Squint, and the picture will look better

Back in Jackson Hole:

HILSENRATH: Dennis Lockhart, president of the Federal Reserve Bank of Atlanta. We’re here in Jackson Hole, talking about the economy. So give us your read: How is the U.S. economy doing right now?

LOCKHART:I think the U.S. economy is expanding at a modest pace. The second quarter (gross domestic product) number—which was 1.1 (percent annual rate of growth), just revised slightly yesterday—I think overstates the slowdown or a slowdown. We have been looking through that number to an account in the GDP accounts called real final sales, which is GDP less inventory.

And what we see there is a better picture and a more consistent picture over the last few quarters. So I think the economy is chugging along, and I’m not one who is interpreting the headline GDP number as somehow suggesting that we have slowed from what was already a slow expansion.

The picture over the past two years strongly contradicts Lockhart: The economy has been slowing for the past two years.


That´s not surprising because all those measures of aggregate nominal activity give out the same information over long periods.


PS I remember that a couple of years ago, some were favoring GDI. At the time GDI was higher than the other measures…But then again:

ABSTRACT  The two official measures of U.S. economic output, gross domestic product (GDP) and gross domestic income (GDI), have shown markedly different business cycle fluctuations over the past 25 years, with GDI showing a more pronounced cycle than GDP. This paper reports a broad range of results that indicate that GDI better reflects the business cycle fluctuations in true output growth. Results on revisions to the estimates, and correlations with numerous other cyclically sensitive variables, are particularly favorable to GDI. The most recent GDI data show the 2007–09 downturn to have been considerably worse than is reflected in GDP.

Contractions & Expansions with Asset (Stocks) Prices Included

The expansion just registered its 7th birthday, but:

Even seven years after the recession ended, the current stretch of economic gains has yielded less growth than much shorter business cycles.

And this chart from Fox News shows how “undeveloped” the child really is.

Contractions & Expansions_1

The set of charts below provide a view of contractions and expansions (and stock prices) since the start of the 1960s (I ignore the 1980-81 cycle). The scales are the same for all contractions and for all expansions to make comparison easier.

Some contractions are short and shallow, some are longer and deeper, but none was as long and as deep as the 2007-09 contraction. That one was also unique in that NGDP growth turned negative. Observe that until that point, the recession was nothing to call home about, but then we experienced the consequence of the greatest monetary policy error of the post war period.

The 1960-61 contraction was mild and stock prices remained flat but picked up before the trough. The ensuing expansion was long and robust. Notice, however that half way through, stock prices flattened. The reason is that inflation began an upward trend, following the faster rise in NGDP.

In the 1969-70 contraction, RGDP stayed put, but stock prices fell significantly. Inflation had become entrenched. The expansion phase was short, with the strong increase in NGDP guaranteeing that inflation kept rising, keeping a lid on stock prices.

Contractions & Expansions_2

The 1973-75 contraction is the prototype supply shock recession. NGDP growth grew robustly, fanning inflation, but restraining the fall in real output. Stock prices plunge. The expansion that followed was characterized by high NGDP (inflation) growth with real output and stock prices subdued.

The 1981-82 contraction is the prototype demand shock recession. NGDP growth (and inflation) was brought down forcefully. Although real output fell by more than in 1973-75, stock prices dropped by much less and picked up before the trough.  The expansion was long and robust.  The 1987 stock crash did not affect real output growth.

Contractions & Expansions_3

The 1990-91 contraction was short and shallow. Inflation was brought down to the 2% level. Stock prices were not much affected. This was followed by the longest expansion in US history. The consolidation of nominal stability that began in in previous expansion is behind the exuberance of stock prices.

In the 2001 contraction, real output didn´t fall at all. The drop in stock prices reflects the Enron et all balance sheet shenanigans. While in the expansion phase the behavior of real output and NGDP were similar to the previous expansion, stock prices were lackluster. The expansion was cut short, giving rise to the Great Recession.

Contractions & Expansions_4

The 2007-09 contraction was a different animal altogether, with things becoming much worse when NGDP tumbled. The strength of the expansion has been held back by a tight monetary policy, where NGDP, after falling substantially in the contraction phase, is growing at a much smaller rate than during the previous two expansions. Since the 2009 trough, stocks prices have shown a robust recovery, but that has petered out since mid-2014, when the Fed began the rate hike talk.

Contractions & Expansions_5

Time heals!

Time Heals_0

The Fed´s mantra: “The effects of lower oil prices and higher exchange rate will dissipate and inflation will converge to target”.


“There is some evidence that the deep recession had a long-lasting effect in depressing investment, research and development spending, and the start-up of new firms, and that these factors have, in turn, lowered productivity growth. With time, I expect this effect to ease in a stronger economy.”

Question: How will the economy become stronger if the Fed wants it kept weak?

How? By keeping NGDP depressed!

Time Heals

For the motivation, see “We´re almost there”.

“Playing the fiddle while Rome Burns”


As James Alexander wrote in the previous post, according to the London Times:

The Bank of England has cut its growth forecasts and signalled that interest rates may rise earlier than expected.

Higher savings levels as families grapple with their debts and weaker productivity than the Bank was projecting three months ago weighed on the outlook for the economy, also hitting jobs.

However, the Bank said inflation would overshoot its 2 per cent target within two years, putting an early interest rate rise on the table.

The MPC must be “MWI” (that´s “meeting while intoxicated”) because the story told by the following pictures is a very sad one!

After more than 15 years of great nominal stability (only more recent period shown), the BoE, like the majority of central banks, thought that nominal spending (NGDP) had to be “jerked down”.


For the past two years it has been trying to “jerk-it-down” even more.


No wonder real output growth “acknowledges” the “jerking-down”


And what about inflation? After a spell at zero it is just positive, but the “farsighted jerks” think that in two years’ time it will likely be “2.1%” and so “we have to act shortly”!


Déjà Vu, and one of the World´s Great Coincidences

We´ve had, in 2016, a continuation of the ‘guessing game’ about when (the month) the FOMC will once again raise rates.

The year started off with Vice Chair Stanley Fischer ‘promising’ four rate hikes during the year. Subsequently, with incoming less than stellar data, that number has been reduced to 3, 2-3 and more recently ‘just’ 2.

As soon as the weaker than expected labor data was released on Friday, ‘bets’ for a June rate hike fell steeply.

Actually, the unemployment rate, which stood pat at 5%, was the result of two offsetting negatives: the small drop in the Population/Employment ratio, which all else equal would increase the unemployment rate, was just offset by the also small fall in the Labor Force Participation rate (LFPR), which all else equal would cause a decrease in the unemployment rate.

Interestingly, regarding the LFPR, we often hear that “a large portion of the decline in the LFPR in this cycle is due to demographics”.

The coincidence of the ‘demographic factor’ with the first large drop in nominal spending (aggregate demand or NGDP) since 1937 must surely be one of the world’s great coincidences!

Great Coincidence

In effect, reducing monetary policy to a ‘guessing game’ about the timing of the next rate hike just shows the ‘poverty’ of present day macro and monetary analysis. No wonder a “Great Stagnation” is the “winning paradigm”!

The Fed creates the “Ugly Duckling”

Ugly Duckling_1

Tim Worstall writes:

The reason this time is different is because, well, this time is different.

Let´s be more precise. The reason this “time is different” is because monetary policy has acted very differently, compressing spending growth thus, turning the 2007 cycle into the “Ugly Duckling”!

Ugly Duckling_2

PS BTW, The Atlanta Fed GDPNow nailed it. The average of it´s 13 successive Q1 RGDP forecasts (annualized) was 0.58%!


Sizing up how the average American voter feels about the economy for a room packed with Ph.D. economists is a tough job.

Charles Cook, editor and publisher of The Cook Political Report, took a shot Tuesday at the National Association for Business Economics policy conference in Washington.

“The recession ended, what five years ago?” he said. A murmur of “seven” rose from the crowd. (The recession ended in June 2009.) Mr. Cook continued with his point: “And you talk to most Americans and they think we’re still in recession.”

That´s because a depressed economy feels much like an economy in an unending recession!





A “strong” employment report in a “weak” economy?

The headline numbers for February: 242 thousand jobs and 4.9% unemployment rate.

Let´s give these numbers some “structure”. The unemployment rate is the result of two forces that reflect economic decisions by individuals and firms. The first is the employment population ratio (EPOP). The second the labor force participation ratio (LFPR). The unemployment rate is equal to 1-(EPOP/LFPR).

The charts show the behavior of unemployment together with its two determinants over the three most recent cycles. The first two (1990, 2001) happened during the “Great Moderation”, while the third (2007) takes place during the “Depressed Great Moderation”.

Employ Report 02-16_1

The green bars denote recessions (as determined by the NBER). The yellow bars denote periods of falling unemployment.

A “healthy” fall in unemployment occurs simultaneously alongside a “strong” rise in EPOP and a “moderate” rise or stable LFPR.

In the present cycle, the fall in unemployment reflects a stable and then “moderate” rise in EPOP and a falling LFPR. It´s another “animal” altogether!

Many say that this reflects mostly structural/demographic changes, like baby-boomers’ retirement. The coincidence in time of the structural/demographic factors with the onset of the “Great Recession” that witnessed the largest drop in nominal spending (NGDP) since 1937 is “too much to swallow”. More likely strong cyclical factors were responsible for bringing forward in time decisions that otherwise would have taken place over the next several years. In this sense the problem is mostly “cyclical”.

Although the economy is still adding jobs at a rate that could be called “healthy”, the relatively low quit rate (which tends to rise when employment opportunities are “bountiful”), the relatively high duration measures of unemployment (indication that opportunities are not “bountiful”) and the relatively weak (if you take into consideration the depth of the employment drop) job growth, indicate that the labor market is some distance away from having fully recovered. In other words, like the economy, it´s still weak!

More evidence on the “special” nature of the present (2007-) cycle.

We start with the chart for NGDP (peak to peak over the cycles)

Employ Report 02-16_2

The 1990 and 2001 cycles are, except for length, identical. The present cycle suffers from lack of spending.

That´s mirrored in the behavior of RGDP

Employ Report 02-16_3

Now, when you look at the behavior of employment, the 2001 cycle shows a “surprising” result. From the behavior of NGDP and RGDP one would expect it to also mirror what happened in the 1990 cycle.

Employ Report 02-16_4

But when you look at the behavior of productivity, the employment difference becomes understandable. The 2001 cycle was “productivity rich”.

Employ Report 02-16_5

The present cycle, on the other hand is both “employment poor” and “productivity poor”. In addition, it is also “price & wage poor”

Maybe it´s not farfetched to associate much of the overall “poorness” of the present cycle to the sorry state of nominal spending, i.e. aggregate demand!

Well done Janet, well done Stanley (irony alert!)

A James Alexander post

Where are the John Maynard Keynes’ and Milton Friedman’s when you need them? The Fed, led by Janet Yellen and Stanley Fischer, has made a huge mistake in tightening monetary policy. The other members of the FOMC are largely irrelevant noise, with the possible exception of the NY Fed’s Dudley, though all carry blame. During 2015 at first they passively tightened by merely threatening to do so, causing US economic growth to slow, and then in December actively doing so, redoubling the negative impact on US economic growth. A recession is not out of the question thanks to this highly irresponsible action.

The Fed should be the most hated and ridiculed financial institution in the world at the moment but there is barely a whimper of criticism. It will come, just not yet. The market’s current swoon shows how it is building. What must not happen is the swoon becoming the cause of the downturn when the culprit is the Fed, front and centre, for tightening too early.

A near wall of silence, except (mostly) for Market Monetarists

Tightening too soon was always a huge risk, one we have highlighted here time  and time again.

Most of the Fed’s central banker peers seemed to think the Fed was doing the right thing, or at least kept quiet. Most of the economics profession seemed to do the same apart from a few exceptions, most of whom we read but no-one could say are widely read. Some, like Paul Krugman or Danny Blanchflower, are just too one-sidedly partisan to be respected across the political spectrum. Most are just not that well known.

Economists in the commercial world, working for banks and companies, or industry lobby groups, also seemed to keep their heads down. Financial journalists were fairly silent too. There were a few murmurings in the blog-sphere and on Twitter but nothing very loud. Many actually agreed with the tightening, partly explaining the initial market welcome to the raise once it became clear in late October that it would happen by year end. The honeymoon hasn’t lasted long.

Why are Nominal GDP growth expectations so important (again)?

As Market Monetarists we think monetary policy should be guided by expectations of NGDP Growth. Expectations drive activity, economic and personal. Always have, always will. It is probably a truism. If consumers or investors expect bad outcomes they will spend or invest less. What is a bad outcome? Lower expected incomes or returns ahead.

For consumers, the most brutal and feared income loss is caused by loss of work, everything else (economically-speaking) pales in comparison. Idiosyncratic or individual loss of work happens all the time of course, it is part of life. But the widespread loss of work only occurs in a recession. Recessions are rightly feared and should be avoided. Or if they happen that they are speedily remedied.

Mass job-reducing recessions occur when business revenues are expected to fall faster than costs. Because nominal wages are hardly ever flexible downwards jobs must be cut to save costs. The US is the most extreme example of this type of reaction as its labour laws are amongst the most flexible. This flexibility, in the long run, is a key reason why the US economy is so much stronger and the country wealthier than any other large developed nation. Highly organised European welfare-oriented countries like Germany can sometimes reduce wages via social cooperation, at least temporarily, and that can help mitigate the impact of recessions. The UK is somewhere between the two.

Other less organised European countries like Italy or Greece cannot be “more like Germany” as the Germans and other highly homogenous northern European nations constantly dream, or only with massive political turmoil. Others like France or Spain make attempts to act like Germany but usually just end up in two-speed economies:

  • protected workers made up of “insiders” in state jobs (in the civil service or universities or health care) or state-related company jobs in quasi-monopolies (like utilities or telecoms), who see nominal incomes and jobs mostly cushioned against economic turmoil;
  • unprotected “outsiders” in the flexible private sector who see pay slashed and unemployment spike very high.

Younger workers are particularly vulnerable as the insider jobs growth is reduced to zero or slightly negative and outsider jobs growth goes very negative. State and state-company pensions can then become highly political footballs too, especially when not pre-funded, as are hardly any.

To avoid all this horrendous nominal adjustment, society has evolved a relatively painless way to adjust costs to weaker revenues. Macro-economists christened it “money illusion”. They did not invent it, but merely discovered it. Steady nominal growth of real growth plus (perhaps) 3% inflation gives enough room for less severe job cuts in recessions, as nominal wage increases can be limited allowing real wage cuts without people feeling too bad, i.e. far better than losing their jobs. This gentle let down allows real costs to be brought into line with weaker nominal revenues. Money illusion acts like a pain-killer, for a sick person. It is a palliative allowing the patient to get better. Using either none, or too much, is a bad thing, of course.

Why has the Fed got it so wrong? Capture by obsessive inflation hawks

Unfortunately, government monetary policy often gets captured by arch conservative types who think that any inflation (or use of pain-killers) is bad. Partly these conservatives are reacting to spendthrift, profligate governments who find it hard to raise enough taxes to cover their spending, and so resort to printing money instead, causing excessive inflation (over-use of pain-killers). Undoubtedly this latter problem occurs a lot, but so does the first problem, too. And this near zero-tolerance of inflation, or rather no more than near 2%, is where we are now. It seems to be a small difference, but real growth of 2-3% and inflation of 2-3% is a healthy 4-6% nominal growth allowing crucial economic flexibility. As real growth approached 0% and inflation is not allowed above 2%, nominal growth hits an inflexible 2%, denying economies crucial (real) wiggle room.

In almost all modern societies the control of the money supply has become a responsibility of governments. As usual, this takeover does not guarantee success, it is merely a “theory” (aka “a hope”) that it will work better than voluntary or market arrangements. These days the theory of market failure, sponsored by socialists and government-backed economists, remains far more developed than the theory of government-failure or public choice economics. Market monetarists believe markets do better at forecasting future nominal growth than central banks.

When private banks controlled the money supply they do appear to have allowed modest inflation, reacting to increases in demand for money with more money. When government-controlled central banks have been too tight with money supply, private initiatives have kicked in to offset them, but only in extreme conditions http://www.alt-m.org/2015/04/28/what-you-should-know-about-free-banking-history/ .

If we have to have government control of money use markets to do it better

A happy middle path of steady nominal growth for money is the most important contribution macroeconomics has made to the world, but one that is often forgotten. Steady market-expected growth in Nominal Gross National Product (or Expenditure or Income – it’s all the same thing) gives economies a fighting chance of offsetting the worst impacts of recessions. NGDP Expectations Targeting now!

Germany vs the Euro 18

A James Alexander post

Almost alone among economic commentators we do actually look at Nominal GDP data as it is released. Full Euro Area NGDP data for third quarter 2015 was released this week alongside the 2nd estimate of Real GDP.

We have already posted here and here on the good news as three of the “big 4” Euro Area countries, making up 75% of the Euro Area economy, had seen accelerating NGDP. The not so good news is that the little countries saw less acceleration; in fact, it looks as though they saw slower growth. It is a bit hard to be exactly precise as the Irish GDP data, both nominal and real does not appear to conform to Eurostat norms. Ireland appears to have been growing NGDP at between 5% and 10% for a couple of years now.



The result is that Euro Area NGDP, according to the first estimate for this figure, is still picking up but 3Q in total showed growth flattening. It is still below the average growth rate for the last twenty years, a period including the last disastrous seven years. RGDP is growing marginally above this trend.



The question of trends is important. If we took the trend from 1996 to 2007 then the current Euro Area NGDP and RGDP growth rates looks awful. What should be unquestionable is the dangers of too low NGDP growth, the only unanimous conclusion of fifty years of macroeconomics. Low or negative NGDP growth causes unemployment and welfare loss – as we are seeing now occurring in Switzerland and have seen in many monetary areas since 2007.

What is too low NGDP growth? Perhaps around 2% given long-run productivity growth of over 2%. Economies work best when they have decent flexibility to allow relatively declining economic sectors the ability to decline gently via declining real returns. And economies work very poorly when there is there is an ever-present threat of negative NGDP growth. It is very hard to see what is wrong with at least a 4% NGDP level target. Prosperity must be a more important goal than inflation.

Have we spotted the reason for stiffening German opposition to more QE?

Another way of understanding the dynamics of the Euro Area and its monetary policy is to look at the performance of Germany, 29% of total GDP, and the most nationalistic and selfish country within the Area when it comes to monetary policy. We have seen time and again that what Germany considers right for itself it considers right for the entire Area. Maybe they are right not to care as they are now nearly 30% of the total. But here we see the essence of the current problem: narrow and often wrong-headed national interest. The Centre for European Reform has proposed an interesting reform of ECB governance to deal with just this issue via a removal of national central bank influence on the board.



German NGDP is growing above trend again, as is its RGDP. Twice Germany was growing so fast it authorised and encouraged the “inflation-nutter” Trichet to his satisfy his mania and crash the Euro Area economy. There are clear signs the Germans are ratcheting up this pressure again.

Fortunately, Draghi is no inflation-nutter. However, he is still trapping himself with the insanely restrictive “close to, but below, 2%” non-flexible inflation target or ceiling. One that only huge amounts of QE can even partially offset.

The natural, normal, “good Europeans”, thing for Germany to do would be to enjoy faster nominal growth than other Euro member states and gradually see itself become less competitive and gradually fall back to relatively less strong growth for a while. Surely, this relative decline would be more in Germany’s longer-run self-interest, rather than crashing the Euro Area economy as a whole again, and probably growing more slowly than it would have done otherwise.