The Fed leadership is asking to be sacked

A James Alexander post

A very long and rambling interview with John Williams, Governor of the SF Fed and a current voting member of the FOMC, highlighted one crucial feature of Fed monetary policy.

“The argument that we should wait until we reach 2% inflation before we start raising interest rates, I don’t agree with that. If we waited until inflation was 2%, unemployment by that point would be probably down to low 4s or something. We would be behind the curve and we would need to tighten monetary policy at that point very rapidly.”

Thus the 2% inflation target is very much a hard ceiling. Any move up towards anywhere near 2% will be met by a very rapid raising of interest rates, especially when unemployment is low.

This threat of massive retaliatory action guarantees that nominal growth will remain highly constrained. This is because the market treats such strong language with a high degree of credibility. Investment and spending decisions will be put off. Expected nominal growth of no more than 3%, made up of 1% or so inflation and 2% or so real is not worth businesses chasing after. Better to throttle back and live within existing means.

There will still be winners with business growth, ie sales and revenue growth, of 5% or more. But the iron logic of 3% or lower, economy-wide, nominal growth means just as many businesses will have sales growth of zero or lower. And they won’t feel good due to downwardly sticky wages and prices. Look at the big retailers, for instance.

Lay on top of this overall subdued outcome any potential or actual negative shocks, like China now or the EuroZone in the recent past, and the downside to even 3% nominal growth increases. And businesses will recognise this and act accordingly.

Williams reluctantly recognises the rise in these downside risks over recent months.

“My interest and my focus is trying to understand, has China’s growth outlook slowed significantly? Is there real information about what’s happening in Asia? Is there real information about any economic or other developments that then feed into my view on the forecast for employment, inflation in the U.S., and obviously the risks around those forecasts?”

But what Williams can’t see is that the potentially damaging effects of these threats are directly increased by his and the Fed’s own hypersensitivity around any moves in inflation towards 2%. The threat of the Fed yielding its rates sledgehammer to crack a low but rising inflationary nut is very scary, and totally counter-productive.

This is just like Japan over the last two decades, until recently. And leads the U.S. directly to the same sort of self-induced low growth trap.

Strong leadership at the Fed is needed to break this psychology. The evidence from Japan is that central banks are totally incapable of generating this change internally. It needed outside political leadership to do it in the form the new Prime Minister, Mr Abe, sacking the head of the Bank of Japan and appointing his own man. Step forward Mr Trump? Or Mr Sanders?

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%


John Williams in “whack-a-mole mode”

The first Federal Reserve official to speak in the wake of this week’s central bank monetary policy meeting said Friday the Fed should raise interest rates twice this year.

“We are getting closer and closer to the time to raise rates,” Federal Reserve Bank of San Francisco President John Williams told reporters following a hometown speech. “My own forecast would be to raise rates two times this year, if the economy performs as I expect.” He added he would like to see those initial increases at 25 basis points each.

As he has on many occasions, Mr. Williams cautioned that whatever happens with a policy that now has short-term rates pegged at near-zero levels will be driven by how the economy performs. And while he is upbeat about the outlook for growth and hiring, he said there are still reasons to be cautious about raising the cost of borrowing in the U.S. economy right now.

“My own view is there are still significant headwinds to this economy,” he told reporters.

In the text of remarks delivered Friday, Mr. Williams also said he was wary of acting before gathering more evidence that “inflation’s trajectory is on the desired path.

“Until I have more confidence that inflation will be moving back to 2%, I’ll continue to be in wait-and-see mode regarding raising interest rates,” he said.

He couldn´t have been clearer!

The Fed is a “tighten-only screwdriver”!

From SF Fed John Williams:

Anyone who knows me, or has listened to my speeches, will notice three recurring themes. The first, and foremost, is that monetary policy is data-driven. I am so data-focused that I literally had a T-shirt made to express my personal policy mantra. The second is that I think patterns and history are important indicators of our economic present and future—they are, frankly, just another form of data to be mined. As is the case with the effect that wages have on overall inflation, sometimes the theory doesn’t play out in practice, and history is an eloquent teacher. The third is that I believe policymakers have to be very careful about not reacting to blips. This again is an extension of the “data, data, data” view: We have to look at what’s happening in the economy not just today, not just this month, but over the medium term, analyzing trends and looking at multiple indicators.

That’s why we should be very circumspect about reacting to short-term fluctuations in commodity or other import prices. Just as the Fed didn’t immediately intervene in the spring of 2011, when inflationary pressures from oil and import prices were going up, we shouldn’t jump the gun now that they’ve gone down. I take a perspective that looks one or two years ahead, which research shows is the minimum amount of time it takes for monetary policy to have its full effect (Havranek and Rusnak 2013). What I’m considering is what impact those factors that are currently unfolding—movements in the U.S. economy, weakness abroad, oil prices—will have not next week or next month, but later this year and the year after that and the year after that. My goal is policy that meets the needs of the path we’re on, not where we’re standing this second.

With that in mind, history and experience show that energy price swings leave an imprint on inflation in the short term, but don’t affect underlying inflation rates over the medium term (Evans and Fisher 2011, Liu and Weidner 2011). The same holds true for movements in the exchange value of the dollar: They obviously affect inflation in the short run, but they don’t have much of an impact further down the road (Gust, Leduc, and Vigfusson 2010).

I’m therefore looking at underlying rates of inflation. Fed economists are frequently accused of neither eating nor driving, because we prefer to measure “core” inflation, which excludes food and energy prices. For the average consumer, those matter a lot—you can’t talk about what a dollar can buy if you don’t look at those products. But for economic trends, and for guiding monetary policy, measures of inflation that remove the most volatile components, like core or “trimmed mean” inflation, give a better lay of the land (see FRB Dallas 2015).

And here´s the “lay of the land” for the past decade or so.



The question that jumps out: Why the FOMC´s ‘state of mind’ was so different, in fact, diametrically opposite, in 2008. Here´s from Bernanke´s summary at the June 2008 FOMC meeting:

My bottom line is that I think the tail risks on the growth and financial side have moderated. I do think, however, that they remain significant. We cannot ignore them. I’m also becoming concerned about the inflation side, and I think our rhetoric, our statement, and our body language at this point need to reflect that concern. We need to begin to prepare ourselves to respond through policy to the inflation risk; but we need to pick our moment, and we cannot be halfhearted. When the time comes, we need to make that decision and move that way because a halfhearted approach is going to give us the worst of both worlds. It’s going to give us financial stress without any benefits on inflation. So we have a very difficult problem here, and we are going to have to work together cooperatively to achieve what we want to achieve.

The last thing I’d like to say is on communications. Just talking about communications following this meeting, I’d like to advise everyone, including myself, to lean, not to lurch. That is, we are moving toward more concern about inflation

One answer might be that there is an asymmetry in FOMC thinking. When oil (and commodity) price goes up, the risk to inflation rises, so policy must tighten. But when oil prices goes down, they shouldn´t be concerned (or react) about too low inflation. “Keep policy steady, but be prepared to tighten”!

And note that between 2011 and mid-2014, both headline and core were coming down even though oil prices were stable!


The politically correct term for depression: “new normal of slow growth”

That´s the takeaway from Matt Obrien´s “The recovery is stalling out again. Is the economy actually in … a recession?

It’s only mostly crazy. And even then, it depends on what you mean by “recession.” If you’re talking about the usual rule-of-thumb of two consecutive quarters of negative growth, then, yes, there’s probably a 5 percent chance that we’ve fallen into one. But if you mean an economic decline that actually makes unemployment go up, then, no, we don’t have to worry about the r-word.

We just have to worry about a new normal of slow growth that might dip into negative territory every now and then even during the good times. In other words, about turning Japanese.

New normal indeed! SF Fed president John Williams, for one, is “happy”:

 “I am very optimistic as to where the economy is going over the next couple of years,” Mr. Williams said. “We’ve gotten the national economy back to basically full strength,” he said, adding what is now a 5.5% jobless rate will likely move to 5% by year’s end.

How fast we have adapted!

Politically Correct Term for Depression

John Williams cannot think “outside the box”

He can only think in terms of interest rates. Since that´s pegged at “near zero levels” he feels lost:

Policy rules also wouldn’t have done much for the Fed in recent years with interest rates pegged at near zero levels, Mr. Williams said in the text of a speech prepared for delivery before an audience at Chapman University in Orange, Calif. These rules would have argued for something not easily done, and that would have been for the Fed to have pushed short-term rates deeply into negative territory, he said.

Mr. Williams said the problem policy rules have with zero interest rates is probably not over. The use of unconventional policy stimulus like bond buying and other tools “are very likely to occur again in the future,” and rule-based policy-making will have nothing to contribute in such a scenario, he said.

Scott Sumner has just written a post that tries to understand the “stance” of monetary policy, and ends thus:

People are constantly telling me that my “tight money” theory of the 2008 recession is loony.  But I am never provided with any good reasons for this criticism.  I have no doubt that there are hundreds of macroeconomists who are much smarter than I am, but I do occasionally wonder if my profession is somewhat lacking in imagination.

Lack of imagination is exactly what John Williams (and his colleagues) exudes!

What a difference one month makes in the views of John Williams

On March 23 it was “up, up and away”:

“Things are looking better–in fact, they’re looking downright good,” the official said in a speech to be delivered to an audience in Sydney and Melbourne via video.

Given how much the economy has improved and is likely to continue to gain ground, “I think that by mid-year it will be the time to have a discussion about starting to raise rates,” Mr. Williams said.

On April 20 another FOMCer is not so sure any longer:

Hopefully” the economic data will “support a decision to lift off later this year,” Mr. Dudley said, in reference to taking the first move to push interest rates off of their current near-zero levels.

But, “because the economic outlook is uncertain, I can’t tell you when normalization will occur,” he said. When it comes to rate rises, “the timing is data dependent. We will have to see what unfolds,” he said.

And on goes the FOMC, directionless!

PS Could have titled this post as “Random Walks at the FOMC”

Remembering 1937

When the “Great Recession” hit, many comparisons were made with the “Great Depression” (see Eichengreen and O´Rourke Vox columns which according to the editor shattered all Vox readership records with over 450,000 views). Eight years after the 2007 peak, now there are “reminders” of 1937, also eight years after the 1929 peak!

Robert Samuelson has a piece:

How fast should the Federal Reserve tighten monetary policy? Should it tighten at all? I recently wrote about these issues but didn’t have the space to explore a fascinating aspect of the debate: the mostly forgotten 1937-38 recession. To many, it’s a cautionary tale against adopting tighter policies too soon. The latest to sound the alarm is Ray Dalio, the respected founder of Bridgewater Associates, a huge hedge fund group. His recent memo to clients inspired a Page 1 story in the Financial Times, headlined “Dalio warns Fed of 1937-style rate risk.”

And goes on to discuss what may have “caused” that event. The “best” candidate:

A final explanation involves gold. Since 1934, the United States had been receiving large gold inflows — reflecting fears of political instability or war in Europe — that stimulated economic expansion. The reason was simple. When the gold arrived here, it had to be sold to the government for dollars. Those dollars were then spent or lent, giving the economy a boost. But in late 1936, the Treasury — again, to quash incipient inflation — decided to offset this boost by draining money from the economy. In economic jargon, the gold flows were “sterilized.”

This turned out to be a massive miscalculation. The sterilization created a “pronounced monetary shock,” argues a paper by Dartmouth economist Douglas Irwin. Growth in the money supply, which had been rapid, halted. Stock prices fell, and interest rates rose. After the Treasury reversed its policy on sterilization in 1938, the economy recovered.

A nominal visual of the period following the Depression trough in March 1933:





Footnote: Orphanides has an enlightening article on the Fed during the Great Depression. Following the downturn in 1937 we read:

Though the extent of the sharp decline in activity was not immediately evident, by Fall it became fully clear to the Committee that the economy was thrown back to a severe recession, once again.

The following evaluation of the situation by (John) Williams at the November 1937 meeting is informative, both for offering a frank admission that the FOMC apparently wished for a slowdown to occur and also for outlining the case that the recession, nonetheless, had nothing to do with the monetary tightening that preceded it.

Particularly enlightening is the reasoning offered by Williams as to why a reversal of the earlier tightening action would be ill advised. We all know how it developed. There was a feeling last spring that things were going pretty fast … we had about six months of incipient boom conditions with rapid rise of prices, price and wage spirals and forward buying and you will recall that last spring there were dangers of a run-away situation which would bring the recovery prematurely to a close. We all felt, as a result of that, that some recession was desirable … We have had continued ease of money all through the depression. We have never had a recovery like that. It follows from that that we can’t count upon a policy of monetary ease as a major corrective. …[Doesn´t that sound familiar?]

In response to an inquiry by Mr. Davis as to how the increase in reserve requirements has been in the picture, Mr. Williams stated that it was not the cause but rather the occasion for the change. … It is a coincidence in time. …

If action is taken now it will be rationalized that, in the event of recovery, the action was what was needed and the System was the cause of the downturn. It makes a bad record and confused thinking. I am convinced that the thing is primarily non-monetary and I would like to see it through on that ground. There is no good reason now for a major depression and that being the case there is a good chance of a non-monetary program working out and I would rather not muddy the record with action that might be misinterpreted. (FOMC Meeting, November 29, 1937. Transcript of notes taken on the statement by Mr. Williams.)

Coincidentally, at present there´s also a John Williams at the FOMC!

Crap from “FOMC´ers”

Scott Sumner is his diplomatic self:

Stanley Fischer is one of the world’s most thoughtful monetary economists. And now he is also vice chairman of the Federal Reserve Board. He recently gave a speech on monetary policy, which as you’d expect contained many wise observations. However I was also deeply troubled by some of his comments.

And than proceeds to “trash” him:

However, I was also deeply troubled by some of his comments.

One “troubling” comment:

For over six years, the federal funds rate has, effectively, been zero. However it is widely expected that the rate will lift off before the end of this year, as the normalization of monetary policy gets underway.

The approach of liftoff reflects the significant progress we have made toward our objectives of maximum employment and price stability. The extraordinary monetary policy accommodation that the Federal Reserve has undertaken in response to the crisis has contributed importantly to the economic recovery, though the recovery has taken longer than we expected. The unemployment rate, at 5.5 percent in February, is nearing estimates of its natural rate, and we expect that inflation will gradually rise toward the Fed’s target of 2 percent. Beginning the normalization of policy will be a significant step toward the restoration of the economy’s normal dynamics, allowing monetary policy to respond to shocks without recourse to unconventional tools.

Stanley Fischer has been the Governor of the Bank of Israel, a country that managed to altogether avoid a recession in 2008-09 for the simple reason that, just like Australia, it was following a de facto NGDP level target. But as I have argued here, that was “luck”! Just before stepping down from the BoI Fischer made a speech:

In my work as a central banker, I have made much use of my knowledge of central banking history around the world. Many of the events that are taking place today remind me of events from the past, and knowing the lessons from the past helps us develop policy in the present.

A prominent example of this is that of Ben Bernanke, who learned the lessons and the mistakes in handling the Great Depression of the 1930s during his research, and knew how to deal with the most recent financial crisis differently and more efficiently than how they tried to handle the situation in the 1930s.

We, the central bankers, thought at the outset of the crisis that we were about to experience another great depression like in the 1930s, when the unemployment rate in the US reached 25 percent. I am not here to claim that the current situation is good, but during the current crisis, US unemployment rate hit 10 percent and then began to decline, and I am sure that the situation would have been very different had Bernanke not acted according to the knowledge that he acquired in the course of his research.

Apparently, learning was only partial and selective because he also said:

There are those who support setting a nominal GDP target. I think that this is very impractical. The data that we receive on nominal GDP are very unstable.  There are changes of whole percentage points between the various estimates of GDP. For this reason, I think that there is no reason to use nominal GDP as a target.

Maybe he thinks inflation, output gaps and natural rates are precisely defined and known!

So much for the Fed´s Vice-Chairman monetary policy “abilities”.

Another voting member this year is also “dying” to vote for a rate rise. This is SF Fed president John Williams:

NEW YORK–Federal Reserve Bank of San Francisco President John Williams reiterated on Monday his belief that central bankers should consider raising rates some time this summer.

Things are looking better–in fact, they’re looking downright good,” the official said in a speech to be delivered to an audience in Sydney and Melbourne via video.

Given how much the economy has improved and is likely to continue to gain ground, “I think that by mid-year it will be the time to have a discussion about starting to raise rates,” Mr. Williams said.

The strength of the U.S. dollar against a “broad index” of currencies is not an impediment to the U.S. economy reaching real GDP growth of 2.5% this year, he said .

“The U.S. economy has good momentum…even with what is a rather large appreciation of the U.S. dollar,” Mr. Williams said.

Fischer wants to raise rates to “restore(!) the economy´s normal dynamics”. Williams thinks things are looking “downright good”! So much crap with a straight face. Only FOMCers can do that and get away with it!

The charts illustrate what “significant progress”, “extraordinary monetary accommodation” “economy looking downright good” and “gradual climb of inflation to 2%” looks like.

FOMC Crap_1

FOMC Crap_2

Now, think for a moment while contemplating the charts above and the next one. If the Fed managed to keep NGDP growing at such a stable (3.95%) rate for the past five years, after the economy “lifted-off” from the depths of the “Great Recession”, don´t you think it would also be capable (if it wanted) to:

1. Give nominal spending an initial boost (6%-7%) for it to regain “height” and

2. Then “levelled ” it off at a 5% growth rate (or 4% if you prefer)?

FOMC Crap_3

Ask yourselves:

1. Would inflation be closer to target?

2. Would RGDP growth be closer to 3+%?

3. Would employment be so “structurally” constrained?

San Francisco Fed John Williams is sanguine

Mr. Williams was quite upbeat about the U.S. economic outlook in an interview with Fox News Channel, echoing remarks made to The Wall Street Journal Thursday.

Citing broad-based employment gains in both low- and high-wage sectors, Mr. Williams said he believes the U.S. unemployment rate, currently at 5.7%, will fall to 5% by the end of this year. That’s a level consistent with full employment, which Fed officials see as the lowest rate of joblessness that doesn’t generate undue inflation.

“We’re seeing lots of positive developments,” Mr. Williams said. “There are lots of signs of a good consumer spending trajectory.”

Asked about U.S. inflation, which has been undershooting the Fed’s 2% target for nearly three years, Mr. Williams was also sanguine. He said the recent hit to consumer prices had been primarily driven by plunging energy costs, adding he expects inflation to stabilize and return to the central bank’s 2% goal over the next couple of years.

Let´s parse him:

The data does not show 5% unemployment as the lowest rate of joblessness that doesn´t generate undue inflation (unless by “undue” he means any positive rate of inflation)

Parsing Williams_1

Where does he see the “good consumer spending trajectory”?

Parsing Williams_2

Inflation has been falling ever since the 2% target became official, irrespective of oil prices remaining high or, more recently, falling!

Parsing Williams_3

Medium and long-term inflations expectations have remained below target throughout and are now plunging!

Parsing Williams_4

Maybe Williams is looking at things upside-down!


When Modigliani and Papademos “invented” NAIRU (NIRU at the time) in a BPEA paper in 1975, their clear aim was to downplay “monetarism” and argue for monetary expansion expansion based on the fact that NAIRU/NIRU was above its “non accelerating rate”:

At this point the analysis confronts a widely held concern, encouraged by at least some monetarists, that such a rapid rate of growth and sudden acceleration of the money supply , would unfavorably influence prices and inevitably set off a new round of inflation.

Our analysis indicates that such concerns are unfounded; it implies that inflation systematically accelerates only when unemployment falls below NIRU, and the M1 growth that we expect will be needed as a component of a policy package aimed at approaching NIRU from above over the next two years.

In economics, it´s interesting to observe how some things, especially those that require “estimation”, become “gospel” and, despite their suspicious origins, never go away, being endlessly “reestimated”.

No surprise, then, that forty years later, Robert Gordon wrote “The Phillips Curve is Alive and Well: Inflation and the NAIRU During the Slow Recovery”:

The triangle model shows that the puzzle of missing deflation is in fact no puzzle. It can estimate coefficients up to 1996 and then in a 16-year-long dynamic simulation, with no information on the actual values of lagged inflation, predict the 2013:Q1 value of inflation to within 0.50 of a percentage point. The slope of the PC relationship between inflation and unemployment does not decline by half or more, as in the recent literature, but instead is stable. The model’s simulation success is furthered here by recognizing the greater impact on inflation of short-run unemployment (spells of 26 weeks or less) than of long-run unemployment. The implied NAIRU for the total unemployment rate has risen since 2007 from 4.8 to 6.5 percent, raising new challenges for the Fed’s ability to carry out its dual mandate.

Maybe John Williams is a fervent adept!