The “Guessing Game” Goes On

Caroline Baum had a nice piece yesterday: “The Fed’s baffling fascination with unreliable information”:

The idea of relying on expectations as a means to an end always seemed more viable in theory than in practice. So I was glad to find some support for my reservations from the economics community: specifically, a blog post by William Dupor, an economist at the Federal Reserve Bank of St. Louis, on the subject of inflation expectations.

Titled “Consumer Surveys, Inflation Expectations and the FOMC,” Dupor notes that “survey-based measures of inflation expectations” are mentioned in each of the statements released at the conclusion of the last 12 meetings of the Federal Open Market Committee. (My search revealed a reference to “survey-based measures of inflation expectations” in both FOMC statements and minutes dating back to January 2014.)

Perhaps it’s a coincidence, but market-based measures of inflation expectations set a near-term peak in January 2014 and have been declining ever since, much to the Fed’s consternation.

I always viewed the inclusion of survey measures as a case of confirmation bias: It gave policy makers the answer they wanted to hear. It allowed them to dismiss the sharp decline in market-based measures of inflation expectations, derived from the spread between nominal and inflation-indexed Treasuries, as a distortion due to liquidity preferences. Based on survey measures, they could take comfort that monetary policy was on the right track.

Now, the Fed clings to the labor market. This Bloomberg piece is telling:

An overlooked line in Federal Reserve Chair Janet Yellen’s speech last week could hold the key to whether Friday’s U.S. jobs report clinches an interest-rate increase this month.

While the focus was on Yellen’s statement that the case for an interest-rate increase “has strengthened in recent months,” she followed with new language that the central bank’s decisions depend on the degree that data “continues to confirm” the outlook. That, and other recent remarks by Fed officials, suggest that job gains need to be merely solid — rather than extraordinary — to warrant raising borrowing costs for the first time in 2016.

If what you want is “comfort”, go lie in the sun, but don´t pin your hopes on irrelevant information.

If ‘push comes to shove’ tomorrow, sell stocks, buy dollars and, maybe with a short delay, buy 10-year bonds

Blissful Ignorance

Janet Yellen:

And, as ever, the economic outlook is uncertain, and so monetary policy is not on a preset course. Our ability to predict how the federal funds rate will evolve over time is quite limited because monetary policy will need to respond to whatever disturbances may buffet the economy. In addition, the level of short-term interest rates consistent with the dual mandate varies over time in response to shifts in underlying economic conditions that are often evident only in hindsight.

For these reasons, the range of reasonably likely outcomes for the federal funds rate is quite wide–a point illustrated by figure 1 in your handout. The line in the center is the median path for the federal funds rate based on the FOMC’s Summary of Economic Projections in June.1 The shaded region, which is based on the historical accuracy of private and government forecasters, shows a 70 percent probability that the federal funds rate will be between 0 and 3-1/4 percent at the end of next year and between 0 and 4-1/2 percent at the end of 2018.2

The reason for the wide range is that the economy is frequently buffeted by shocks and thus rarely evolves as predicted. When shocks occur and the economic outlook changes, monetary policy needs to adjust. What we do know, however, is that we want a policy toolkit that will allow us to respond to a wide range of possible conditions.

The range of reasonably likely outcomes for the FF rate is so wide it´s useless.

Blissful Ignorance

One property NGDP targeting (in fact NGDP LEVEL Targeting) is that it is the appropriate framework for “all seasons”, i.e. you don´t need to keep tinkering with monetary policy. In addition to keeping the central bank from mishandling supply shocks, it keeps the central bank from generating demand shocks, which throws both inflation and real growth in the same direction, up as during the “Great Inflation” and down as in the “Great Recession”.

Yellen: “We will keep plodding”

In her opening remarks at Jackson Hole:

…my primary message today is that I expect monetary policy will continue to play a vital part in promoting a stable and healthy economy. New policy tools, which helped the Federal Reserve respond to the financial crisis and Great Recession, are likely to remain useful in dealing with future downturns. Additional tools may be needed and will be the subject of research and debate. But even if average interest rates remain lower than in the past, I believe that monetary policy will, under most conditions, be able to respond effectively.

Unfortunately, that is not happening. As illustrated in the charts, monetary policy has been overly tight, with a brief respite.


Why they don´t perceive this and make a real effort to overhaul the monetary policy framework is beyond comprehension!

The Fed wants to tighten but can’t; the ECB wants to loosen but can’t. Currency stalemate

A James Alexander post

What is more important the short, medium or long term? The recent gyrations of the EUR/USD exchange rate have grabbed a lot of attention since the start of the year.

In theory the strong easing bias of the ECB versus the confusing position of the Fed should mean the EUR weakens versus the USD. Or should it? That currency story based on the stance of the respective central banks is surely “in the price” already.

The new information that could shift the EUR/USD is more debate about what more the ECB thinks it can do within its mandate of inflation ceiling mandate of  “close to, but below 2%”. The Fed has been tightening for many months, first passively and then actively. The debate is now, what will it do next?

Actually, we now have more uncertainty about the relative stance of monetary policy in the two biggest (freely-floating) currency blocs than for a long while.

Over the last four months it looks as if there has been a major strengthening of the EUR vs the USD judged by the short term currency chart. The sharpest movement within this time frame was the dramatic reaction to William Dudley’s dovish speech on February 2nd in the midst of the market’s first quarter swoon. It was the first major recognition by the Fed that perhaps things had changed since the December rate hike.

We commented on it at the time as a remarkable ride to the rescue by the market’s chief representative on the FOMC. The NY Federal Reserve was thus doing its time-honoured job of forcefully presenting the actual state of things to the often out-of-touch board staff and regional governors. It absolutely goosed the FX markets, and with other follow-ups over the next two weeks turned around what was fast becoming a nasty situation in the markets.

On February 11-12, a couple of things happened. There was Jamie Dimon’s massive confidence-boosting purchase of his bank, JP Morgan’s, shares; there was the apparently panic-driven calls from Yellen to the heads of the Bank of England and the ECB. And just 5 days later, the icing on the cake when the swing voter on the FOMC, Bullard, swung.

JA USD-Euro1

The subsequent strengthening of the USD versus the EUR, as the wider markets also recovered, has now been offset by a weakening again. Draghi has done his best to show the ECB is still very much in easing mode, via increasing the size, scope and duration of its QE programme. Rates have gone even more negative. But still the markets want more and were disappointed by some comments during the March press conference that maybe rates could not go more negative.

Draghi’s problem remains that the ECB’s mandated inflation ceiling adds such a heavy tightening bias onto the easing bias of the practical measures. The German lobby on the ECB is also known to be powerful, so the dynamic of the ECB Council is very different to that of the FOMC where the Chair is far more powerful and there are little or no regional or political influences. Sometimes Market Monetarists wish there were more political influences on the Fed, especially when they go all obsessive about microscopic inflation or on “normalization” wanderings and simply ignore the overriding goal to support prosperity.

The medium term

A lot of the last four months in the life of the USD, especially versus the EUR, has been mere noise. The currency move from late 2014 and during the first half of 2015 when the Fed began to seriously contemplate tightening is still the standout feature. The EUR weakened substantially during this period and it has not reversed. The Fed was determined to tighten and the ECB to loosen. By mid-2015 these new biases were very much in the price of the EUR/USD.

Nothing much has changed since mid-2015, although both central banks have had to work hard at keeping markets convinced that they mean business: the Fed by actually tightening and raising rates, the ECB by increasing QE and moving to negative rates.

JA USD-Euro2

The Fed’s tightening bias, seen by various regional governors immediately starting up the tightening talk anytime the markets stabilise, means the USD will likely strengthen again. The strength won’t last as US NGDP growth is too weak to take the tightening. Some Market Monetarists like Scott Sumner and David Beckworth might charitably call this sort of thing an improved Fed reaction function. It looks more like ignorance flavoured with panic to me. Whatever. The result will most likely be sideways drift.

And on the other side, the ECB looks boxed in by its complete inability to focus on nominal growth over inflation. It´s often repeated fixation on the ceiling is just horribly counterproductive. Until it sees the problem, or until some sort of economic slowdown hits Germany, things seem unlikely to improve very much. The result will be drift in the Euro Area too.

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.

Timothy Lee points Yellen the way

The next recession could be around the corner, and the Fed isn’t ready for it:

Around the world, markets are in chaos. Japan’s stock market plunged 5 percent on Friday, while markets in France, Germany, and the UK all saw big losses on Thursday. The US stock market is doing better than most, but it is also down since the start of the year. Oil hit a new low on Thursday of $26 per barrel.

These declines reflect growing concerns that the world economy is headed for another recession. Before 2007 we’d say “if things get bad, the Fed will cut interest rates.” But with the Fed’s benchmark rate below 0.5 percent already, a substantial cut would mean rates that are below zero. That’s an unorthodox strategy, and it might not even be legal, according to testimony by Fed Chair Janet Yellen before congressional committees this week.

The Fed needs a new strategy: Stop targeting interest rates and instead target the growth of the overall economy. Moving away from interest rate targeting would give markets confidence that the Fed has the tools to deal with the next economic downturn, which would reduce the danger of another 2008-style meltdown.

Unfortunately, there’s little sign that the Fed is laying the groundwork for a shift in strategy. Instead, Yellen seemed to be in denial about the magnitude of the challenge she is facing.

“Let’s remember that the labor market is continuing to perform well,” Yellen said to the Senate Banking Committee on Thursday. “We want to be careful not to jump to a conclusion about what is in store for the economy.”

Maybe not — but the Fed needs to be prepared for the worst.


So even if the Fed adopted negative rates, it wouldn’t improve the effectiveness of the current interest rate targeting regime very much. Just as the Fed got stuck at zero percent interest rates in 2008, it could get stuck at -1 percent interest rates in 2017 or 2018. So the Fed is going to need a new framework that’s less dependent on interest rates regardless. It might as well get started.

The chart illustrates that:

  1. Don´t lose the “target trend”
  2. If you do, try to get the economy back on it as soon as possible
  3. If you demure, it will become harder and harder to do it. You´ll have to be satisfied with an increasingly partial recovery!

Tim Lee

Naturally, if you wait too long, the present trend level will become the “new normal”!

Circular reasoning or, reasoning from a price change, pervades Yellen´s testimony to Congress

Lately, Yellen has been sounding as “robotic” as Marco Rubio:

Financial conditions in the United States have recently become less supportive of growth, with declines in broad measures of equity prices, higher borrowing rates for riskier borrowers, and a further appreciation of the dollar. These developments, if they prove persistent, could weigh on the outlook for economic activity and the labor market, although declines in longer-term interest rates and oil prices provide some offset.

Of course, economic growth could also exceed our projections for a number of reasons, including the possibility that low oil prices will boost U.S. economic growth more than we expect.

To a large extent, the low average pace of inflation last year can be traced to the earlier steep declines in oil prices and in the prices of other imported goods. And, given the recent further declines in the prices of oil and other commodities, as well as the further appreciation of the dollar, the Committee expects inflation to remain low in the near term. However, once oil and import prices stop falling, the downward pressure on domestic inflation from those sources should wane, and as the labor market strengthens further, inflation is expected to rise gradually to 2 percent over the medium term.

Yellen confirms the “gradual normalization” framework of monetary policy:

The decision in December to raise the federal funds rate reflected the Committee’s assessment that, even after a modest reduction in policy accommodation, economic activity would continue to expand at a moderate pace and labor market indicators would continue to strengthen. Although inflation was running below the Committee’s longer-run objective, the FOMC judged that much of the softness in inflation was attributable to transitory factors that are likely to abate over time, and that diminishing slack in labor and product markets would help move inflation toward 2 percent. In addition, the Committee recognized that it takes time for monetary policy actions to affect economic conditions. If the FOMC delayed the start of policy normalization for too long, it might have to tighten policy relatively abruptly in the future to keep the economy from overheating and inflation from significantly overshooting its objective. Such an abrupt tightening could increase the risk of pushing the economy into recession.

In the accompanying Monetary Policy Report presented to the Congress we read a beautiful example of circular reasoning:

Policy divergence between the U.S., where the economic recovery is strong enough to warrant a gradual tightening of monetary policy, and Europe and Japan, where downside risks are prompting central banks to boost stimulus, have pushed up the dollar. That appreciation is damping U.S. exports and thereby economic growth, and also contributing to stabilization abroad.

All else being equal, a smaller contribution to the U.S. economy from the external sector likely points to a more gradual pace of policy normalization in the United States. By the same token, the economic stimulus from more-depreciated currencies abroad may allow foreign central banks to provide less monetary accommodation — or to start removing it earlier — than would otherwise be the case.

Not for a moment does Yellen consider that it may be the tightening of Fed policy, as gleaned from the downward trend in NGDP growth which began in mid-2014, that is responsible for the price effects she alludes to!

Yellen in Congress_1

Yellen in Congress_2

The Fed is more like the ECB 2011 than Fed 1937

A James Alexander post

Ja-net Yel-len, Ja-net Yel-len, are you Tri-chet in dis-guise?

At football matches in England there is always a particularly hurtful chant that goes up around the ground when a team, a player or a referee is doing badly. They are very often compared to some team or referee or player whom everyone knows is far worse. It is sung to the tune of a famous hymn, like many football songs, “Guide me, O thou great redeemer”. Janet Yellen’s record so far as Chairman of the Fed reminds of this chant, and particularly Jean-Claude Trichet’s penultimate year (mis)guiding the ECB.

13th July 2011 should go down as a day of infamy in the Euro Area. It was date of the second rate rise by the ECB that year, that tanked markets and led more or less directly to a dramatic liquidity squeeze for Euro Area banks, and caused the plunge into the second part of the Area’s double dip recession.


We all now know that Euro Area troubles started in 2008 when the world was plunged into the Great Recession by pro-cyclical monetary tightening by various central banks, just as NGDP growth expectations were falling rapidly at the time of the Lehman default. A lot of other stuff was going on, for sure, but it was noise compared to the core monetary story.

The US and Europe had already spent two hard years escaping from the consequences of the 2008 tightening. Then, in an attempt to out-macho the US and impress the selfish German establishment, the ECB under Trichet decided to stamp on headline inflation hitting nearly 3% in early 2011, while core remained solidly below 2%. The ECB therefore directly smashed the early stages of recovery with a heavy tightening bias and two rate rises. The different paths of the two big currency blocs has been very well documented here with a good summary here.

Trichet and those two ECB 2011 rate rises

The first of the rate rises that year on 3th April 2011 did not cause undue damage. 1Q11 Euro Area NGDP had almost hit the dizzying 3.9% YoY. Within the Area German NGDP was at 6.4% YoY that quarter. This was too strong for Germany and so they pressed for a tightening and Trichet was only too happy to oblige, forgetting about the rest of the Euro Area, especially the periphery. In that quarter Spain and Portugal were already enduring marginally negative NGDP growth. Yes, they were in outright deflation but had their monetary policy tightened substantially – it seems really crazy the more you think about it. Greece had very negative NGDP YoY at -9%.

Never mind, the selfish, almost anti-European, old DM/German bloc anti-growth bias had to be appeased. Actually, it was even worse, Trichet was actually rather fanatical in thinking he was doing the right thing for the Euro Area as a whole. It was his final goodbye press conference that made me rethink my priors. He was forced to defend what havoc he’d caused by trying to claim credit for giving the Euro Area a lower inflation rate than Germany had experienced prior to the Euro – and hang the consequences of a double dip recession. It was all deeply personal and subjective. Central bankers can do no wrong and certainly cannot take criticism.

Well, the rest is history. The Euro Area slowed during 2Q11, as you’d expect from such a tightening of monetary policy. Although the Euro Area stock markets merely drifted, NGDP growth fell to 2.9%. The stock market drift may have lulled Trichet and his ECB into a false sense of confidence.

As expectations for NGDP growth dropped further, they made their second fateful move. Stocks tanked within days, the banking crisis re-erupted, engulfing the French bank SocGen in particular. NGDP fell to 2.4% during 3Q and carried out on down. It was too late, the damage had been done and the cycle was hard to turn.

Market response to April 2011 ECB rate similar to December 2015 Fed rise

We often see articles and blogs wondering whether the US rate rise in late 2015 will end up forcing the country to re-live the great 1937 stumble in the recovery from the Great Depression when monetary policy was tightened too early. The Euro Area from 2011 seems far more apt, and fresh in our memories. A slow recovery, with a few hot spots, was stamped on by two rate rises amidst a severe tightening bias. Rates ended up falling, of course. The first rate rise was seen by the markets as almost manageable, or rather it was met with a degree of sang froid. The second seemed mad given where NGDP expectations had tumbled.

The December 2015 rate rise seemed to be met with a similar sang froid, after all it had been expected for months. Some, particularly market Monetarists, had warned of the dangers of the monetary tightening and thought actual and expected NGDP growth too weak to cope. The market sang froid was probably mistaken by the Fed as an acceptance that its full-blown “normalisation” programme could proceed as they planned. Vice-Chairman Stanley Fischer’s now notorious 6th January interview on CNBC, especially his articulation that four more rate rises this year was “in the ballpark”.

Economic news has been poor since then, reflecting the impact of the 2015 monetary tightening, and now expectations are falling. The question remains: Is Janet Yellen Jean-Claude Trichet in disguise? Will she take some market tranquillity as a justification for a second rate rise? Maybe. Just how much does she fear inflation rising to the Fed’s forecast of 2%, how stubborn will she be in pursuing her “normalisation” programme come what may?

“You don’t know what you’re doing”

When the team, referee or player continue to invite really bad comparisons the football fans often switch to an even more hurtful chant, “you don’t know what you’re doing, you don’t know what you’re doing”. It is sung to the tune of “Que sera, sera” (whatever will be, will be). Fatalistic, but apt.

Give the Fed a new compass. We´re going in the wrong direction

According to the news:

Friday’s employment report clears the way for the Federal Reserve to raise short-term interest rates by a quarter-percentage point at its Dec. 15-16 policy meeting, ending seven years of near-zero interest rates.

The Fed can reasonably well control nominal spending (NGDP) growth. Stable NGDP growth at the appropriate level well defines what good monetary policy is supposed to look like.

If that´s true, when NGDP growth falters, things like employment growth will register the “punch”, just as it will “blossom” when monetary policy pulls NGDP growth up. Stable NGDP growth goes hand-in-hand with stable employment growth (only thing is if NGDP level falls short, so will the level of employment)

Examples from the mid-1990s and early 2000s show the Greenspan years. For the last ten years, we have been under Bernanke and Yellen. The pictures are illustrative. (The montlhy NGDP numbers come from Macroeconomic Advisers)

Throughout the period, inflation was not a problem. By the mid-1990s, it had reached the “low and stable” target of the time. Ironically, after the numerical 2% target was set in January 2012, inflation has languished, but is still “low and stable”!

Employ Report 11-15_1

Employ Report 11-15_2

But if you zoom in on the past 15 months, things seem “fishy”. For all the Fed´s “communication”, the truth is that they have been tightening policy. NGDP growth is coming down which was shortly followed by decreasing employment growth. Won´t even mention inflation.

Employ Report 11-15_3

To wrap up, where´s the much touted wage growth-inflation nexus so cherished by some at the FOMC?

Employ Report 11-15_4

Great harm might be on the way!

PS If you don´t believe me about the “beauty” of stable nominal spending, believe George Selgin:

a central bank that allows the overall volume of spending to collapse has blown it, no matter how much emergency lending it undertakes.  Indeed, to the extent that a central bank engages in emergency lending while failing to preserve aggregate spending, it may be guilty of compounding the damage attributable to the collapse of spending itself with that attributable to a misallocation of scarce resources in favor of irresponsibly-managed firms.

Haruhiko Kuroda Again The Globe’s Best Central Banker. FOMC Look Like Fops

A Benjamin Cole post

In Japan, the inflation rate is about 1.2% by the Bank of Japan’s alternative index, and the unemployment rate is a scant 3.1%. The stock market is up 15.1% in the last year. Capital spending by Japanese companies in Q3 was up 11.2% year-over-year.

Haruhiko Kuroda is the Governor of the Bank of Japan, and the world’s best central banker. Kuroda could wring his hands about “long and variable lags,” and curtail the Bank of Japan’s quantitative easing program, now running about $50 billion a month in an economy half the size of the United States economy. BTW, the Bank of Japan pays 0.10% interest on excess reserves.

Instead Kuroda shows steel and resolve. Read this from Nov. 30, Reuters: “Bank of Japan’s governor has dismissed calls from critics to go slow on hitting the central bank’s 2% inflation target and stressed the need to take ‘whatever steps necessary’ to achieve its ambitious consumer price goal.”

Kuroda told an audience of Toyota auto execs and others, “In order to overcome deflation—in other words, break the deadlock—somebody has to show an unwavering resolve and change the situation. When price developments are at stake, the BOJ must be the first to move.”

Contrast the stalwart Kuroda with the feeble, dithering, inflation-cowering of Chairman Janet Yellen and Vice Chairman Stanley Fischer of the U.S. Federal Reserve Board.

But first consider: The U.S. unemployment rate is 5.0%, much higher than Japan’s 3.1% rate. The core U.S. PCE inflation rate is 1.3%, about the same as Japan’s, and below target. The S&P 500 is about back to where it was a year ago, not up 15.1% like the Japan’s stock market. U.S. capital spending is weak, while Japan capital spending is strong.

While the mediocre U.S. economy compares unfavorably to Japan’s on many levels, the Fed is actually and presently tightening monetary policy. Think about it: Where Japan does $50 billion monthly in QE, the Fed is shrinking its balance sheet, or reverse QE. Where the Bank of Japan pays 0.10% IOER, the Fed pays 0.25%. And the Fed, after endless fretting, appears ready to raise rates at their Dec. 16 meeting.

So we have the U.S. central bank conducting reverse QE, raising interest rates, and paying banks not to lend through IOER. All this while the PCE price index is below target and falling, and real growth is sluggish.

Please Mr. Kuroda, come to America. We need you at our central bank.