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.

  1. 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.”


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 … 

  1. 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?] …

  1. 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] …

  1. 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!

Lael, a “courier pigeon”?

Last month, John Williams wrote an “out-of-the-mainstream” letter. He was quickly reined in and three days later “toed the line”.

Now, we are told that Lael Brainard will give a speech in Chicago on September 12:

One of the most influential Fed doves has announced that she will speak on Monday, Sept 12 on the US economy in Chicago at noon local time (1 pm ET).

The location is the Chicago Council on Global Affairs and they say she will discuss “the economic outlook for the United States and monetary policy implications” and will be in conversation with Michael Moskow, who was CEO of the Chicago Fed.

Maybe it’s been in the works for a while, maybe she’s been dispatched to reel in hike expectations for September 21. Either way, that’s going to be a critical speech.

The fact that she´s regarded as an “influential dove” increases the “likelyhood” of a September hike if she so indicates. It will certainly be interesting to read.

The data is Fed-dependent

A James Alexander post

The Federal Reserve and other central banks like to see themselves as “data-dependent”. They sit in objective judgement of the facts of the economy as revealed by “data” and then portentously decide whether to attempt to alter the future facts with monetary tightening or loosening.

And then when the new “facts” begin to roll in, the data somehow becomes independent of the prior central bank actions. Or rather the data is seen as independent if it doesn’t go the way the central bank wants.

If the data goes the way the central bank wants then the self-same central bank usually is all too quick to claim the credit. Well, they can’t have it both ways: avoiding the blame for missing targets and only taking credit for meeting them.

It sometimes seems as if in their own eyes the Fed can do no wrong, or at least not admit it until decades later. Central banks are duty bound to maintain an absolute confidence in the efficacy of their actions, regardless of the facts.

For Market Monetarists the current run of weak nominal data in the US is not somehow independent of prior Fed actions but a consequence. The Fed is the creator of the nominal data given its power over money, one side of all transactions. For a given level of productivity, if the Fed wants a higher price level then it creates more money to achieve that, if it wants a lower price level it destroys money to achieve that goal. If it wants a steady growth in the price level then it should achieve a steady growth in money.

The nominal data is thus Fed-dependent rather than the Fed being data-dependent.

Because productivity can never really be known with much degree of accuracy, more so these days than ever due to the size of the service sector, targeting the price level is a hopeless course of action. It is far better to just target a nominal growth path and let economic historians puzzle out what part of that growth is due to productivity and what part to changes in the price level. Or politicians.

We were very pleased to see that the notion that data is dependent on the Fed recognised by Lael Brainard, one of the new’ish permanent governors of the Federal Reserve Board, in a recent speech:

Thus, while the easing in financial conditions since mid-February is very welcome, it is important to recognize that some of the conditions underlying recent bouts of turmoil largely remain in place, and an important reason for the fading of this turbulence was the expectation of more gradual U.S. monetary policy tightening. Should an event trigger renewed fears about global growth or a reassessment of the policy reaction function in the United States, turbulence could well return.

Unfortunately, this heresy about the Fed’s role in causing the data was not followed up in the rest of the speech. Although recognising, dovishly, that the economy was weak and growth seemed very low, she did the usual thing of blaming everything but the Fed in allowing growth to weaken. Weak productivity growth took a big share of the blame:

From 1953 to 2003, potential output growth varied between 3 and 4-1/2 percent, with one brief exception, according to the Congressional Budget Office. Over the recovery, it has averaged only 1-1/4 percent. One contributor to this decline has been a reduction in the labor force participation rate due to population aging. Another has been a marked slowing in productivity growth. Over the six years from the end of 2009 to the end of 2015, productivity grew only a little over 1/2 percent per year, compared with average growth of 2-1/4 percent over the 50 years prior to the Great Recession.

The reasons for such a dramatic slowing in productivity growth are not clear. Possible explanations include the fading of a one-time boost to productivity from information technology in the late 1990s and early 2000s; the reduced movement of resources from the least productive to the most productive firms, including new businesses, perhaps due to greater financial constraints for new and small businesses; and a delay between the introduction of new technologies, such as robotics, genetic sequencing, and artificial intelligence, and their effect on new production processes and products.

But if productivity growth really is as weak as Brainard claimed then the Fed has a duty to stimulate  more to keep nominal growth on track. I suspect that if productivity really is as weak as reported this may be more due to weak nominal growth, rather than vice versa. Correlation is not causation. In particular, faster nominal wage growth, back up to 5% or so, gives many more incentives for labor-saving improvements in technology and techniques than if labor remains cheap.

Oh well, Rome wasn’t built in one day, and Brainard has to try and build a new consensus inside the Fed rather than becoming isolated and eventually calling it a day as seen with other sensible members in the recent past like Mishkin and Kocherlakota.

FOMC splits, and it is a good thing!

A James Alexander post

It had already been argued here last month that the FOMC looked like it was splitting judged by the January 2016 Minutes. We said that this was a good idea given the hopeless leadership from the Yellen/Fischer axis.

It has also been looking like William Dudley, newly reappointed as governor of the NY Fed, has been expressing the market views even more clearly. Letting markets set monetary policy is a good thing, the sum of all views and not just those of a few people sitting on a committee.

Well, it looks like the split has come to pass. The newswires were hot when Brainard gave a clearly dovish speech earlier this month the very same day as uber-hawk Fischer tried to claim that inflation was about to accelerate out of controlfour more hikes .

With hindsight, the particularly old school speech Fischer gave to the NABE looks to have been even more of a retirement speech than it read at the time. His disastrous “four more hikes” interview in early January has damaged his credibility beyond repair, his retirement cannot come too soon.

As we argued in February, especially after looking into Brainard’s biography she is a deeply political figure, very close to the Clintons. If Hilary is to win the election only a fool or an inflation hawk (they are often the same) would think that tightening monetary policy is a good thing. Just to be clear, Market Monetarists are hawks too, whenever nominal growth is persistently above trend.

If we are right and politics has split the FOMC then we are in for a really good spell of dovish monetary policy out of the Fed. Yellen’s comments today show either someone confused, covering up a split or secretly supportive of the splitters – and against the Fedborg and their “normalisation” mania (remember that).

She said nothing much had changed on fundamentals but the FOMC wanted to be more accommodative.

She said that the FOMC had declined to declare where the bias on risk was because some thought them balanced but some thought them to the downside (ie the splitters) – “there is no collective judgement in this statement … we declined to make a collective statement”.

She said that the things pushing up core CPI were volatile – but the normal view is that core excludes volatile items.

Who cares for now. Looser monetary policy in an environment of weakening NGDP growth has to be a good thing.

The splitters need to build on their success by shifting focus to NGDP Growth targets and away from targeting, unmeasurable, inflation.

Implication of Lael Brainard´s conclusions

Much like she did before the last FOMC meeting, Lael Brainard advises caution, concluding:

A variety of evidence suggests that the longer-run neutral rate is lower now than it has been historically, and that the very low shorter-run neutral rate may adjust to it very slowly, due to a combination of weaker foreign demand growth, greater risk sensitivity as a result of the crisis, higher risk premiums for productive investment, and lower growth in potential output.

The lower neutral rate means the normalization of the federal funds rate is likely to follow a more gradual and shallower path than in previous cycles, although the actual path will be determined by economic conditions.

It also implies that the likelihood of the federal funds rate hitting the zero lower bound will be persistently greater than it has been previously, which could make it more difficult to achieve our objectives of full employment and 2 percent inflation. With the nominal neutral interest rate lower than in the past, and with policy options being more limited if conditions deteriorate than if inflationary pressures accelerate, the asymmetry in risk-management considerations counsels a cautious and gradual approach.

If she listened to herself, she would conclude that what needs “normalization” is not the federal funds rate but the level and growth rate of nominal spending (NGDP).

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

None of the “love me, love me not” style of monetary policy from Lael Brainard

Making a speech at the Annual Meeting of the National Association for Business Economics, Lael Brainard starts with a pointed criticism of her “calendar bosses” Yellen and Fischer:

The will-they-or-won’t-they drumbeat has grown louder of late. To remove the suspense, I do not intend to make any calendar-based statements here today. Rather, I would like to give you a sense of the considerations that weigh on both sides of that debate and lay out the case for watching and waiting.

While Yellen is a Phillips Curve worshiper:

Economic theory suggests, and empirical analysis confirms, that such deviations of inflation from trend depend partly on the intensity of resource utilization in the economy–as approximated, for example, by the gap between the actual unemployment rate and its so-called natural rate, or by the shortfall of actual gross domestic product (GDP) from potential output.

Lael Brainard is skeptical:

To be clear, I do not view the improvement in the labor market as a sufficient statistic for judging the outlook for inflation. A variety of econometric estimates would suggest that the classic Phillips curve influence of resource utilization on inflation is, at best, very weak at the moment. The fact that wages have not accelerated is significant, but more so as an indicator that labor market slack is still present and that workers’ bargaining power likely remains weak.

In her “Policy Considerations” she argues:

There is a risk that the intensification of international crosscurrents could weigh more heavily on U.S. demand directly, or that the anticipation of a sharper divergence in U.S. policy could impose restraint through additional tightening of financial conditions. For these reasons, I view the risks to the economic outlook as tilted to the downside. The downside risks make a strong case for continuing to carefully nurture the U.S. recovery–and argue against prematurely taking away the support that has been so critical to its vitality.

Her speech is of a higher quality than the ones we´ve recently had from most FOMC members, but like the others she slips on “reasoning from price changes” when mentioning oil prices and the dollar exchange rate, and also on “reasoning from quantity changes” when spending time on “GDP components contributions”.

She´s partly right when she says:

Over the past 15 months, U.S. monetary policy deliberations have been taking place against a backdrop of progressively gloomier projections of global demand. The International Monetary Fund (IMF) has marked down 2015 emerging market and world growth repeatedly since April 2014.

But misses the fact that the “gloomier projections of global demand” in no small part derive from the tightening of US monetary policy that has taken place over this period, as can be gleaned, for example, from the falling growth rate of US aggregate demand (nominal spending or NGD). After all, the US is a monetary superpower!

Lael Speeks

And it´s not the case that they don´t know the consequences!

Lael Speeks1