Bernanke: interest rate junkie and inflation-targeting nutter

A James Alexander post

Seems like Ben Bernanke has tried to get the final word before the next FOMC meeting, as sort of ex officio member. In a blog post he strongly defends negative interest rates and rails against raising the inflation target as if people were proposing 10% inflation targets. It seems no more than 2% inflation or we are all doomed. He does mention NGDP targeting but misunderstands it badly.

His post is so full of errors that it has hard to know where to start.

“Nominal interest rates are very low, and in a world of excess global saving, low inflation, and high demand for safe assets like government debt, there’s a good chance that they will be low for a long time.”

What does “excess global saving” mean? In macroeconomics “saving” is part of an identity equal to “investment”. Like MV=PY. Saving can’t be in excess it has to equal investment.

Being generous, perhaps he means there is too much demand to hold money? In which case, central banks should supply more to bring demand and supply into balance; or threaten to do so until demand increases and more is spent.

Interest rates are my first love

“When the next recession arrives, there may be limited room for the interest-rate cuts that have traditionally been central banks’ primary tool for sustaining employment and keeping inflation near target.”

This is a very basic error. It is a view that sees interest rates as the primary tool, rather than a symptom of monetary policy. Interest rates react to nominal growth expectations and these are driven by central banks supplying more or less high-powered money. Interest rates are low in the US because nominal growth expectations are low. Yet US Base Money has been shrinking at between 3-6% for over a year now. Doesn’t he know this?

Gets the case for NGDP Targeting very wrong

“Outside the United States, Mark Carney, governor of the Bank of England, has expressed openness to targeting nominal GDP (which essentially involves targeting a higher inflation rate when GDP growth is low) … ”

Err, just no, that is not what it is. NGDP targeting asks for a stable growth of NGDP. It particularly targets expectations of growth as expectations drive action – just like in the theory of targeting inflation expectations. Targeting expectations also avoids near term noise in actual data, just like with inflation targeting. More generally, it provides nominal stability, thus preventing the occurrence of major demand shocks, especially those that flow from monetary policy reacting to supply shocks (like the one Bernanke himself presided over in 2008).

NGDP targeting does not target “higher inflation”. It is agnostic about inflation. Market Monetarists are often very sceptical that inflation can be accurately measured. And, they are certainly sceptical a central bank can target inflation. It is a sprite and it makes (Real) GDP equally hard to calculate, in real time or even forecast. People live and work in the nominal world, not the Real world.

Interest rates are best even when negative

The rest of the article is all about the pros and cons of negative interest rates (many pros) versus a higher inflation target (many cons).

The extended discussion on real rates leaves me cold. I don’t really understand what inflation is so I struggle to understand the meaning of a real interest rate and find it very hard to comprehend the neutral real rate.

I also know the public finds negative rates almost incomprehensible and regard such a policy as a total failure by “the authorities”, whoever they are. Bernanke’s strong support for negative rates shows just how out of touch he must be with real people. He claims Europeans and Japanese under these negative interest regimes are coping well. That is just not true.

He even suggests that negative rates are only temporary, and that everyone knows it, not realising that this renders them toothless, as it promises tightening around the corner.

Whoooo, don’t let the inflation genie out of the bottle

“Higher inflation has costs of its own, of course, including making economic planning more difficult and impeding the functioning of markets. Some recent research suggests that these costs are smaller than we thought, particularly at comparatively modest inflation rates. More work is needed on this issue. Higher inflation may also bring with it financial stability risks, including distortions it creates in tax and accounting systems and the fact that an unexpected increase in inflation would impose capital losses on holders of long-term bonds, including banks, insurance companies, and pension funds.”

It is hard to know what “higher inflation” he is talking about. 3%, 4%? The golden eras of the US economy usually had higher inflation than today. The lowflation, or rather low nominal growth, of the Great Stagnation he helped create is the thing making economic planning more difficult and impeding the functioning of markets. Economies need healthy nominal growth to be flexible enough in rewards to allow all to see growth in returns, some faster than others. At a crushing 3% or less nominal growth, at a depressed NGDP level (see chart below), this cannot happen.

Downwardly sticky wages are a massive problem causing recessions, but also constraining productivity growth  in a low nominal growth environment. Yet Bernanke calls for more work! What have the thousands of central bank-employed PhDs been doing all these years? Twiddling their thumbs.

Is Bernanke talking his own book and/or that of his employers?

Financial stability risks are worst in deflationary environments, no question, just look at the Great Recession or the Great Depression. Tax and accounting issues arise only when inflation is well above 10% or more, and then they are still quite theoretical rather than real. Bernanke seems to be fearing a return to the worst years of the 1970s. He can’t be serious.

And then he worries about his various new employers seeing capital losses from betting wrong on financial markets. Well, does he think they should be guaranteed winnings?

The article goes on and on with the familiar litany of worries about higher inflation hurting savers, needing political approval etc. etc. No one is proposing 10% inflation. Just 3 or 4%, or better still a commitment to a level target, an average target, and not constant undershooting. Or, better, a nominal income/NGDP level target.

He seems to be randomly firing at straw men. He even clutches at the idea of more fiscal activism, as if that could work without threatening the inflation target. He well knows the Fed would offset it at the first opportunity.

He never used to be quite this bad, as Scott Sumner tirelessly points out when Market Monetarists get fed up with these manias of the modern Bernanke.

Perhaps he’s worried about his lowflation legacy crumbling. It couldn’t happen soon enough for us. He seems to have become a caricature of things he may have ridiculed in the past: an interest rate junkie and an inflation-targeting nutter.

UK Monetary Policy Revolution

A James Alexander post

The great mid-2015 tightening

From the August 2015 Inflation Report opening remarks:

Policy outlook

The MPC’s projections are conditioned on Bank Rate following the gently rising path implied by
market yields. Under this assumption, demand growth is expected to be sufficient to return inflation to the target within two years. Inflation then moves slightly above the target in the third year of the forecast period as sustained growth leads to a degree of excess demand.
….
As the UK expansion progresses, speculation about the precise timing of the first move in Bank Rate is increasing. This is understandable and is another welcome sign of the economy returning to normal. The likely timing of the first Bank rate increase is drawing closer.

The great mid-2016 loosening

From the August 2016 Inflation Report opening remarks  :

Policy trade-off

The MPC’s Remit recognises that when the effects of shocks persist over an extended period, the MPC is likely to face an exceptional trade-off between returning inflation to target promptly and stabilising output.
When this is the case, the Remit requires the MPC to explain how it has balanced that trade-off, including the horizon over which it aims to return inflation to target.

Fully offsetting the persistent effects of sterling’s depreciation on inflation would require exerting further downward pressure on domestic costs. And that would mean even more lost output and a total disregard for higher unemployment.
In the Committee’s judgement, such outcomes would be undesirable in themselves and, moreover, would be unlikely to generate a sustainable return of inflation to the target beyond its three-year forecast period.

As a result, in order to mitigate some of the adverse effects of the shock on growth, the MPC is setting policy so that inflation settles at its target over a longer period than the usual 18-24 months.

Two presidents and a governor

A James Alexander post

In the last day of public comments by FOMC members before the whole committee entered purdah the market was treated to three separate statements.

1. Kashkari

First off was Neel Kashkari. He knows little about monetary economics and it showed he hasn’t bothered to find out anything since his appointment. He should take this course for starters. At least is he is enthusiastic and inquisitive.

In a blog post entitled “Nonmonetary Problems: Diagnosing and Treating the Slow Recovery” he rather airily dismissed the idea that the slow recovery was due to poor monetary policy. He tasked his economics team at the Minneapolis Fed with building on some random thoughts of Greg Mankiw in a New Times op-ed. Mankiw came up with five, Kashkari and his team added two more, I think.  I have read so many of the secular stagnation theses and other ad hoc nostrums I go a bit bored.

What was not seriously discussed was monetary policy. He did at least mention raising the inflation target, moving to a level target or even NGDP targeting. But he then spoilt these promising thoughts with this incredible statement:

“However, there are significant downside risks with these policy recommendations [raising the IT, LT of NGDPLT] that I believe must be carefully considered before being adopted. First, the Federal Reserve is struggling to hit its current target of 2 percent and has come up short for four years. Market forecasts and expectations about our ability to hit 2 percent have fallen. If we announced a new higher target, it isn’t clear why anyone would believe that we could hit it. The Federal Reserve’s credibility could be weakened.“

The trouble is, the Fed has buckets of credibility. Despite “struggling to hit its current target” it ended QE in 2014, threatened all through 2015 to raise rates and did so in December. And then the Fed projected four more 25bps hikes in 2016 and around eight more within two years or so. What on earth effect does Kashkari think all that actual and clearly threatened firepower have on inflation expectations? No wonder the inflation data the Fed is so dependent upon keeps disappointing.

Still Kashkari is a lot more dovish than his two peers in the Kansas (George) and San Francisco (Williams) Feds, and will swing the average vote much more dovish in 2017 when it is his turn to vote.

2. Lockhart

The president of the Atlanta Fed is a bit on the hawkish side, but mostly a bit of a tease. He said nothing of note in his speech and ended a bit dovish, but teasingly so:

“Among these—and I will close on this note—are, first, what is the right policy setting given an outlook of getting to full employment and price stability relatively soon—in the next couple of years? And, if 1.6 percent inflation and 4.9 percent unemployment were all you knew about the economy, would you consider a policy setting one tick above the zero lower bound still appropriate? These are some of the questions on my mind as I approach the next few meetings. I think circumstances call for a lively discussion next week.”

3.Brainard

This was the big one. The speech worried markets on Friday 9th September when it was announced, especially after a litany of hawkish regional Fed presidents reiterating their inane and extremely tired views on the coming hyperinflation unless rates were raised soon.

The markets need not have worried. Brainard echoed many of the very sensible comments made by her governor colleague Tarullo.

“1. Inflation Has Been Undershooting, and the Phillips Curve Has Flattened … With the Phillips curve appearing to be a less reliable guidepost than it has been in the past, the anchoring role of inflation expectations remains critically important. On expected similar to realized inflation, recent developments suggest some reasons to be concerned more about undershooting than overshooting. Although some survey measures have remained well anchored at 2 percent, consumer surveys have moved to the lower end of their historical ranges and have not risen sustainably“

The other four sections were all pretty sensible:

2. Labor Market Slack Has Been Greater than Anticipated …the unemployment rate is not the only gauge of labor market slack, and other measures have been suggesting there is some room to go … 

3. Foreign Markets Matter, Especially because Financial Transmission is Strong  …In turn, U.S. activity and inflation appear to be importantly influenced by these exchange rate movements. In particular, estimates from the FRB/US model suggest that the nearly 20 percent appreciation of the dollar from June 2014 to January of this year could be having an effect on U.S. economic activity roughly equivalent to a 200 basis point increase in the federal funds rate

[but whose fat finger caused the USD appreciation?] …

4. The Neutral Rate Is Likely to Remain Very Low for Some Time … Ten years ago, based on the underlying economic relationships that prevailed at the time, it would have seemed inconceivable that real activity and inflation would be so subdued given the stance of monetary policy. To reconcile these developments, it is difficult not to conclude that the current level of the federal funds rate is less accommodative today than it would have been 10 years ago. Put differently, the amount of aggregate demand associated with a given level of the interest rate is now much lower than before the crisis

[OK, this is really confused. Interest rates are not monetary policy, expected nominal growth is. High rates mean money is or was easy, low rates mean it is or was tight] …

5. Policy Options Are Asymmetric… From a risk-management perspective, therefore, the asymmetry in the conventional policy toolkit would lead me to expect policy to be tilted somewhat in favor of guarding against downside risks relative to preemptively raising rates to guard against upside risks.”

And then we get what seems to be a highly encouraging trend, seen first with John Williams, but repeated by Neel Kashkari today, a nod to alternative policy options:

“There is a growing literature on such policy alternatives, such as raising the inflation target, moving to a nominal income target, or deploying negative interest rates.15 These options merit further assessment. However, they are largely untested and would take some time to assess and prepare. For the time being, the most effective way to address these concerns is to ensure that our policy actions align with our commitment to achieving the existing inflation target, which the Committee has recently clarified is symmetric around 2 percent–and not a ceiling–along with maximum employment.”

The last point echoes what we have identified coming from the Bank of England, that 2% is not necessarily a ceiling, although the Fed is not yet saying that about projected inflation.

There is no mea culpa, that the Fed has caused the inflation undershooting by excessively tight monetary policy but, hey, we can’t have everything just yet.

And all this is going to be evaluated in the “months ahead”. Read my lips: no September, November or even December rate hike. A good news day!

Europe overtakes US growth

A James Alexander post

It’s taken a while but the evidence is now in. Euro Area NGDP growth has overtaken US NGDP growth. Congratulations to the ECB, commiserations to the Fed. Go Europe!

Sadly, it is not quite so simple. While the Fed has much to atone for letting NGDP drift so far off trend, the ECB has much more below trend growth to make up as the growth “gap” since the Great Recession makes very clear.

For those who prefer “Real” GDP, i.e. a real number GDP deflated by inflation, then we can also see a similar pattern of Europe overtaking the US.

The main reason for this Euro Area relative resurgence is that monetary policy remains on a tightening bias in the US despite these terrible trends in Nominal and Real GDP, while the ECB is still very much in easing mode. The trends are equally visible in Base Money growth: 6% down YoY in the US, 30-40% up in the Euro Area.

The regional drivers of Euro Area growth are the big four countries who make up 75% of Euro Area GDP, while BeNeLux makes up a further 10%. Their report cards show:

• Germany (29%) – NGDP slowed to 3.2% YoY in 2Q 2016 from a 3.6% trend over the last five quarters. It seems to have been driven by a fall in the deflator rather than RGDP growth which was stable at 1.7% YoY.
• France (21%) – still growing at over 2% YoY NGDP doesn’t sound exciting but is very good for that country which has a terribly sluggish nominal economy hidebound by labor regulations and other restrictions. QoQ growth was 0%, which wasn’t too bad given the country had terror attacks and a major football championship keeping people away from the shops. Equally, keeping large parts of the labor force out of the economy as evidenced by its very low Labor Force Participation and Employment/Population ratios helps France´s productivity statistics but doesn’t make the country happy or grow very fast.
• Italy (15%) – Despite the long-drawn out saga of the low nominal growth-inspired banking crisis, NGDP growth in Italy is above 2% for a second quarter running, helping keep RGDP positive YoY. ECB monetary policy is set for the average grower inside the Euro Area and Italy is very definitely average.
• Spain (10%) – NGDP picked up after a 1Q2016 dip but did not regain the 4% recorded in 2H 2016. Still, it is very welcome given the political chaos engendered by not having a government and as the country has much catch up to do in terms of lost NGDP growth during the double dip recession.

Even writing these mini-report cards on various regions within the Euro Area, one feels very conscious that one is approaching the monetary area the wrong way. It is, or should be, seen as one bloc but the national politics keeps interfering. It mirrors the tension between the permanent Federal Reserve governors and the regional Fed presidents on the FOMC. The US is far more of a single market than the Euro Area but can still see tensions, especially when the central governors are two seats short due to nomination blocs by Congress on Presidential appointees.

Perhaps the sheer diversity of ECB council members strengthens the central officers in a way Janet Yellen can only dream. Who knows? But what is clear is that the ECB is on the right path at the moment while the Fed is not.

The BoE’s new monetary policy tool: toleration of above target projected inflation

A James Alexander post

Watching Bank of England Governor Mark Carney joust again with Jacob Rees-Mogg MP at the UK’s Treasury Select Committee yesterday got me looking back to the May press conference when Carney launched his warnings about the riskiness of voting Leave, that were then repeated at the May Treasury Select Committee hearings.

There was a lot going on at the time but Carney had a secret weapon, a new monetary policy tool whose importance is still being overlooked.

Carney took sides, but …

The intensity of the debate over Brexit was terrific during May and June. The Bank of England was clear that there could be financial chaos and a technical recession. There was only downside risk from the voting Leave. In that view the BoE was amplifying, but with authority, the typical consensus expert view. It took sides with the Cameron/Osborne government, clearly and simply, loyally.

Remain supporters amongst journalists and politicians were very pleased. Leave supporters were not. Rees-Mogg was entirely right to question the independence of the bank. If Carney had talked in any remotely balanced way about the potential benefits of Leave then he would have been fair but as Rees-Mogg noted, he didn’t take up that opportunity. All serious people agreed Brexit would be a disaster, and Carney is a very serious person indeed.

However, the sub-text was also crystal clear. And FX markets, a prime window onto, and channel of, monetary policy very much got the message. If the UK voted Leave then all the monetary policy power of the Bank of England would be brought to bear immediately to offset any shock to demand, due to fears about the supply side.

Once it was clear that the UK had voted Leave then the markets immediately knew what to expect from UK monetary policy. Potential rate cuts, QE and other liquidity schemes – plus the bonus of a dramatic and statesmanlike broadcast from Carney himself. Sterling fell 10% in response to the u-turn in monetary policy, UK domestic equities fell in response to demand shock fears caused by long-run supply side fears. Political turmoil didn’t help much either. But, it wasn’t a disaster. Financial institutions sailed through unscathed, many even profitably. There was no repeat of Lehman.

With one step he was free

In the hearing yesterday Carney was not exactly smug, but he did say he was “serene” about the new stance. He also elaborated about just how profound the 180-degree u turn on monetary policy had been. He said monetary policy was on a tightening bias as late as May/June, and the next moves in rates were due to be up. That had all changed now and he clearly was a much happier man as a result. His incorrect monetary policy stance of the previous year and a  half was now just a distant memory, “ancient history” as he called it.

No monetary shock here, so no demand shock either

While the vote to leave was a shock a bigger shock, a monetary shock, would have been if the Bank of England hadn’t intervened to offset the uncertainty shock.

If it had decided to defend the currency with a monetary tightening, that would have been truly disastrous. Some central bankers have made that mistake in the past and it never ends well.

If it had appeared to stand pat and just keep its tightening bias, that would still have been a shock. Some central bankers have done that too, and it didn’t end well.

The BoE had primed markets that it would respond appropriately and it did. GBP immediately fell 10%, and then rates were cut and QE was expanded. Osborne’s replacement, Philip Hammond, also made it very clear that the response to the Brexit shock was monetary, not fiscal.

The BoE even said it would also tolerate an above target inflation rate – all in order to ensure financial stability and a return of inflation to 2% in the longer term. That “even ” is subtle, but very powerful.

Overshoot of projected inflation now tolerated

Why did Carney never say during 2015 that it would tolerate a period of above target inflation in order to bring current inflation up to target. Well, the obvious answer is because the BoE took its own projections seriously, and they showed inflation returning to 2%.

Those projections always showing this happening kept monetary policy tight, with promises of more tightening to come if those projections showed an overshoot. The fact that this stance meant constant under-shooting was lost on the BoE.

Is this a new tool?

After the Brexit vote the UK central bank seems to have added this new weapon to its toolbox: Toleration of projected overshoots to its inflation target at a time when actual inflation is stubbornly below target.

The BoE tolerated current inflation above target when it was above target, but what else could it do? It was a fact, but was it a choice too? We don’t really know. We do know that it wouldn’t tolerate inflation projections going above its target until we had the vote to leave, now we do.

Perhaps this new tool could also be used by other central banks. Temporary overshoots of projected inflation in order to get current inflation up to target. Are you listening at the Fed, ECB and BoJ?

Switzerland escapes deflation … by printing money

A James Alexander post

Back in Autumn last year I was concerned  by the negative trend in Swiss NGDP during 3Q 2015. In January 2015 the new head of the Swiss National Bank broke the fixed ceiling on the currency vs the Euro that had prevented appreciation and a consequent monetary tightening. The ceiling had been so credible that after early attacks the SNB had not had to defend it by selling currency and thus expanding its balance sheet – a major cause of concern inside Switzerland.

On breaking the ceiling the currency duly rose dramatically and the SNB was forced to sell currency in order to stop what it saw as “excessive” appreciation. Effectively, the SNB was now running an unofficial peg vs the Euro. It was forced to begin expanding its balance sheet all over again. The initial currency appreciation was monetary tightening and did see NGDP slow and then turn negative, dragging down RGDP too, but not quite sending Switzerland into a recession.

Over the last three quarters the recession was narrowly avoided so there has been no poor ending yet. Why not?

• The unofficial peg vs the Euro means that monetary policy has stopped tightening.

• The cost of maintaining the new unofficial peg means Switzerland is actually engaged in monetary easing as Base Money has grown steadily thanks to the continual sale of currency in return for foreign assets. If a major country did this it would be termed “currency manipulation”, but the US Treasury has only named China, Japan, Korea, Taiwan and Germany on its infamous May 2016 “Monitoring List”.

• It won’t have helped that Switzerland is running with very negative policy rates, but it doesn’t appear to have hurt either.

In just the 2nd quarter of 2016 alone he SNB has bought more USD (11.5bn) and more EUR (16bn) than they owned before the financial crisis.

By tying itself again to Euro monetary policy Switzerland has effectively outsourced its monetary policy direction to the ECB, which itself is trying hard to ease monetary policy via its QE programme, despite the massive handicap of its absurdly low inflation ceiling. Euro Area NGDP and RGDP growth has avoided disaster as a result, and has had a similar impact on Switzerland.

August payrolls – in line, except for awful AWE

A James Alexander post

The auguries for the August payrolls have not been good judging by industry-side surveys of August activity, and they still disappointed expectations.

Monthly jobs growth was relatively weak. With the participation rate flat there were not enough jobs created to keep pace with entries into the labour force and so the unemployment rate ticked up to 4.9%. No big deal and certainly nothing to move markets or expectations about Fed action.

What should trigger Fed action and more concern generally is the very weak Average Weekly Earnings (AWE) number. It is derived from two more commonly watched numbers, Average Hourly Earnings (AHE) and Average Weekly Hours (AWH). Hourly earnings had made some progress over the past 18 months, rising from a risible 2% YoY growth to a slightly less risible 2.5% or even 2.6%. Hawks had gotten very excited seeing incipient take-off in wage inflation, especially when annualizing a 3-month trend etc. More careful analysis showed that this very modest growth had been accompanied by lower hours worked per week, thus suppressing AWE growth to just 2% or so.

The August data showed both weaker growth in AHE and another drop in AWH (plus a revision down in the July hours) leading to weekly earnings growth dropping from 2.1% YoY to just 1.5%. It has to be remembered that this is nominal growth and so really depressing for wage earners. Other non-wage costs are rising, like medical cover but it remains incredibly dull for employees.

Incredibly, and perhaps tellingly about the market’s view of the FOMC, the chances of a September rate rise stayed put at 24% but the chances of a December hike rose from 54% to 60%. The market is always right, after all. Both equities and the USD initially fell, but then went up, as might have been expected. Even the long bond yield initially rose, before paring back.

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;

or,

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;

or,

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 because the 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.

 

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.