Is “zero” an unavoidable magnet or sign of Central Bank incompetence?

Matt O´Brien has a wonderful post – The Federal Reserve is trying to do what nobody else has been able to do – which opens with this picture:

Zero Attractor

And writes:

But wait, why is raising rates from zero so difficult? It seems like you should just be able to … raise them from zero. Well, there are two problems with that. The first is that an economy that needs zero interest rates is probably an economy that needs even more than zero interest rates. It probably needs negative interest rates, like the U.S. did, but can’t get them since central banks can’t cut rates that far without lenders hoarding money rather than paying people to borrow it. Now, it’s true that central banks can make up for at least some of that by buying bonds with newly-printed money, but they don’t like to do that. The result is that economies with zero interest rates don’t get as much monetary stimulus as they need, so they don’t grow as much as they could. And since rates follow growth, that means there isn’t as much pressure for rates to rise once they do fall to zero.

The next sentence says everything about their incompetence:

The second reason lifting off is hard to do is that central bankers want to do it too much. They just don’t like zero interest rates. Central bankers, after all, are supposed to be the ones taking away the punch bowl just as the party gets going, not plying recovering alcoholics with bottomless booze. Or at least that’s what they tell themselves.

To top it off, today the alternative measure of inflation, the CPI, declined 0.1% in August over July. The core version showed an increase of 0.1%!

The Fed just doesn´t get that its incompetence is contributing to the fall in oil (and commodity) prices!

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

Ben´s blogging has generated more heat than light so far

So far the former and wannabe Fed Chairmen crossed swords over the irrelevant and misguided concepts of GSG & SS. (I´ve given those things some thought here and here).

With big dogs growling at each other, Krugman simply could not help butting in (really to show he had been there before). And for very obvious reasons he ends up giving each a “bone”:

There’s been a really interesting back and forth between Ben Bernanke and Larry Summers over secular stagnation. I agree with most of what both have to say. But there’s a substantive difference in views, in which Bernanke correctly, I’d argue, criticizes Summers for insufficient attention to international capital flows – but then argues that once you do allow for international capital movement it obviates many of the secular stagnation concerns, which I believe is wrong.

As it happens, the role of capital flows in the logic of liquidity traps is an issue I tackled right at the beginning, back in 1998; and I’ve been trying to work out how it plays into the discussion of secular stagnation, which is basically the claim that countries can face very persistent, quasi-permanent liquidity traps. So I think I may have something useful to add here.

Start with Bernanke’s critique of Summers. The most persuasive evidence that the US may face secular stagnation comes from the lackluster recovery of 2001-2007. We experienced the mother of all housing bubbles, fueled by a huge, unsustainable rise in household debt – yet all we got was a fairly unimpressive expansion by historical standards, and little if any inflationary overheating. This would seem to point to fundamental weakness in private demand. But one reason for the sluggish growth in demand for U.S.-produced goods and services was a huge trade deficit, the counterpart of huge reserve accumulation in China and other emerging markets. So Bernanke argues that what Summers sees as evidence of secular stagnation actually reflects the global savings glut.

The 2001-2007 recovery is not evidence, let alone persuasive, of secular stagnation. Krugman is on the right track when he says this “would seem to point to fundamental weakness in private demand.” But at the last minute he veers off in the wrong direction by making the fundamental mistake of “reasoning from a (GDP) component change” (a close cousin of “reasoning from a price change”).

A huge trade deficit somewhere is always the counterpart of a huge reserve accumulation elsewhere. The important reasoning is to discover why this came about when it did and if it might be related to other stuff (such as the US housing boom). For an explanation, read here (below the fold).

If “movements in GDP components” had not distracted Krugman he would probably have found out that the post 2001 recession recovery was slow up to mid-2003, being due to the tightness of monetary policy, despite fast falling interest rates.

When the Fed made monetary policy more expansionary in mid-2003 by adopting forward guidance (FG), despite interest rates remaining put, the recovery took off, with nominal spending rising back to trend. Interestingly, many see this strong growth in nominal spending as reflecting a “loose/easy” monetary policy. Grave mistake. Faster NGDP growth was necessary to take nominal spending to trend. Monetary policy was “just right”!

At that point, unemployment begins to fall and core inflation rise towards the “target” level.

Bernanke had the bad luck to take over almost concomitantly with the peak in house prices. Initially house prices fell only a little, increasing the speed of fall after financial troubles erupted in some important mortgage finance companies.

Unfortunately, the Fed was exceedingly focused on headline inflation, fearful of the oil price rise. Interest rates remained elevated, only being reduced after August 2007, when three funds from Bank Paribas folded. However, the pace of interest rate reduction was deemed too slow by the market. In the December 11 2007 FOMC Meeting, for example, the markets were negatively surprised by the paltry 25 basis points reduction in the FF rate. On that day the S&P fell 2.5% and the 10 year TB yield dropped 17 basis points.

Rate reductions stopped in April 2008 (only resuming in October, after Lehman!). In the June 2008 FOMC, it came out that the next move in rates was likely up!

With all this monetary tightening, nominal spending decelerated and then fell at an increasing rate. One casualty was Lehman! The rest is history!

Give me a break and let´s stop talking “Gluts” and “Stagnations”. Bernanke would do much better if he starts shinning some light and blog about how monetary policy could really have been much better! Will he be daring?

The charts illustrate the story

Gluts & Stagnations_1

Gluts & Stagnations_2

Gluts & Stagnations_3

 

Matt O´Brien thinks it´s the opposite in “Larry Summers and Ben Bernanke are having the most important blog fight ever