Greenspan´s last 10 years and Bernanke/Yellen´s first Decade

Greenspan´s first 10 years

No visible difference in the behavior of inflation, which remained closer to “target” during Greenspan´s last decade.

There´s a big difference in the behavior of unemployment, much lower during Greenspan´s tenure.

The defining difference is in the behavior of nominal spending (AD or NGDP) growth, which translates into a significant difference in the growth of real output.

Note than in 2001, when Greenspan allowed NGDP growth to drop below trend, unemployment goes up and stays up until NGDP growth returns to trend. In 2008, unemployment soars when NGDP growth tanks and becomes negative. The yellow bar shows that when NGDP growth stops falling, unemployment “levels off”, beginning to fall when NGDP growth becomes positive once again.

Unfortunately, the Fed this time around chose an inadequate level of spending growth. The result is that the economy got stuck in a “Great Stagnation”, defined by a level of real output and employment well below the previous trend level!

To get out of this trap, the monetary policymakers have to start thinking outside the “interest rate box”! From all the nonsense we hear from them, that is not likely.

Yellen´s unchanging beliefs

The pity is that they are wrong beliefs! From the September 1996 FOMC:

I believe that a very solid case can also be made for raising the federal funds rate at least modestly, by 25 basis points, on the grounds that the unemployment rate has notched down further, the decline in labor market slack is palpable, and the odds of a rise in the inflation rate have increased, whatever the level of the NAIRU and the associated level of those odds. I believe I am echoing Governor Meyer in saying that I favor a policy approach in which, absent clear contra-indications, our policy instrument would be routinely adjusted in response to changing pressures on resources and movements in actual inflation.

She clearly belongs in the “accelerationist” camp recently defined by Justin Wolfers, where the other camp is the “inflation targeters”, to which Bernanke belonged:

What does this mean for the Fed? It’s too simple to characterize the current debate as one between hawks who dislike inflation and doves who are more concerned about unemployment. Rather, the main divide may be between accelerationists worried that rising wage growth signals an economy at full capacity, versus inflation targeters, who argue that weak wage growth signals that unemployment remains too high. And in the next few weeks, we’ll find out who’s winning that argument.

How did things work out in 1996 and what´s the scenery now?

After Yellen´s “solid case” for a modest rate rise in September 1996, wage growth continued to increase, unemployment continued to fall and so did inflation!

After the July 2014 FOMC Meeting, when it became clear that QE3 was about to close (taper would begin in October), unemployment continued to drop, but notice that wage growth and inflation turned “south”.

Yellens Beliefs

Justin Wolfers post is titled “Is the Economy Overheating? Here’s Why It’s So Hard to Say”. I prefer to ask: Is the Economy Overcooling”?

Friedman and Bernanke agree that interest rates are a bad indicator of the stance of monetary policy (which controls the economy´s “temperature”). It is much better, according to Bernanke, to look at what´s happening to NGDP and inflation.

According to those metrics, in 1996 the economy´s “temperature” was about right, with NGDP growth on a stable path. Now, for the past year, NGDP growth has been falling, indicating that the economy´s “temperature” has been dropping!

By clinging to her “Phillips Curve Faith”, the odds that Yellen´s Fed will make a big mistake in the foreseable future are rising!

Why have such a large research staff if their findings are ignored?

Yellen earlier this year:

“We will be looking at wage growth” as a signal of inflation though “I wouldn’t say either that that is a precondition to raising rates.” [Translation: I´ll raise them anyhow!]

Results over two decades for the general theme: Are wages useful in forecasting inflation?



Researchers have extensively studied how wage data might help predict future price inflation. The overall conclusion of the literature is that wages generally provide less valuable insight into future prices than some other indicators. In fact, models that do not incorporate wages often result in superior inflation forecasts.

In 2000:

Concluding Observations

The cost-push view of the inflation process that is implicit in the expectations augmented Phillips curve model assigns a key role to wage growth in determining inflation. In this article, I evaluate this role by investigating empirically both the presence and stability of the feedback between wage growth and inflation during the U.S. postwar period, 1952Q1 to 1999Q2. The results indicate that wage growth does help predict future inflation over the full sample period considered here.

However, this finding is very fragile, and it appears in the full sample because the estimation period includes the subperiod 1966Q1 to 1983Q4 during which inflation steadily accelerated.

Wage growth does not help predict inflation in two other subperiods, 1953Q1 to 1965Q4 and 1984Q1 to 1999Q2, during which inflation remained low to moderate.

In contrast, inflation always helps predict wage growth, a finding that is both quantitatively significant and stable across subperiods. These results thus do not support the view that wage growth has been an independent source of inflation in the U.S. economy.

In 1996:


Many analysts have heralded the slow growth of unit labor costs during recent years as a harbinger of continued low inflation. In this article, we investigate the usefulness of labor costs as a predictor of inflation. Earlier studies have focused on in-sample causality tests. Our in-sample causality tests indicate that, during the pre-1980 period, wage growth did have information content for future core inflation (CPIC) but not overall CPI inflation. During the post- 1980 period, however, this information content has disappeared.

Additionally, we find that the evidence of inflation causing wage growth is quite robust across samples.

In contrast with earlier studies, we also investigate out-of-sample forecasts of inflation using labor costs in an error-correction model. Out-of-sample forecasts offer the ultimate test of whether wages help predict future inflation. For recent years, the out-of-sample forecasting exercises offer no evidence that wage growth contributes to any reduction in forecast errors compared with univariate autoregressive models of inflation. Therefore, when assessing future inflation developments, these results suggest that policymakers and analysts should put little weight on recent wage trends.

“Looking for Wally when there are many Wallies”

That well describes the challenges faced by monetary policymakers according to this piece from Bloomberg Business “Are we tight yet? The Fed´s problem in finding the neutral rate”:

Federal Reserve officials just aren’t sure how much stimulus their zero-interest-rate policy is providing.

At issue is the level of the so-called natural, neutral or equilibrium rate of interest, which is the borrowing cost — adjusted for inflation — that keeps the economy at full employment with stable prices.

Economists from the academic world and even within the central bank are vigorously airing differing views on where the rate lies in the aftermath of the worst recession since the Great Depression. The uncertainty is yet another reason for Fed officials to go slowly as they begin raising interest rates for the first time since 2006.

According to this older piece from Brueguel:

What’s at stake: The natural rate of interest is a key ingredient in the recent discussion of secular stagnation, and more generally in New-Keynesian models of the Great Recession. But the concept is often poorly understood, in part because the term refers to different things for different people.

A couple of examples:

Richard Anderson writes that the Swedish economist Knut Wicksell based his theory on a comparison of the marginal product of capital with the cost of borrowing money. If the money rate of interest was below the natural rate of return on capital, entrepreneurs would borrow at the money rate to purchase capital (equipment and buildings), thereby increasing demand for all types of resources and their prices; the converse would be true if the money rate was greater than the natural rate of return on capital.

Axel Leijonhufvud writes that Erik Lindahl (1939) and Gunnar Myrdal (1939) refined the conceptual apparatus, in particular by introducing the distinction between ex ante plans and ex post realizations and thereby clarifying the relationship between Wicksellian theory and national income analysis.

And there are several others.

In short, the Fed is faced with an “estimation” problem. To make that clear, think of a Taylor-Rule for setting the Fed Fund (FF) rate:

Looking for Wally_1

The circles around the level of “potential output” (y*) and the level of the natural rate (NR) represent the “uncertainty” about their estimated values.

For example, San Francisco Fed senior economist Vasco Cúrdia argued in a paper published earlier this month that the equilibrium rate may have dropped so much that “monetary conditions remain relatively tight despite the near-zero federal funds rate.” He provides a chart which indicates that at present the “natural rate” could be anywhere from -3% to 6%!

Looking for Wally_2

Similar uncertainty surrounds the value of “potential” output.

In essence, facing the “estimation” problem, the situation of monetary policy makers is well captured by this picture!

Looking for Wally_3

An alternative, to try to overcome the “estimation” problem would be for the Fed to try some “experimentation”.

That has happened before. In March 1933, in the depths of the Great Depression, President Roosevelt decided to “innovate” and free the economy from the “gold standard shackles”, delinking from gold. The effect was immediate as illustrated below.

More recently, in the heights of the Great Inflation, Paul Volcker also decided to innovate:

On Oct. 6, 1979, the Federal Open Market Committee—under the leadership of Paul Volcker—made a decision that would come to be known as a key moment in U.S. economic policymaking, a turning point in the history of the Federal Reserve that would forever alter central banking. And those are the understatements.

A defining moment may shape the direction of an institution for decades to come. In the modern history of the Federal Reserve, the action it took on October 6, 1979, stands out as such a milestone and arguably as a turning point in our nation’s economic history.(A Greenspan)

So, what did the FOMC do? It made a short-term change in the method used to conduct monetary policy, from making adjustments in the federal funds rate to containing growth in the monetary aggregates. (Yes, the Fed now targets the funds rate again—the 1979 change was reversed in 1982—but more on that in a minute.) This meant the Fed would focus on controlling the amount of reserves provided to the banking system, which would ultimately limit the supply of money.

By many, that “experiment” was seen as a failure. Nevertheless, judging by the results it worked, in that inflation was permanently brought down.

In what follows I´ll give a “liberal” interpretation of the experimentation, based on NGDP. The interpretation is not so farfetched because the NGDP targeting concept was extensively discussed both by the Volcker Fed in 1982 and by the Greenspan Fed in 1992.

The first charts show how rising core inflation was the outcome of a rising NGDP growth. The follow up shows that by “downsizing” NGDP growth inflation was brought down.

Looking for Wally_4

This was followed by Greenspan´s “consolidation” in 1987-92 and almost “smooth sailing” from then to the end of his mandate in January 2006. These last two periods came to be known as the “Great Moderation”.

Looking for Wally_5

I interpret the “experiment” as trying to find first the level and then the stable growth path for NGDP. As the next chart shows, by 1987 the Fed had “hit” on the NGDP level and from then onwards NGDP growth rate was stabilized, i.e. kept close to the trend path.

Looking for Wally_6

There were “mistakes” along the way, notably in 1998-03, when NGDP first rose above trend and then fell below, but by the end of 2005, NGDP was back on trend.

Looking for Wally_7

Soon after taking the Fed´s helm, Bernanke allowed NGDP to begin once more to fall below trend. This was magnified in 2008, probably because of the Fed´s exclusive focus on headline inflation, which was being propelled by an oil and commodity price shock. In an environment where the financial system was “wounded”, allowing NGDP to crumble is mortal!

Looking for Wally_8

At present we have the opposite situation of the 1970s. Instead of high/rising inflation due to rising NGDP growth, we have low/falling inflation due to low/falling NGDP growth. So this time around it may be fruitful to devise an NGDP based experiment in reverse. Try to establish a higher level of NGDP that when attained is “consolidated” through a stable NGDP growth rate.

This “experimentation” would be much more helpful than spending time on “estimation” of the “natural rate of interest” or the “potential level of output”.

PS In the comments, bill writes:

“I need to go see the correlation between corporate spreads and NGDP growth. I think those spreads have been widening which I take as a good sign that the market expects less than optimal choices by the Fed in the near future.”

The chart shows how the recent fall in NGDP growth has been accompanied by a rise in less than stellar bond spreads over 10yr treasuries:

Looking for Wally_9

The crappiest of ideas

That´s the ‘dot plot’, conceived by the “Transparency Committee” headed by Janet Yellen while a Governor at the Board.

Interestingly it came ‘on line’ for the first time in January 2012 at the same time inflation hit the target. Since then inflation has mostly trended down. It has done so even while oil prices remained high. Naturally, when oil prices tumbled in mid-2014, headline inflation followed suit.

Dot Plot_1

However, by the time the first dot plot was released in January 2012, the Fed was no longer expecting to chart an exit from stimulus soon. The economy had taken a turn for the worse; in fact, additional bond-buying was on the horizon.

Then-Fed Chairman Ben Bernanke consequently downplayed the dots, a tradition that Janet Yellen continued when she assumed leadership of the Fed at the beginning of last year. At times, the chart—with its 17 disparate projections of the future path of policy—can conflict with the unified message the committee is trying to send.

In her first press conference as Fed chair in March 2014, Yellen told reporters “one should not look to the dot plot, so to speak, as the primary way in which the committee wants to or is speaking about policies to the public at large.”

Over the last several quarters, however, the dots have come back down, suiting Yellen’s message that the pace of tightening to follow what would be the Fed’s first rate increase in nearly a decade will be gradual.

So Yellen has turned back to the dots as “Exhibit A” for investors. During her press conference in June of this year, she pointed to it repeatedly when asked about the central bank’s likely course.

Other signs of utter confusion

Dudley in August:

“From my perspective, at this moment, the decision to begin the normalization process at the September FOMC meeting seems less compelling to me than it was a few weeks ago,” Dudley told a news conference Wednesday at the New York Fed.

I really do hope that we can raise interest rates this year, because that would be a sign that the U.S. economic outlook is good and that we’re actually on track to achieve our dual mandate objective,” Dudley said.

Dudley today:

Federal Reserve Bank of New York President William C. Dudley said the central bank will “probably” raise interest rates later this year despite uncertainties over global growth.

Unemployment in the U.S. has fallen to its lowest level in more than seven years, making it harder for the Fed to justify interest rates near zero. Inflation, however, has remained well below the Fed’s target. It was 0.3 percent in the 12 months through August, as measured by the Fed’s preferred gauge of price movements.

Dudley said inflation probably would move back toward the target over time, and that 2 percent was “the right target.”

With the biggest confusion being the view that monetary policy has been accommodative:

“We’ve had so many years of accommodative policy, I think the market is losing faith in the Fed,” said Priya Misra, the head of global interest-rate strategy in New York at TD Securities, one of the 22 primary dealers that trade with the central bank. “You’re not really seeing the impact of policy end up in inflation.”

Which completely misses the logic that “you’re not really seeing the impact of policy end up in inflation” exactly because monetary policy has been anything BUT accommodative!

Looking back, during the Greenspan years monetary policy worked fine. Greenspan was the “anti-transparency”:

 “I know you think you understand what you thought I said but I’m not sure you realize that what you heard is not what I meant”.

Nowadays we feel like it´s more like a take on George Santayana´s:

Having lost sight of our objectives, we redoubled our efforts.”

Forget interest rates as providing the stance of monetary policy, and look instead at NGDP growth and inflation (remembering that the rising dollar and falling commodity and oil prices are consequences or symptoms of monetary tightening).

The Hot Potato Monster

A James Alexander post

Despite some promising progress of late why is that Market Monetarism hasn’t been more widely adopted? Perhaps it’s just patient debate that’s needed. There always seems there´s a psychological step to get over before the penny drops on the idea.

One way of looking at it is via a sort of in-joke of Market Monetarists, the one about people from the “concrete steppes”. When newbies to Market Monetarism first try to get to grips with the theory they almost always have a “concrete steppes” question. It is usually posed along the lines of: “What is the transmission mechanism for monetary policy if it isn’t interest rates or QE? How can central banks really get inflation going? Can you talk me through the concrete steppes?”

The answer turns on the role or power of expectations. Krugman’s desire  for the central bank to be irresponsible, to threaten to print, or to actually print as much new money as will really scare people into actually believing that the central bank is irresponsible. Market Monetarists don’t like this irresponsible notion of a central bank, they merely want it to set the right target and promise or threaten to use all means to meet it. The target itself should be a responsible one, like 5% NGDP (Forecast) Growth. And then the central bank policy will also be responsible.

But what about the mechanism that makes people actually change their behaviour so the central bank can see a change, a move towards its target, when an economy is operating below trend nominal income (NGDP) growth. The core is the well-known “hot potato effect“. People have to believe that the central bank money creation will lead to money being devalued, and so it has to be spent sooner than otherwise as prices of real goods, services and assets rise. This creates more spending out of nothing, raises nominal demand, and enables the economy to escape from any putative liquidity trap, or monetary strangulation.

The question is why don’t more economists advocate using this very basic economic theory, or central banks really work with it? Instead, central banks have gone out of their way to neutralise the new money they have created by introducing IOER or constantly reiterating that their inflation targets are sacrosanct.

JA Hot Papato_1It is almost as if the central banks fear this hot potato effect, and have turned it into more of a “hot potato monster”. The moment the newly baked potatoes are taken out of the oven central bankers seem to fear a contagious outbreak of mad behaviour that could tip economies into out of control hyperinflation that will only be remedied with sharp rises in interest rates.

Listening to Janet Yellen at the September FOMC press conference and in her recent speech these fears seem to play a huge part in her thinking.

From the Q&A on 17th September 2015 (my transcription):

” … we have immensely accommodative monetary policy in place … just to [delay] beginning to diminish the extraordinary degree of accommodation for monetary policy we would likely overshoot substantially our 2% objective and then we might have to be faced with tightening to a degree that could be disruptive to the real economy …

” …… if we maintain a highly accommodative monetary policy for a very long time from here and the economy performs as we expect … and the risks that are out there don’t materialise … [my concern [is] much more tightening in labour markets … lags will be probably slow, but eventually we will find ourselves with a substantial overshoot of our inflation objectives … forced into a kind of stop-go … we will have pushed the economy too far it will become overheated … instead of slow, steady growth … not good policy to slam on the brakes and risk a downturn in the economy …”.

JA Hot Papato_2Yellen’s “substantial overshoot” is the hot potato monster. It seems a psychological problem she and her central bankers have rather than something based on reason. Yet the hot potato is also her friend and the main tool for monetary policy. It needs to become a hot potato sheep dog (apologies for mixing the metaphors), nipping, barking and driving the sheep backwards and forwards when necessary, at other times just watching, lying low. When the sheep need to move the dog springs into action and gets the velocity up. A really good sheep dog does very little indeed. The sheep remain calm. The Fed is a bit like a not very good sheep dog at the moment, not a wild one like in 2008 running in all directions causing chaos, just a poor one. I’m not sure what the analogy is to too low velocity: sheep dogs can actually kill sheep if they are not well trained.

Formal model-obsessed macro-economists inside and outside the central banks don’t help as they can’t compute how hot to take bake the potatoes (interest rates) or how many to bake (QE). The heat and quantity of the potatoes necessary can’t be easily gauged except in the outcome. The outcome is nominal growth expectations, but the macroeconomic conditions in which those expectations are formed are constantly changing dependent on all the usual AS and AD issues like confidence, war, politics, investment cycles, etc, etc.

The great insight of Market Monetarism is that you can control the hot potato more or less precisely because you can set the controls of the potato oven to the market’s expectations for nominal growth, or growth in aggregate demand. Or rather, act like a sheep dog, keeping its flock calm and on track, through expectations.

The mess that is the Yellen Fed! Monetary policy conducted according to likely dates and time spans

FOMC Jan/14 (Bernanke´s last)

The Committee also reaffirmed its expectation that the current exceptionally low target range for the federal funds rate of 0 to 1/4 percent will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.

Yellen´s Fed quickly changed “guidance” from “numerical values” (a.k.a. Bernanke-Evans Rule) to likely “dates and time spans”.

FOMC March/14 (Yellens´first)

The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.

(Note: For the first time, Ms. Yellen attempted to define that term, saying it is “hard to define” but “probably means something on the order of around six months.”)

FOMC Dec/14 (“Considerable time” becomes “can be patient”)

Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy.

FOMC Jan/15

Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy.  However, if incoming information indicates faster progress toward the Committee’s employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated.  Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated.

News Feb/15 (“patient” defined by “at least 2 meetings”)

Yellen Tuesday repeated that the Fed’s pledge to be “patient” on beginning to raise the benchmark interest rate means an increase is unlikely for “at least the next couple” of meetings. The central bank adopted the guidance in December and repeated it in January.

FOMC Mar/15 (Dropped “patient” but it´s all “open-ended”)

Consistent with its previous statement, the Committee judges that an increase in the target range for the federal funds rate remains unlikely at the April FOMC meeting. The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term. This change in the forward guidance does not indicate that the Committee has decided on the timing of the initial increase in the target range.

Dog chases tailAnd the result, as I argued here, has been a progressive tightening of monetary policy! It´s pure circular reasoning and the image of a dog chasing its own tail comes to mind!

Five-Year TIPS Say Fed Undershoots IT Target—By Half?

A Benjamin Cole post

If the Fed were your haberdasher, you would get arrested for indecency—half dressed, so to speak.

The Treasury Inflation Protected Securities market, or the “TIPS market,” is a market-based predictor of inflation. These are bonds sold by the U.S. Treasury that protect investors against inflation, as measured by the consumer price index (CPI).

Right now, institutional investors are buying five-year TIPS that offer a yield of 1.27% more than the yield on regular five-year Treasuries. Ergo, the market says the CPI will run at 1.27% in the next five years.

But the Fed claims its average inflation target (IT) is 2%, and that rate is based on inflation as measured the Personal Consumption Expenditures price index (the “PCE deflator”). However, that index generally runs around 30 to 40 basis points below the CPI.

So, what Wall Street is saying is that inflation in the next five years will be under 1% on the PCE deflator—in other words, an inflation rate will be less than half of the Fed’s IT of 2%.

Fed Credibility?

From somber central bankers to crackpots, we have often heard pompous pettifogging about the need for central banker resolve and credibility…and now that Wall Street says the Fed will miss its IT target by half, where are the sanctimonious sermonettes? When the Fed says it’s IT is 2%, but the market says inflation is at 1%, the market is saying the Fed has no credibility.

It May Get Worse

According to a recent report from the Council of Economic Advisers, over-estimating inflation and interest rates are a chronic predilection of professional U.S.-based economists:

Ben Cole Aug19-15

The short story is that economists say interest rates will soon be 2% higher —a sentiment expressed at any time by forecasters, and wrong for 20 years in a row.


With consensus-builder Fed Chairman Janet Yellen in charge, and an entire profession inexplicably yet chronically over-impressed with the potential for inflation and interest rates to rise, I think we can expect Japanification to continue in the United States.

Indeed, the Fed might undershoot its IT target by half, yet raise interest rates within the calendar year.

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.

The Depression´s “Great Moderation”

It´s always interesting to see that not many perceive the low growth of this ‘recovery’ as clear evidence that the economy is in a depression (not a “Great” one, but one nevertheless).

The chart provides an illustration:

Depressions´ Great Moderation_1

At the WSJ Jon Hilsenrath writes about his (and the markets´) befuddlement in Why the Economy—and the Fed—Keeps Getting Knocked Off Track:

The peril of a slow-growing economy is that even small disturbances can knock it off stride, a reality now bedeviling the U.S.

A slew of soft economic reports in recent days has led Wall Street analysts to again reduce their estimates of U.S. growth. It now looks possible U.S. output will nearly be flat for the first half of 2015, and might even contract on average over the first half. J.P. Morgan economists see a growth rate of just 0.5% for the first half.

This softness, which is likely to constrain the Federal Reserve as it eyes when to raise short-term interest rates, is befuddling many economists who just months ago pointed to signs the U.S. economy was kicking into a higher gear. Many of the economy’s underlying fundamentals still look strong: companies are hiring, and incomes and wealth are rising. Interest rates are low and supportive of growth while government fiscal policy—a drag early in the recovery—has become neutral.

A variety of indicators, though, tell a different story. The Federal Reserve on Friday reported U.S. industrial production contracted in April for the fifth straight month, down a seasonally adjusted 0.3% from the month before. A University of Michigan index of consumer sentiment also droppedSoft April retail-sales data and dismal trade numbers, both on Wednesday, had already led analysts to reduce their estimates of growth.

“Economies, like bicycles, are more stable when growing at moderate speed than when growing slowly,” said Lawrence Summers, a Harvard University economics professor and former Obama administration economics adviser, in an interview. A slow-growing economy “is one moderate sized shock away from recession.”


The U.S. economy has actually been less volatile than normal since the recession ended in mid-2009, according to James Stock, a Harvard University economics professor who coined the term “Great Moderation” to describe the steady growth rates of previous decades.

Deviations in growth from one quarter to another have been no larger in this recovery than they were in the three recoveries preceding the past recession, he said. Moreover, deviations in growth from one year to the next in this recovery have actually been half as large as they were during the three previous recoveries.

Yet he sees a risk if economic turbulence grows.

“If you are growing at a low level, you are going to be more vulnerable to those major shocks than you would be if you were growing at 3.5% or 4%,” he said. “This is a major challenge for policy.”

Because interest rates are already near zero—in part because of the slow growth rate—the Fed doesn’t have room to cut them in response to a downturn if one actually does occur.

The thing is that most talk about “Great Moderation” as something only pertaining to growth, forgetting about the associated level.

The chart below illustrates why the ongoing “Great Moderation” is consistent with a depressed economy. The chart describes in ‘phase space’ the degree to which growth ‘spreads out’ (is volatile).

Depressions´ Great Moderation_2

It is clear that real growth volatility is significantly lower during the ongoing ‘recovery’, than it was during the original “Great Moderation”. If you discard the low growth of the 2001 recession, real growth at present has been far lower than real growth in 1992 -07.

If you look at the first chart above, you see why we are in a depression. During the “Great Recession”, real output contracted and extremely low growth thereafter has not directed it back to trend.

The next chart describes in ‘phase space’ the behavior of nominal growth (NGDP or nominal spending growth). It is even more stable now than before, but note that at present, the growth rate is not much different from the nominal growth rate observed during the 2001 recession.

Depressions´ Great Moderation_3

The big question is; if the Fed has the ability (and note that for decades nominal growth was very volatile) to provide nominal growth stability (that translates into real growth stability), why can´t it also do it at a non-depressed level?

In other words, if it can keep nominal growth chugging along at a ‘constant’ rate, why can´t it temporarily increase that rate so that the economy will climb out of the ‘hole’ it´s in?

It´s certainly not because interest rates are at the ZLB. As Watson puts it, rates are near zero in part because (nominal) growth has been so low. For goodness sake, then, increase the nominal growth rate!

Unfortunately, Janet & Friends prefer to speak about “policy normalization”, meaning increasing the FF target rate. They would do much better if they switched to a target level for nominal spending.