Hot potatoes? Encouraging news from Euro land

A James Alexander post

It’s been lonely blogging that the Euro Area economy was not nearly as bad as consensus reckons, even consensus amongst our fellow Market Monetarists. But the data has consistently shown Euro Area NGDP growth doing better, and at least as good as the long-term average.

The long-term avearge is dragged by the twin recessions and growth is still way below trend but it is far from hopeless. The Euro Area PMIs for July out today are quite good in themselves and especially good given they were taken after the Brexit shock and incorporate the impact of the growing Italian bank crisis and the terrorist tragedies in France. The Composite Index may be at 18 month lows but it was expected to be much worse that the still positive 52.9 reading.


Monetary policy is just about as easy as it could be given it is operating with the handbrake firmly on. The ECB balance sheet is roaring up and taking Euro Base Money with it. Draghi has said that he will keep the policy of QE for as long as it takes.

There is constant worrying chatter about the challenges of finding appropriate stuff for the ECB to buy – and this is great news. It is the “Chuck Norris” effect in action as it demonstrates the ECB’s commitment to QE on top of the actual financial asset buying it is undertaking. It will make economic actors begin to believe nominal growth really will accelerate even if the ECB doesn´t take further concrete steps (or “steppes”). The hot potato monster  may be stalking the land again.

German and Spanish NGDP growth rates are a great cause for hope. Draghi must know Italy desperately needs stronger NGDP growth to help solve its bad debt problem as our friend Lars Christensen has shown in a “one graph”  version. If Italy doesn’t get it then the EU may soon suffer another exit.

Releasing the handbrake represented by the foolishly self-defeating 2% inflation ceiling would mean that none of this money growth is actually necessary but, hey-ho, that is the way of the world with inflation ceilings or inflation targets that morph into ceilings.

A “Follow-the-leader” Monetary Policy Game

Lars has a good short post on China:

Yesterday we got the the Q3 numbers and as the graph shows the sharp slowdown in Chinese NGDP, which started in early 2013 continues. A similar trend by the way is visible in Chinese money supply data.

This is of course very clearly shows just how much Chinese monetary conditions have tightened over the past 2 years and this is of course also the main reason for the sell-off global commodity prices and in the Emerging Markets in the same period.

I suppose it has nothing to do with Janet & Friends “wrongful” monetary policy. Maybe I´m wrong.

Follow the leader

For more than one year monetary policy has been tightening, but the Fed thinks it´s highly accommodative!

Lars Christensen has a good post – Yellen is transforming the US economy into her favorite textbook model:

When I listen to Janet Yellen speak it leaves me with the impression of a 1970s style keynesian who strongly believes that inflation is not a monetary phenomena, but rather is a result of a Phillips curve relationship where lower unemployment will cause wage inflation, which in turn will cause price inflation.

And what that model is doing is to tighten monetary policy!

They should know better. In 2003, Bernanke wrote:

The imperfect reliability of money growth as an indicator of monetary policy is unfortunate, because we don’t really have anything satisfactory to replace it. As emphasized by Friedman  . . . nominal interest rates are not good indicators of the stance of policy . . .  The real short-term interest rate . . . is also imperfect . . .  Ultimately, it appears, one can check to see if an economy has a stable monetary background only by looking at macroeconomic indicators such as nominal GDP growth and inflation.

And those indicators of the stance of monetary confirm that the Fed is tightening the screws, with NGDP growth and inflation going down.

Stance of policy_1

A spillover effect of the monetary policy tightening is the appreciation of the dollar and the fall in commodity and oil prices.

Stance of policy_2

But the geniuses at the FOMC reason from a price change and argue that the fall in inflation is a consequence of the fall in oil prices and appreciation of the dollar, and when these effects dissipate, inflation will climb towards the 2% target!

With that caliber of central bankers, no wonder things are a mess.

More than most, Terrorists understand the importance of economic history

Lars e-mailed this news:

Bin Laden´s reading list

Materials Regarding France   (19 items)
  • Call for Submissions to French Culture, Politics, and Society Journal
  • Did France Cause the Great Depression?” by Douglas Irwin, National Bureau of Economic Research
  • Economic and Social Conditions in France during the 18th Century by Henri See (2004)
  • “Economic Survey of France 2009”
  • “France Country Report,” European Network and Information Security Agency (Jan 2010)

As Lars notes: “maybe he realized that the worst form of terrorism is monetary policy failure”

“I’m reluctant to criticize the excellent RBA, but they do need to ease policy a bit.”

That´s one line towards the end of this Scott Sumner post. It reminded me that some months ago I had entertained the idea that the RBA was “cutting it close”:

It would be a pity if this late into the game Australia “crossed the Rubicon” and let NGDP go south of trend!

Unfortunately, it has!

The “Australia story” is interesting from the point of view of Market Monetarists because it emphasizes the crucial role of monetary policy not only in avoiding crashes but also excessive fluctuations.

The focal point is that monetary policy should keep the economy evolving along an NGDP level such that nominal stability results. For some economies (US, Eurozone, Japan) that NGDP level should be the target. In the case of small open economies such as Australia, strongly dependent on commodity exports, it should adopt an Export Price Norm (EPN), which Lars Christensen characterizes as the open economy version of NGDP level targeting.

EPN simply means that the central bank should peg the exchange rate to the price of the commodity. In this case, if the exchange rate moves together with the commodity price, monetary policy is “just right”. If the exchange rate moves by less than commodity prices monetary policy will be “too easy” if commodity prices are rising and “too tight” if commodity prices are falling.

With those considerations in mind, we can chart the history of monetary policy in Australia since the early 2000s. [Historical note: During the Asia crisis of 1997/98, Australia escaped “scot-free” exactly because the EPN was in full play].

The top chart shows the A$/USD exchange rate and commodity prices. For different periods, the nature of monetary policy is characterized by comparing moves in the exchange rate with moves in commodity prices. For example, during 2004-06 monetary policy was “too easy”. While the exchange rate remained “flat”, commodity prices climbed significantly.

The bottom chart shows the corresponding movements in NGDP. For example, in 2004-06, with monetary policy being” too easy”, NGDP began to rise above trend. When monetary policy didn´t tighten (to compensate for the previous easing), NGDP remained above trend.

Australia below trend

During the international crash, when NGDP dropped far below trend in most economies, Australia was able to ease sufficiently to avoid being “penalized”.

Between the second half of 2011 and early 2013, with NGDP above trend, monetary policy tightened. With this, NGDP remained “flat” and converged to trend.

An indication that the RBA is at least conscious of the EPN is gleaned from comments by the RBA Governor in February 2003:

“The inflation outlook, as assessed at present, would afford scope to ease policy further, should that be necessary to support demand [“code” for NGDP],” Governor Glenn Stevens said in a statement today in Sydney after leaving the overnight cash-rate target at 3 percent.

“On the other hand, the exchange rate remains higher than might have been expected, given the observed decline in export prices, and the demand for credit is low, as some households and firms continue to seek lower debt levels,” he said.

Right after those comments, the exchange rate depreciates to “catch-up” with the fall in commodity prices.

Unfortunately, for most of 2014, monetary policy becomes excessively tight again. Australia got infected by with the “financial stability virus”, which previously had “put Sweden to bed”.

In its severest warning yet on house prices, the RBA said surging investor demand for property may cause the market to overheat and invite sudden price falls.

A housing-market crash might undo a lot of the central bank’s efforts supporting a still-fragile economy trying to cope with a downturn in mining investment.

Record-low interest rates were supporting the economy, but policy makers needed to be aware of the risks to future growth accompanying “a large further build-up in asset prices,” the minutes of the bank’s September 2 policy meeting said.

Hopefully, the recent large drop in the exchange rate is indicative that the RBA has learned from the mistakes, and NGDP will be “carried back to trend”.