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.

If 2% is not enough, don´t double it

According to the Economist:

…How might these problems be fixed? One possibility is simply to raise the inflation target to, say, 4%. Credibly enacted, that ought to alleviate the risk of impotence. If investors and consumers believe inflation will reach 4%, nominal interest rates should eventually rise to 5% or so even if real rates stay low. But rich-world central banks have undershot their targets for so long they may struggle to persuade the public to expect higher inflation. And a higher target would still leave central banks with a dilemma when economic growth and inflation diverge. Neither would it make up for big misses.

A more radical option is to move away from targeting inflation altogether. Many economists (and this newspaper) see advantages in targeting the level of nominal GDP, the total amount of spending in the economy before adjusting for inflation. A nominal-GDP target would allow for temporary variations in inflation. Downturns would be tempered by an expectation of protracted stimulus later on to make up lost ground. In better times, a rise in real GDP would provide the lion’s share of the required nominal-GDP growth and inflation could drift lower.

Swiss National Bank On The Defensive At Jackson Hole

A James Alexander post

Although it appeared that the VSPs gathered in Jackson Hole could only worry about non-existent inflation, I detected a defensiveness too. There were several considerations of alternative policies, in particular a higher, or more flexible, inflation target.

The Chairman of the Swiss National Bank, Thomas Jordan, could see the problem clearly, and had thought about a solution:

“Given that Switzerland is confronting an overvalued currency and negative inflation, one might argue that a higher inflation target or a looser definition of price stability is beneficial. A prolonged period of Swiss franc overvaluation is usually linked to the fact that the central bank has limited scope to cut nominal interest rates. A higher inflation target that induces higher average nominal interest rates could increase the SNB’s room for manoeuvre in times of crisis.”

But then starts the confusion:

“However, a looser quantitative definition of price stability would not be in line with the SNB’s mandate of ensuring price stability.”

This makes little sense, a different definition of stable would not be, well, stable. Mmm.

“A higher level of inflation often goes hand-in-hand with large fluctuations in inflation rates, which lead to the misallocation of resources, as well as to random and undesirable income and asset redistributions.”

A flexible target doesn’t automatically mean higher target. But anyway, isn’t a flexible target meant to be, well, flexible?

“This, in turn, could undermine public confidence in the SNB.”

The confidence that was so well established by the unbreakable CHF 1.20 floor through which the Euro would not be allowed to drop versus the Swiss Franc. Yeah, right. How did that work out?

“Furthermore, likely indexation, combined with a failure to anchor inflation expectations, would diminish the effectiveness of monetary policy and lead to greater fluctuations in interest rates, economic activity and employment.”

Greater fluctuations than the 20% intraday rise in the Swiss Franc on 15th January 2015? Greater fluctuations than the negative RGDP in 1Q15 and the measly 2Q15 outturn compounded by a negative GDP Deflator of 1.2% and now plunging consumer confidence. Bravo! And things look set to get worse.

“As a result, higher inflation is likely to be associated with considerable costs in the longer run and thus does not seem to be a suitable solution (see Ascari and Sbordone 2014). It also seems highly unlikely that marginally more scope for cutting interest rates would, on its own, have been sufficient to significantly dampen Swiss franc appreciation during the ‘Crisis Period’.”

But printing money was working very well. Monetary Policy 101 says that Policy is implemented  by control of base money, not by moving around target interest rates. And the SNB was doing a great job satiating foreign demand for Francs first by printing and then merely by threatening to print.


And now the SNB is back printing to buy FX to hold down the Swiss Franc, just like it did before the Euro floor, as it has no clear target or “anchor”. One of the supposed reasons for ending the floor was the growing balance sheet of the SNB.

It had stopped growing due to the hard won confidence in the floor.  Only for it to surge again as the breaking of the floor caused currency chaos and the SNB had to intervene heavily to ensure some form of stability. Maybe this intervention was a little understandable at first. But it is still growing the balance sheet according to the latest figures for the Feb-April period. The SNB is still actively intervening to stop the too tight monetary policy causing the Franc to appreciate vs the Euro. The prospective tightening by the Fed may help ease pressure vs the Dollar as both appreciate into a recession together. A silver lining of sorts, I suppose.

The SNB’s credibility has been destroyed by Jordan and his speech shows remarkable blindness from the man at the top who flip-flopped in panic when the ECB adopted a far better monetary policy.

Worse than his own loss of credibility is the damage his policy is now causing to the Swiss economy. Perhaps one of the world’s richest per capita economies can take the damage in it’s stride, but we shall see.

The Jackson Hole Fed Confab: Worse Than You Thought

A Benjamin Cole post

The financial media did a reasonable job in covering the Kansas City Fed’s recent Jackson Hole bias-confirmation fest, duly reporting that the Fed may raise rates, that everybody talked ceaselessly about raising rates, and of the extraordinary reasoning brought to bear to tease out some sort of reason to hike interest rates.

But the popular media did not print the Jackson Hole meeting schedule. A synopsis of the schedule speaks volumes. Here it is:

Friday August 28

8:00am  Inflation Dynamics Through Firms’ Pricing Behavior

9:00 am  International Aspects of Inflation Dynamics

10:25 am Central Bank Perspectives on Inflation Dynamics

Saturday August 29

8:00 am Reinflation Challenges and the Inflation: Targeting Paradigm

9:00 am Inflation Dynamics During and After The Zero Lower Bound

10:25 am Overview Panel: Global Inflation Dynamics

There you have it—not single panel devoted to, say, the strange esoteric topic of macroeconomic growth.  The word “inflation” is literally in every panel title.

Now, with aggregate demand feeble and inflation dead in the United States, deader in Europe, and long dead in Japan, you might think “inflation dynamics” would be a passé topic.

Evidently not when central bankers convene. Indeed, “inflation dynamics” is of over-arching, all-consuming and riveting interest. There is nothing else to talk about—at least at Jackson Hole.

Egads, what does that tell you?

The Jackson Hole Score: Inflation, 1000. Aggregate Demand, 2. Fed Veep Stanley Fischer Mentions inflation 75 Times In Brief Presentation; Aggregate Demand, Once.

A Benjamin Cole post

When the Federal Open Market Committee was meeting in 2008, and the globe sinking into the worst recession since the Great Depression, there was nearly only one topic on FOMC attendees’ minds: Inflation.

Transcripts released of 2008 FOMC meeting reveal the world “inflation” was mentioned 2,664 times in the year’s eight meetings. It was a monomania.

Nothing Has Changed

But, in reading about the Fed and global central-banker confab in Jackson Hole, it is painfully obvious that little has changed since 2008.

Forget that global trade in H1 2015 is down YOY, and that inflation is dead in the United States, really dead in Europe, and long dead in Japan. Forget that Q2 in Singapore was a deflationary contraction. Forget that nowhere on Earth is there an industry straining to meet demand.

There is only one topic central bankers know, and that is inflation. The topic “football” is less-mentioned at Super Bowl parties.

Fed Vice Chair Stanley Fischer’s presentation was, sadly, typical fare at the Jackson Hole group-think, bias-confirmation fest.

Fischer gave a brief talk at Jackson Hole (well, “brief” by economists’ standards), and the word “inflation” was mentioned 75 times. The word “growth” appeared three times in the Fischer soliloquy. The phrase “aggregate demand” appeared…once.

Lonely Man Kocherlakota

At Jackson Hole, and looking out of place as a pickled onion in an ice-cream banana split, was Minneapolis Fed President Narayana Kocherlakota. The Wall Street Journal said “Narayana Kocherlakota was an isolated voice among officials for sustaining near-zero interest rates.”

Investors—when central bankers determine your fate, think 2008.

Go Long Bonds?

The outlook does not look good for stocks and property, though perhaps risk-free U.S. government bonds will do well enough. Deflation could be on the global horizon, plus recession.

Invest accordingly. If you know how, send me a note.

The Fed Paints Itself Into A Smaller And Smaller Corner Jackson Hole Could Spell Bad News

A Benjamin Cole post

The Fed entrapment of itself began with ex-Chairman Ben Bernanke, who slated the tapering down of quantitative easing before leaving office. Bernanke did not reduce QE to, say, “a low and variable level,” that would leave open the door for increasing QE as needed, as a mere policy adjustment.

By closing off QE as an option in 2014, Bernanke left his successor, Janet Yellen, without QE as tool. To use QE again, Yellen would have to engage in a “flip-flop” or policy reversal, considered a cardinal sin in Washington, D.C. talking-head circles.  Worse, Yellen faces a vociferous gaggle of tight-money ideologues and extremists, eager to pounce on any Fed policy they can denounce as “activist,” “hyperinflationary” or ineffective.

Not content with having closed off one door, Yellen grabbed the paint brush herself and kept backstepping and improving the floor around her, reminding everyone everywhere that the Fed would likely raise rates in 2015.

So now we are bearing down on 2016, and the Fed still has not raised rates, leading to rising, acute and evidently hysterical discomfort among the prominent herds of “interest-rate crackheads.”  For months, the only topic in the FOMC room, and tight-money circles, has been hiking interest rates.


Global trade H1 was down year-over-year. Singapore is in a deflationary recession, Hong Kong’s stock market off YOY. China is wobbly, and Europe in deflation. The Atlanta Fed says Q3 GDP in the U.S. is penciling out flat.

Wages in the United States are dead, and inflation below the Fed’s IT target—and the market expects inflation in the next five years to run at less than 1% on the PCE, or at about one-half of the Fed’s putative “average” target.

Worst of all, the U.S. RGDP is perhaps 10% below where it should or could be, had mediocre economic growth rates been obtained since 2008.  I know of no industry straining to meet demand—indeed, most industry denizens still speak of weak demand, and certainly aggregate demand is weak.

But the Fed is trapped. Global central bankers and the other usual tight-money fanatics are now convening at the Fed’ annual Jackson Hole confab, to gird each other up for even tighter money ahead.

Jackson Hole is not a conclave of venture capitalists, real estate developers, business operators or even labor groups and truckdrivers or dockworkers.

People in the real economy are not invited to Jackson Hole.

At one time, the economics profession embraced “independent” central banks as a good idea. Is anyone so sure anymore?

“Central bankers aren’t sure they understand how inflation works anymore”

JACKSON HOLE, Wyo.—Central bankers aren’t sure they understand how inflation works anymore:

Inflation didn’t fall as much as many expected during the financial crisis, when the economy faltered and unemployment soared. It hasn’t bounced back as they predicted when the economy recovered and unemployment fell.

The conundrum challenges much of what central bankers thought they understood about the world, as well as their ability to do their job. How will they know when to raise or lower interest rates if they’re unsure what causes consumer prices to rise and fall?

“There is definitely less confidence, a lot less confidence” about how inflation works,James Bullard, President of the Federal Reserve Bank of St. Louis, said in an interview here Friday.

The economy’s performance has “really challenged” the notion of a strong link between unemployment and inflation, Mr. Bullard said on the sidelines of the conference. The existence of such a link was also challenged in the 1970s, an era of high inflation and high unemployment.

Today’s uncertainty is a turnabout in a community that gave itself credit for figuring out and taming inflation after bringing it down sharply from double-digit rates in the 1970s.

The Fed’s thinking about inflation forces has changed before. For a while in the 1980s the central bank focused on managing the growth of the supply of money in the banking system. One view was that the purchasing power of dollars was closely connected to the supply of dollars in the economy. The Fed gave up on this approach in the 1990s when links between measures of money supply and measured consumer prices seemed disconnected

Since then, central banks moved toward setting inflation targets and trying to reach them by adjusting interest rates, often in response to the amount of slack in the economy, as shown in unemployment rates and other measures…

Maybe they never did understand! Let me help them with a hint.

Hint: The inflation dynamics is closely tied to the Fed´s success in obtaining NOMINAL STABILITY!

The charts illustrate. Immediately after WWII and extending to the mid-1960s, inflation was “low” (average=2%) but volatile (St Dev=2). Average NGDP growth was 6.3% with St. Dev. of 4.5. That compares with “low” (average=2.5%) and stable inflation (St Dev=1). Meanwhile, NGDP growth averaged 5.7% but it´s standard deviation (1.4) was just one-third the standard deviation of the 1948-65 period.

Inflation Dynamics_1

What have we had for the past 9 years, since Bernanke (followed by Yellen) took over the Fed?

The chart shows that inflation has been a little “too low” (average 1.8%) and stable (St Dev=1.1), while NGDP growth has also been “too low” (average=3.2%) and only relatively stable (St Dev=2.3).

Inflation Dynamics_2

You could say that there has been nominal stability. Unfortunately, the stable LEVEL path is “too low”!

The market monetarist conclusion is: Target a level path for Nominal Spending (NGDP). Inflation will remain “low” and stable, but the rest of the economy will feel much better!

To cap it up, the next chart allows you to get a feel for the “dynamics of inflation” when NGDP growth rides on a rising trend and when inflation is “spiked” by a couple of “strong” oil shocks!

Inflation Dynamics_3

The NGDL level target story is certainly much “cleaner” than the Phillips Curve (growth/low unemployment) drives inflation story.

Jackson Hole

Tomorrow, Fed Vice-Chair Stanley Fischer will speak on Global Inflation Dynamics. At the opening dinner last night he told reporters:

The Federal Reserve’s No. 2 official said Friday the central bank hasn’t settled on whether to raise interest rates next month, and the option remains on the table.

“I think it’s early to tell” what will happen at the Fed meeting, Federal Reserve Vice Chairman Stanley Fischer told CNBC, citing the market turbulence of the past weeks.

Until recently, “there was a pretty strong case” to raise the Fed’s benchmark short-term interest rate from near zero at the central bank’s policy meeting Sept. 16-17, Mr. Fischer said. “It was not a conclusion yet; it was a case.”

But recent events—worries over China’s growth outlook, its currency devaluation and volatile global markets—suggest Fed officials need to step back and mull incoming data before deciding what action to take, he said.

“The change in circumstances which began with the Chinese devaluation are still relatively new, and we are still watching how it unfolds. So I wouldn’t want to go ahead and decide right now what the case is, compelling or less compelling” for rate rises.

It seems markets have concluded that the “case is less compelling”!

Rate Hike

Get me out of my misery: just “pull the trigger”!

JACKSON HOLE, Wyo.—After months of forewarning by Federal Reserve officials that they are preparing to raise short-term interest rates, some international officials attending the Fed’s annual retreat here this week have a message: Get on with it already.

“If you delay something that you were planning to do, then you leave the impression that your compass is different than what you led markets to believe,” Jacob Frenkel, chairman of J.P. Morgan Chase International and former head of the Bank of Israel, said in an interview Thursday. Market drama is increased by delay, he added.

Interestingly, in 2013, when Jacob Frenkel was appointed to replace Stanley Fischer as head of the Bank of Israel (although that didn´t pan out), he said:

At the conference, Frenkel had an enlightening conversation with Axel Weber, today the chairman of the Swiss banking group UBS and formerly the leader of Deutsche Bundesbank, the German central bank.

“We were both formerly central bankers and I personally can say I wouldn’t want to be a central banker today, with interest rates at rock bottom, because there’s almost nothing that can be done,” Frenkel observed. Every central banker knows that keeping interest rates that low isn’t sustainable, he added: “That doesn’t mean it’s a bad policy, but that’s not a place anybody would want to be.”