The problem with procyclical inflation

Here’s Charles Evans in the WSJ:

“We’ve averaged well under that 2% mark for the past six-and-a-half years,” Mr. Evans said. “With a symmetric inflation target, one could imagine moderately above-target inflation for a limited time as simply the flip side of our recent inflation experience–and hardly an event that would impose great costs on the economy.”

There’s no doubt in my mind that a policy of letting inflation run a bit above target during the next boom will not cause great hardship during the next boom

But a policy of running inflation below target when unemployment is high and above target when it is low makes the business cycle much worse, and does impose great hardship.  Some conclusions:

1.  A procyclical inflation policy violates the dual mandate.

2.  NGDP targeting would lead to countercyclical inflation (a good thing).  As Nick Rowe likes to say, you want to make it so that the public’s stupid belief that inflation is bad . . . is true.  Good supply-side policies would become anti-inflation policies.

3.  Discussions of “what should the Fed do now?” are meaningless and incoherent, unless embedded in a clearly specified long run policy regime, as are discussions of whether QE “increases inequality.”

Charles Evans is actually one of the best people at the Fed.  Then there is the other Charles:

Federal Reserve Bank of Philadelphia President Charles Plosser said Friday that inflation levels that have fallen persistently short of where the central bank wants them to be are not a significant issue to him right now.

It’s true that inflation levels are “a little bit low” relative to the Fed’s desire to have price pressures hit 2%, Mr. Plosser said at an appearance in New York. But, “for the most part, I’m not too concerned about that,” he said.

What he doesn’t say is that the reason the Fed has failed is partly due to the fact that he’s consistently been pressuring them to be more contractionary, even as they were already far too contractionary to hit their dual mandate. So Plosser’s telling us that the Fed is not doing its job, partly due to his consistently bad advice, but he doesn’t much care.

Fortunately, market monetarist ideas are gradually seeping into the media.  A few days ago we saw this at the Financial Times, now it’s Bloomberg’s turn:

Based on the gap between yields of government notes and TIPS, traders have scaled back estimates for average inflation through 2019 by a half-percentage point since June to 1.52 percent, Fed data compiled by Bloomberg show.

.  .  .

With the Fed’s preferred measure averaging 0.34 percentage point less than CPI in that span, traders are signaling prices based on that gauge may rise as little as 1.18 percent. Through August, the personal consumption expenditures deflator has fallen short of the Fed’s 2 percent goal for 28 straight months.

Fed officials “need to be paying attention to that because there’s a collective wisdom element to the TIPS market,” Mitchell Stapley, the chief investment officer for Cincinnati-based ClearArc Capital, which manages $7 billion, said in an Oct. 8 telephone interview.

Layoffs reach the lowest level EVER

A few weeks ago I pointed out that new claims for unemployment (4 week average) as a share of total employment had reached the lowest level since April 2000.  I predicted it would soon beat that record.  Now it has; they are at the lowest level ever.  Here’s what we know (or at least I suspect) about the new economy:

1.  Low interest rates are the new normal.

2.  Low layoffs are the new normal.

3.  High stock prices are the new normal.

4.  Greater income inequality is the new normal.

5.  Fewer people moving between states is the new normal.

6.  Slow RGDP growth is the new normal, probably due to both slower employment growth and lower productivity growth.

7.  The Great Moderation is back after a one year hiatus (mid-2008 to mid-2009).  This expansion may last a record 10 plus years, but will still be a lousy expansion.  Don’t call it the Great Moderation, call it the Mediocre Moderation.  Mediocre labor markets are the new normal.

8.  Just as overall economic growth reflects deep institutional realities, the quality of macro policy reflects the quality of institutions doing macro teaching and research.  A small country like Canada can easily outperform a big region like the eurozone, if its macroeconomists (Laidler, Rowe, Carney, etc.) are better informed about the realities of monetary economics and AD than those macroeconomists of the eurozone, who don’t even seem too sure of what AD is.  But these differences are not carved in stone—Germany was ahead of the English-speaking world in their understanding of monetary economics during the 1970s.  As the issues change, the relative strength of each country changes.

Update:  The Nikkei Asian Review has published a phone interview of me.  I’m told this is a major Japanese paper.

Did QE worsen inequality? That’s not even a question

When people ask whether QE worsened inequality they think they are asking a coherent question. But that merely shows how poorly most people understand monetary economics.

Let’s ask a different question:  Did Obama’s appointment of Ben Bernanke increase inequality? Any sensible listener would ask: “Compared to what?”  After all, most models are roughly linear, at least for very small changes (I’m rusty at math, so tell me if that is wrong.)  In other words, whatever impact monetary policy has on inequality, the impact of picking Bernanke over a more dovish alternative (Romer) would have been the opposite of Obama picking Bernanke over a more hawkish alternative (Summers.)   I can’t imagine anyone being able to make sense of the question “did Bernanke increase inequality” without knowing the counterfactual Fed chair.  And of course the same is true for Fed policies, is the counterfactual more or less contractionary than the actual policy?

Now some people will say; “the obvious implication is that the counterfactual was no QE, and that this was a more contractionary alternative.”  This is very likely how people think about it, but of course that assumption is wrong.  My preferred policy would have been far more expansionary, and hence would have involved far less QE.  Let’s break this down into 2 questions:

Does monetary stimulus increase inequality?

Does delivering monetary stimulus via QE affect inequality more than some other method?

I’ll take the second question first.  Suppose Bernanke did not do QE, but rather some equally effective stimulus method.  Perhaps slightly raising the inflation target, or going to level targeting. Would that make any difference for inequality?  I hope it’s obvious that it would not.  The mechanics of QE are totally uninteresting.  You are just swapping one Federal government interest bearing liability (reserves) for another federal government interest bearing liability (T-bonds.)  Any “Cantillon effects” are trivial.  I hope I don’t have to explain to people that this “money” did not “go into the stock market”:

a.  The money went into bank reserves, or currency.

b.  Money never goes into markets; there is no giant safe on Wall Street storing all the money invested in stocks.  Money goes through markets.  You buy, someone else sells.

If there were no QE, but equally fast NGDP growth produced by a higher inflation target, stocks would have done equally well.  Indeed stocks responded more strongly to forward guidance than QE3 in late 2012.

So now we can rephrase the QE question: “Did Bernanke’s monetary policy since 2009 worsen inequality?”  Now it’s much easier to see that we need a counterfactual.  You might prefer to describe that policy as 1.5% inflation, or perhaps 4% NGDP growth (my choice.)  Either way it’s a fairly contractionary policy.  And it’s no longer “obvious” what the counterfactual is, would it be 3% or 5% NGDP growth?  In my view 5% growth would have helped the unemployed and the rich more than the middle class with stable jobs (say teachers.)  So that has mixed effects on inequality, indeed so ambiguous that it’s probably not worth even thinking about, as the effect would be trivial compared to the net gain to America from a stronger economy.

If you think the alternative to QE was a more contractionary policy, say 3% NGDP growth, then it would hurt the rich and poor more than the middle class.  In order to favor that policy you’d have to hate the rich so much that you be willing to impoverish millions of poor people to screw the rich. But even someone who hates the rich as much as Paul Krugman favors QE.

Sorry, but “does QE increase inequality?” is a really, truly moronic question.  I apologize for wasting your time.

PS.  Here’s Buttonwood at the Economist:

This is at the heart of the matter. Even if the Fed does not increase rates next year, it will surely take a big economic shock to make it resume QE. The markets have relied on the central banks for so long, like a small child holding his dad’s hand when learning to ride the bike. It is time to let go of the hand now, but there will be a few bumps and bruises along the way.

This is truly a horrible metaphor, and helps explain how the developed world got so far off course. Taken literally, the counterfactual to “using monetary policy” is barter. Obviously that’s not what people mean when they say it’s time to stop using monetary policy.  Buttonwood probably means that we are propping up the economy with an excessively expansionary monetary policy.  But of course that’s confusing the tools (fed funds targets, the monetary base, etc.) with the actual policy itself (1.5% inflation, 4% NGDP growth, etc.)

By 2007 almost no serious economist in America believed that money was “easy” in the early 1930s, despite ultra-low interest rates and massive QE.  And now almost all serious economists believe monetary policy has been “easy” in recent years precisely because of ultra-low rates and massive QE.  This fact is appalling.  The intellectual decline in mainstream macroeconomics since 2007 is stunning–nothing like this regression has happened since the early 1970s, or perhaps the late 1930s.  And this time the worst mistakes are being made by those on the right.

By the way, the right metaphor is not training wheels, but rather which way do you want to steer the bicycle?  No serious pundit is advocating walking.

Ben Southwood finds lots of evidence for (market) monetarism

Ben Southwood of the Adam Smith Institute has several recent blog posts that are well worth reading.

When the Bank moves its key policy rate, commentators talk about it hiking or cutting interest rates; on top of this, we’ve seen extremely low effective interest rates in the marketplace; together this makes it reasonable to believe that the central bank is the cause of these low effective rates.

There are lots of reasons to doubt this claim. In a previous post I pointed out that the spreads between Bank Rate and market rates seem to be narrow and fairly consistent—until they’re not. I made the case that markets set rates in an open economy. And I arguedthat lowering Bank Rate or buying up assets with quantitative easing (QE) may well boost market rates because they raise the expected path of demand, the expected amount of profit opportunities in the future, and thus investment.

Since then I came across an elegant and compelling explanation of exactly why this is. In a 1998 paper, Tore Ellingsen and Ulf Söderström show that this is because some monetary policy changes are purely expected and ‘endogenous’ responses to economic events, whereas some monetary policy changes are unexpected ‘exogenous’ changes to the central bank’s overall policy framework (like raising or lowering the inflation rate that markets believe they really want).

When changes are expected, market rates keep a tight spread around policy rates; when changes are a surprise, cutting Bank Rate actually results in higher interest rates in the marketplace.

The post has some nice graphs showing this distinction.  He has another post citing no less that 4 papers with monetarist-friendly findings.  Here’s one example:

In “QE and the bank lending channel in the United Kingdom”, BoE economists Nick Butt, Rohan Churm, Michael McMahon, Arpad Morotz and Jochen Schanz tackle the popular creditist view that movements in lending drive overall activity, and that quantitative easing works by stimulating lending, and find “no evidence to suggest that quantitative easing (QE) operated via a traditional bank lending channel”. Instead, their evidence is consistent with the monetarist view, that “QE boosted aggregate demand and inflation via portfolio rebalancing channels.”

They find this result by looking at the difference between banks that dealt directly with the Bank of England when it was buying gilts (UK government bonds) with new money in its QE programme. If the creditist view held, these banks would be more able to expand their lending with the extra deposits created when the BoE hands over new money for gilts.

And a post exposing the silliness of internet Austrian commenters, who seem to think that anyone who is not an Austrian is a Keynesian.

Ben’s colleague Sam Bowman (also at the ASI) has a good post explaining NGDP targeting.

Meanwhile, the only head of a major central bank ever to say good things about NGDP targeting now presides over an economy that is creating jobs at a rate no one could have imagined 18 months ago.

Quick update on NGDP futures

No one told me it was going to be hard to give away money!  Seriously, there are a few more complications than I anticipated, and I am now waiting for specific instructions from iPredict and Hypermind about how to proceed.  But it will get worked out.

Meanwhile the early Hypermind Q3 futures contract, with 100 euros in prize money, has now been upgraded to a combined Q3 and Q4 with 1000 euros in prize money. So it just became much more attractive.  Recall that at Hypermind, traders do not have to put up their own money–it’s not “gambling.”  But you do need to register first.  

Eventually we will deliver much more money for prizes at Hypermind.

Update:  I was sent the following information:

The real-time forecasts are published on this page, which requires the password: “illusion“.

https://hypermind.lumenogic.com/hypermind/app.html?gtp=vitrine&selection=NGDP

The contracts are at about 34/35 right now, which means 3.4% to 3.5% annualized growth.  That seems like an opportunity.  :)

PS.  Super busy this week.  All I have time for is to point out that the collapse of the Chinese economy, predicted for 20 years, once again failed to materialize in Q3.  Now some brave souls are predicting Chinese growth will slow over time.  You mean they won’t keep growing at 10% as they become highly developed?  I never would have guessed.