Inflation, Stanley Fischer And Dybbuks

A Benjamin Cole post

Some Fed watchers took heart when Stanley Fischer, smart guy and former Israeli central bank chieftain, took the No. 2 slot at the U.S. Federal Reserve in 2014.  After all, Fischer had guided Israel through the 2008 global tight-money debacle, by using his central bank to counteract the worst effects of the worldwide slowdown. Fischer printed shekels, and it worked.

But the Fed has dybbuks (spirits), which have taken over Fischer. Some call it the Fedborg.

“Given the apparent stability of inflation expectations, there is good reason to believe that inflation will move higher as the forces holding down inflation dissipate further,” Fischer just yesterday told the ongoing Fed confab in Jackson Hole.

Really? What stability is that?

The “Stability”

BC on Fischer_1

Another chart (both swiped from Tim Duy, btw):

BC on Fischer_2

There in fact seems to be a stable trend on the two charts—downwards, that is.

Of course, I can remember when the markets anticipated double-digit inflation, and homebuyers took out 18% mortgages in the United States. So what makes inflation expectations stable?

If the Fed would raise rates now, when would it not raise rates?

In 2008?

A Strange Time

We live in strange times, when a hysterical squeamish prissiness about microscopic rates of inflation passes for monetary policy.

Remember the much-loved “Inflation Fighter” President Ronald Reagan? Or the towering iron-willed price-stablizer and central banker Paul Volcker?

In Reagan’s last full year in office, 1988, the CPI was rising at 4.4%. Inflation then accelerated to 4.6% the next year.

President Obama and Fed Chief Janet Yellen (and Fischer) make Reagan and Volcker look about as tight with money as wastrel winos headed to the corner liquor store.

I will leave it to pathological sociologists to explain the current phobia about inflation (as dubiously measured, no less). It is certainly not about macroeconomics.

I just wish we could get back to 1980s and 1990s, when the U.S. had robust growth and moderate inflation. Seems like a long, long time ago now.

Jackson Hole

Tomorrow, Fed Vice-Chair Stanley Fischer will speak on Global Inflation Dynamics. At the opening dinner last night he told reporters:

The Federal Reserve’s No. 2 official said Friday the central bank hasn’t settled on whether to raise interest rates next month, and the option remains on the table.

“I think it’s early to tell” what will happen at the Fed meeting, Federal Reserve Vice Chairman Stanley Fischer told CNBC, citing the market turbulence of the past weeks.

Until recently, “there was a pretty strong case” to raise the Fed’s benchmark short-term interest rate from near zero at the central bank’s policy meeting Sept. 16-17, Mr. Fischer said. “It was not a conclusion yet; it was a case.”

But recent events—worries over China’s growth outlook, its currency devaluation and volatile global markets—suggest Fed officials need to step back and mull incoming data before deciding what action to take, he said.

“The change in circumstances which began with the Chinese devaluation are still relatively new, and we are still watching how it unfolds. So I wouldn’t want to go ahead and decide right now what the case is, compelling or less compelling” for rate rises.

It seems markets have concluded that the “case is less compelling”!

Rate Hike

Stanley Fischer “forgets 1978”

That´s the year Fischer and Dornbusch (and Robert Gordon, independently) introduced by way of macroeconomics textbooks what recently Bob Gordon called 1978 Era Macro. In a nutshell, they put forth the dynamic AS/AD model to study macro fluctuations.

In the first edition of their book D&F have a careful analysis of the effects of supply shocks, and their implication for monetary policy.

Now things have turned upside-down. The supply shock is positive. But that shouldn´t change the analysis. Fischer, like others at the FOMC is nervous about the time span policy has been “accommodative”. So he appeals to the “temporary nature of very low inflation”:

U.S. inflation is only temporarily “very low” due in part to commodity prices, while the U.S. economy has nearly achieved full employment, Federal Reserve Vice Chairman Stanley Fischer said on Monday.

A large part of the current inflation is temporary. It has to do with the decline in the price of oil; it has to do with the decline in the price of raw materials,” he said on Bloomberg TV.

“These are things which will stabilize at some point,” Fischer added, in comments that were careful not to tip his hand on when he thinks U.S. interest rates should rise.

“We are in a situation with … nearly full employment but very low inflation.”

Rates will not stay this low “forever, and we need to be looking ahead as we go,” said Fischer, a close ally of Fed Chair Janet Yellen. Employment has been “rising pretty fast yet inflation is pretty low.”

He said the Fed “would be happier if we saw more physical investment than financial investment” given the monetary accommodation.

Globally, Fischer said the deflationary trend “bothers” the Fed, but is one of many factors the U.S. central bank is watching.

Sounds very much like the utterances of a neophyte policymaker or one that only learned to deal with “too high inflation”! In the case of “too low inflation”, it appears he thinks the economy will naturally take care of it, while ‘we´ll only come in to stop it going overboard!’

And how will he know that the “time has come to step in”? To him (and others) the signaling mechanism is the “nearly full employment and fast rising employment”.

Given that his book with Dornbush has a whole chapter (10) on “The Kennedy and Johnson Years: The New Economics and the Emergence of Inflation”, he should know that monetary policy should not be geared to, let alone guided by unemployment!

The charts indicate that (a) “too low inflation has not been a temporary fact”, even abstaining from oil and commodities; (b) that inflation and unemployment have no close links and (c) it seems that NGDP growth, pretty much under Fed control, is a much better indicator of the stance of monetary policy and the behavior of inflation. Inflation is “too low” despite “fast rising employment” because NGDP growth is “too low”. (Also, the level of NGDP is lower than the “ideal”).

Stan Fischer forgets 1978


New “con game” in town: Naming dots!

Here’s How Quickly Yellen Wants to Raise Interest Rates, According to a Former Fed Policy Maker:

In what’s become known as the “dot plot,” Fed officials earlier this month showed the public their best estimates for where the central bank’s policy rate will be over the next few years. It’s valuable information for investors who are desperate to know how quickly borrowing costs will rise in the U.S. What makes things tricky is that these dots are anonymous, and no one’s views matter more than the chair’s.

Enter Meyer, who was a Fed governor from  1996 to 2002 and is now senior managing director at Macroeconomic Advisers. He’s taken a stab at guessing which dots belong to whom (scroll down for the chart). He estimates that Yellen in June foresaw a single rate hike this year. That would make her dot one of five at 0.375 percent, which is below the median of her fellow Federal Open Market Committee participants.

Meyer also expects her to change her view by September, by which point he expects to see an economy on stabler footing.

Con Game

In Does the Fed finally realize forward guidance is folly? Caroline Baum thinks this is a waste of time:

In the last two weeks, three Federal Reserve officials have said or implied that the first rate increase could take place in September. The reaction? The September federal funds futures FFU5, +0.01%   set a new contract high of 99.83, an implied yield of 0.17%.

Just imagine what Fed officials must be thinking…

Fed Chairman Janet Yellen: “What part of September don’t they understand? In the old days, the Fed said almost nothing, or leaked it to The Wall Street Journal. Fed watchers had to deduce our stance from open-market operations. Yet traders were quick to tell their underlings: Don’t fight the Fed. Now we basically tell everyone what we are going to do and when, and the response is: So what?”

Fed Vice Chairman Stanley Fischer: “Perhaps it’s because we keep moving the goal posts. Sometimes we use a date for guidance. Other times it’s a threshold. Once our thresholds are breached, we have to hide behind a mish-mash of indefinite words, such as “considerable time” or “patient.” What exactly does that mean?”

Yellen: I think it’s very clear what we mean.

Fischer: Yes, it’s clear that we don’t know when we are going to raise rates, by how much and at what intervals. That’s what is clear. How could we be expected to know that given the nature of a rapidly changing global economy? As I said before I joined the Fed, and refrained from public comments to that effect since: ‘You can’t expect the Fed to spell out what it’s going to do. Why? Because it doesn’t know.’”

And concludes:

If policy makers want to understand why markets are ignoring the likelihood of an imminent increase in interest rates, look to the ever-changing nature of the guidance. Say what you mean, mean what you say, and realize that some things are best left unsaid.

Pearls of unsound wisdom

If Stanley Fischer is a representative agent for Central Bankers thinking, God help us!

From his speech “What have we learned from the crises of the last 20 years?”:

Monetary policy in normal times.6 In normal times, monetary policy should continue to be targeted at inflation and at output or employment.7 Typically, central bank laws also include some mention of financial stability as a responsibility of the central bank.

Another issue that remains to be settled is that of the possible use of monetary policy, i.e. the interest rate, to deal with financial stability.

Active fiscal policy.8 There is a great deal of evidence that fiscal policy works well, almost everywhere, perhaps especially well when the interest rate is at its effective lower bound.

We should not make the mistake of believing that we have put an end to financial crises. We can strengthen the financial system, and reduce the frequency and the severity of financial crises. But we lack the capacity of imagining, anticipating and preventing all future financial sector problems and crises. That given, we need to build a financial system that is strong enough to withstand the type of financial crisis we continue to battle. We can take some comfort–but not much–from the fact that this crisis was handled much better than the financial crisis of the Great Depression. But it still imposed massive costs on the people of the United States and those of other countries that were badly hit by the crisis.

Confidence in the financial system and the growth of the economy has been profoundly shaken. There is a lively discussion going on at present as to whether we have entered a period of secular stagnation as Larry Summers argues, or whether we are seeing a more frequent phenomenon–that recessions accompanied by financial crises are typically deep and long, as Carmen Reinhart and Ken Rogoff’s research implies. Ken Rogoff calls this a “debt supercycle”.

One reason we should worry about future crises is that successful reforms can breed complacency about risks. To the extent that the new regulatory and supervisory framework succeeds in making the financial system more stable, participants in the system will begin to believe that the world is more stable, that we suffered a once in a century crisis, and that the problems that led to it have been solved. And that will cause them to take more risks, to exercise less caution, and eventually, to forget the seriousness of the problems we are confronting today and will confront in the future.

This is a process that will one day lead to an unhappy result. You, the regulated, and we, the regulators, will have to work very hard, for a very long time, and then keep on working hard, to reduce the frequency and magnitude of those future crises.

In other words, given that the major lesson for central banks – don´t let NGDP become unhinged – wasn´t even considered, my take is: “we´re screwed”!

What´s constraining monetary policy?

“Zero” rates

For more than six years monetary policy has been “unconventional”; meaning that interest rates have not been available to do the work.

Over the ages, monetary policy has become synonymous with interest rate policy. If, for example, the interest rate goes down/is low/or even zero, monetary policy is deemed easy/expansionary/accommodative, and vice-versa.

The tight association of monetary policy with movements and levels of interest rates is not only stupid but has for long been discredited by many, including such high profile “outsiders” as Ben Bernanke and Frederick Mishkin.

Why does this misconception endure?

One possibility is that it has become ingrained. More recently, textbooks, which tend to lag “practice”, have elevated the interest rate to the category of “the” monetary policy instrument. An ironic example is given by Mishkin´s Macroeconomic Theory and Practice textbook.

Although laughable, it is not surprising to read this comment from Fed Vice-Chair Stanley Fischer:

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.

Translation: Lift rates now so you can lower them when the need arises!


The fact that inflation has remained well below “target”, for most of the last six years is bothersome to the Fed, because it “constrains” their desire to quickly become “conventional”.

Yellen tries to get around the “inflation constraint” saying:

…that inflation is currently depressed by the fall in oil prices and other one-time factors the Fed regards as “transitory.” As a result, she said that she might favor raising rates ahead of any indications that prices excluding the energy market started picking up significantly. Otherwise, she said, the Fed would risk significantly overshooting its inflation target.

Note the subtlety. Inflation has not been depressed for more than six years, only currently, and that´s transitory; and if we delay raising rates we risk significantly overshooting the target. The fact that the target has been undershot for six years is conveniently “erased”!

If they only recognized that the target has been missed from below for most of the time during the past six years, they would have to conclude that monetary policy has not been easy or highly accommodative, as they like to say, but in fact unduly tight.

That would bother them no end!