories because they are worried that the global slowdown will hurt them, and that those qualms will affect their hiring decisions.

The GDP figures might mask what’s happening with demand, but sometimes the mask matters.

Unfortunately, it´s not masking anything. Final nominal sales (FSDP) follows closely on the heels of nominal spending (NGDP). They´re both chasing “zero” growth!

And while the Fed has confidence that inflation will “move towards target”, it has moved away and stayed away. Furthermore, with (“unmasked”) demand weakening by the quarter, there´s no chance it will do so!

Pill to swallow

The last exit!

Since there´s only one meeting left, “how long” had to become “next meeting”. The parsed statement:

To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. In determining [how long to maintain this] whether it will be appropriate to raise the target range at its next meeting, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation.

There´s been no material change in the statement. They just wanted to keep the “this year” option on the table. But it won´t be exercised.

Things change but they don´t budge from the view that inflation will settle near the target!


Inflation is anticipated to remain near its recent low level in the near term but the Committee expects inflation to rise gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of declines in energy and import prices dissipate. The Committee continues to monitor inflation developments closely.

Four years ago:

The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee’s dual mandate as the effects of past energy and other commodity price increases dissipate further. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.

And they consistently get it wrong!

Last Exit_1

Four years ago, oil prices had climbed from $40 in mid-09 to near $100 in November 11 when the meeting took place. With oil prices stable after the steep climb, inflation did not settle near the target, it kept falling!

Now they parrot-like repeat the meme that the downward pressure on inflation of the fall in oil prices will dissipate.

It won´t, because the Fed has been tightening monetary policy for more than one year, as indicated by the NGDP monthly growth rate (from Macro Economic Advisers). That´s one of the reasons oil prices fell to begin with!


The Fed is holding the economy down!

The Peterson Institute for Intenational Economics has a piece titled “The Fed’s Confusion over Interest Rates“. At the end we read:

The Fed insists it wants to raise rates before the end of the year, but markets insist in not believing it, because if one uses the reaction function the Fed has always communicated there is no reason to do it. The markets have followed Bernanke’s teachings and learned the Fed’s reaction function over the years, and have concluded that, in view of the economic outlook, interest rates should not be raised until mid-2016.

If the Fed has changed its reaction function, it should explain it and openly acknowledge that there are factors beyond the inflation outlook that are affecting its decision making. Transparency is critical. If the Fed is not able to explain convincingly why it wants to start raising rates, the risk of failure will be high. The world economy is in transition and developed economies have to replace emerging markets as a source of stability.

The Fed is caught in its own inertia, as it has spent many months preparing the ground for a rate hike in the second half of this year. But the reality is that if one ignores the inertia, there is no good reason to raise rates this year. And, with rates at zero, there is little room to correct mistakes. The Fed is confused, and the cost of this confusion could be very high.

The Fed certainly is confused (and after recent talks by Lael Brainard and Daniel Tarullo, divided). It´s not a question that the costs could be very high, the costs are already rising strongly!

Since the tapering and post tapering, monetary policy is being tightened. No one would notice that from looking at the Fed Funds rate, which has remained at “zero”. Bernanke himself long ago said that to gauge the stance of monetary policy, don´t look at interest rates, look at things like NGDP growth and inflation.

The chart provides clear evidence that according to those two gauges, monetary policy is in tightening mode. The Fed´s revealed confusion only adds to uncertainty and worse outcomes. In other words, the Fed is already failing!

Fed Confused

Brazil seems eager to relive the ‘good ole days’

In December 1985, Thomas Sargent spent some time in Brazil, giving speeches and talking to policymakers. Back home in January 1986, he published in the WSJ an Open Letter to the Brazilian Finance Minister:

…When you have exhausted all of your opportunities to borrow, you will have to make one or more of these unpleasant adjustments: raise taxes, lower government expenditures, or default on some of you debt…

Inflation is very useful to you because it raises an “inflation tax” of substantial proportions…Reducing your inflation tax by borrowing more in your domestic market is counterproductive…So my first piece of advice is that you had better retain the inflation tax and make heavy use of it, until other adjustments have been made in your finances…

The economics behind Sargent´s Letter:

In order to be solvent, the government must be ready to back up the existing amount of debt with either future seignorage, or with taxes.

More formally, the current debt must be equal to the discounted present value of all future revenues from taxes and/or from seignorage.

Implications (for those interested, see Sargent & Wallace “SomeUnpleasant Monetary Arithmetic“):

If the government implements a stabilization scheme, such that the revenues from seignorage go to zero, and it has some outstanding debt, it must raise taxes sooner or later.

If the government does not change its fiscal policy, it must go back to printing money at some point.

This is why in the experiences of hyperinflation the fiscal reform made the stabilization program more credible.

Inflation can begin also without growth in the money supply, if fiscal policy induces people to believe that deficits will be monetized.

The chart shows what happened to inflation shortly after Sargent´s Letter. After trying to “control” inflation by freezing prices, the (hyper)inflation process became much more acute (yes, that´s thousand %!). The government was only successful in “eliminating” inflation after 1994, with the introduction of the Real Plan.


Fast forward almost 3 decades.

For the last fifteen years Brazil been an inflation targeting country. Since 2004, the mid-point of the target range has been 4.5%, plus or minus 2.0%. So it´s a wide band. Even so, over the past several years the Central Bank has barely managed to keep inflation within the band, and more recently, the “genie has escaped from the bottle” completely.


We seem to be back to Sargent´s worries of 1985. Since April of last year, the primary surplus began to fall dramatically, more recently turning into deficit. With that, the nominal deficit (which includes interest payments) ballooned. The result has been a steep and fast rise in the public debt/GDP ratio.


The political background is inimical to the introduction of a credible fiscal adjustment. Therefore, higher inflation is inevitable.

In other words, the central bank is fast loosing the power to control inflation. Worse, the more it tries, by raising interest rates, for example, the higher inflation rises, since the increase in interest rates worsens the debt dynamics, requiring more inflation to produce the requisite seignorage revenues (in addition to reducing the present value of real debt through a rise in the price level). This is shown in the next chart.


So Brazil has better get its act together fast. Otherwise…

Reasoning from a price change at the Fed is endemic!

Reuven Glick, is a group vice president at the Federal Reserve Bank of San Francisco. He stated his views here:

Reuven Glick_1

Inflation, as measured by the change in the personal consumption expenditures (PCE) price index, was 0.3% in the 12 months through August. Very low overall inflation is largely attributable to lower prices of energy goods and services, which have fallen by over 16% in the past year. Excluding energy as well as the typically volatile food component of spending, core PCE rose 1.3% over the past 12 months. Inflation has remained below the Federal Open Market Committee’s 2% target since mid-2012. Absent further declines in energy prices or a further strengthening of the U.S. dollar, we expect that stable inflation expectations and diminishing slack will push core and overall PCE inflation up gradually towards 2%.

And goes into finer detail:

Reuven Glick_2

In recent years, core services inflation has tended to be positive, except during the recession and the early recovery. Core goods inflation has tended to be negative, with brief exceptions around 2009–10 because of tobacco tax hikes and 2011–12 because of rising textile and apparel costs. In recent months both core goods and services inflation have slowed, that is, services inflation has been less positive and goods inflation has been more negative.

The decline in core goods inflation can be attributed to declining import costs associated with the appreciating value of the dollar as well as lower costs abroad. Because goods account for most international trade, movements in exchange rates and foreign prices tend to exert more pressure on goods prices than on service prices. Lower prices of imported consumption goods directly affect core goods inflation. They also affect goods prices indirectly through imports of raw materials, such as metals, plastic, and rubber, used in the U.S. production of goods for domestic consumers.

Core service inflation has been pulled down by more subdued increases in health-care service costs, which represent a quarter of core services spending and 19% of overall core spending. Health-care services inflation has been slowing for several years and fell off sharply in 2014, primarily from capping of increases in Medicare payments to physicians.

And gets rid of “inconvenient” items:

Reuven Glick_3

The impact of import, energy, and health-care costs on core inflation can be gauged by “what-if” exercises that remove these sectors from the calculation. Excluding relatively import-intensive (for example, apparel and other nondurables) and energy-intensive (for example, transportation) sectors would raise core inflation modestly, by around 0.2%. Removing health-care services spending from the calculations would raise core inflation by an additional 0.3%.

Is he a monetary analyst that contributes to monetary policymaking or a “spreadsheet analyst” that contributes nothing to monetary policymaking?

It seems that it never crossed his mind that inflation is low, and even falling, because monetary policy has been tight, or even tightening!

He never noticed, for example, that headline inflation was dropping long before oil prices tumbled!

Reuven Glick_4

By osmosis, inflation will converge on 2%!

John Williams is the “on one hand on the other hand” kind of guy:

I’ll start with the arguments for continued patience in removing monetary accommodation. First, we are constrained by the zero lower bound in monetary policy and this creates an asymmetry in our ability to respond to changing circumstances. That is, we can’t move rates much below zero if the economy slows or inflation declines even further. By contrast, if we delay, and growth or inflation pick up quickly, we can easily raise rates in response.

This concern is exemplified by downside risks from abroad. One such risk is the financial turmoil and economic slowdown in China, which I’ll get to shortly. More generally, economic conditions and policy overseas, from China to Europe to Brazil, have contributed to a substantial increase in the dollar’s value, which has held back U.S. growth and inflation over the past year. Further bad news from abroad could add to these effects.

That brings me to inflation, which has been under our target for over three years. This is not unique to the United States—inflation is very low in most of the world. Although we can ultimately control our own inflation rate, there’s no question that globally low inflation, and the policy responses this has provoked, have contributed to put downward pressure on inflation in the U.S. Although my forecast is that inflation will bounce back, this is only a forecast and there remains the danger that it could take longer than I expect.

Those are arguments on the side of the ledger arguing for more patience. On the other side is the insight of Milton Friedman, who famously taught us that monetary policy has long and variable lags. I use a car analogy to illustrate it. If you’re headed towards a red light, you take your foot off the gas so you can get ready to stop. If you don’t, you’re going to wind up slamming on the brakes and very possibly skidding into the intersection.

Luckily Bullard doesn´t vote, otherwise there would have been two dissents:

“The case for policy normalization is quite strong, since Committee objectives have essentially been met,” he said during his presentation titled, “A Long, Long Way to Go.”

However, he noted, “Even during normalization, the Fed’s highly accommodative policy will be putting upward pressure on inflation, encouraging continued improvement in labor markets, and providing the best contribution to global growth that we can provide.”

Bullard noted that the FOMC wants unemployment at its long-run level and inflation at the target rate of 2 percent. “The Committee is about as close to meeting these objectives as it has ever been in the past 50 years,” he said.

In justification of his dissent, Lacker wrote:

“I dissented because I believe that an increase in our interest rate target is needed, given current economic conditions and the medium-term outlook.

“Inflation has run somewhat below the Committee’s 2 percent objectivein recent years and was held down late last year by declining oil prices and appreciation of the dollar. Since January, however, inflation has been very close to 2 percent. Movements in oil prices and the value of the dollar in recent weeks have renewed downward pressure on inflation. As with last year’s episode, this disinflationary impulse is likely to be transitory. So I remain confident that inflation will move back to the FOMC’s 2 percent objective over the medium term.

They can go on “wishin´and hopin´”, but it just won´t happen, at least not while NGDP growth is so low and constrained!


Déjà Vu

“As we write, the money is even on whether the Fed´s Open Market Committee will choose to push up the Fed funds rate at its meeting tomorrow, or perhaps after the election in November. With unemployment at a seven-year low of 5.1%, the Street´s priests are warning that higher inflation is around the corner unless the economy makes the autumnal sacrifice of a pre-emptive rate hike.” WSJ, 23 Sept. 1996

What happened?

The Fed did not raise rates at the September FOMC meeting (nor after the November election). It did a “one and done” in March 97.

And below inflation and unemployment.

Deja vu

John Williams´ Oasis: A mirage!

Nonetheless, I still expect inflation to move back up to our target over the next couple of years. With a strengthening economy, special factors dissipating, wages on the rise, inflation expectations stable at 2%, and, full employment right around the corner, I see all the factors in place to meet our inflation goal by the end of next year (see Nechio 2015). But the point of being data dependent is that information drives your decisions; and while my forecast looks great, I am wary of acting before gathering more evidence that inflation’s trajectory is on the desired path.

All in all, things are looking good. I see growth on a solid trajectory, full employment just in front of us, wages on the rise, and inflation gradually moving back up to meet our goal. I can’t tell you the date of liftoff, but I can say that it’s going to be an interesting rest of the year for monetary policy, and the Fed in general.

What it really looks like:

Falling unemployment amidst a labor force “dead in the water” is very different from falling unemployment with a growing labor force


Wages lag far behind previous expansions


And inflation may be going somewhere, but surely not 2%