Archive for the Category Monetary Policy


There’s no such thing as “out of ammo”

This really misses the point:

It’s time for central bankers to ask for help.

As the International Monetary Fund prepares to downgrade its outlook for the world economy again, monetary policy makers are running low of ammunition to fight a fresh downturn. Bank of America Merrill Lynch calculates they have reduced interest rates more than 600 times since the 2008 collapse of Lehman Brothers Holdings Inc. with theReserve Bank of India extending the run on Tuesday by cutting its benchmark more than expected.

While the European Central Bank and Bank of Japan haven’t ruled out buying even more bonds, there are doubts over how much more quantitative easing can achieve given yields are already around record lows and inflation still remains beneath the target of most policy makers. Even easier monetary policy may just end up propelling asset markets rather than economies.

That leaves economists and investors increasingly looking toward governments to lead the rescue efforts should the China-led slowdown in emerging markets infect developed nations. BofA Merrill Lynch sees a 25 percent chance of a recession-like slump this year.

“Monetary policy is basically exhausted in terms of producing real growth and even inflation,” billionaire Bill Gross of Janus Capital Management LLC told Bloomberg Television this month. “Fiscal policy is the second piece of the leg that has to take place in order to get us back to where we want to go.”

Almost every day something happens that refutes the claims made here.  First of all, there is no evidence that central bankers are not achieving their goals.  The Fed is about to raise rates.  The ECB seems satisfied with its progress in promoting a eurozone recovery.  I don’t think it should seem satisfied, but it does.  Ditto for the BOJ.  Just weeks ago Draghi said he’d do more QE if necessary.  And yet if you believe what I just quoted above, Draghi’s recent announcement should have had no impact on the markets, either because there are no more bonds to buy (out of ammo) or because QE has no effect. Instead here’s what happened to the euro:

Screen Shot 2015-09-30 at 4.58.54 PMIf Bill Gross were correct then it should be impossible to guess what time of day Draghi made his announcement.  But I’ll bet even Ray Lopez can guess.  (Hint, easier than expected money usually makes a currency depreciate in value.)

A beggar thy neighbor policy?  Let’s see how Wall Street reacted:

Wall Street has also welcomed Mario Draghi’s pledge to take more stimulus measure if needed.

The Dow Jones industrial average, and the broader S&P 500, are both up by almost 1%.

The following sounds appealing, until you think about the implications:

If the world economy enters a downdraft, Steven Englander, global head of G-10 FX strategy at Citigroup Inc., proposes a more revolutionary response, akin to the “helicopter money” once advocated by Milton Friedman.

In what he calls “cold fusion,” politicians would cut taxes and boost spending. Central banks would then cover the resulting increase in borrowing by purchasing more bonds as part of a commitment to permanently expand their balance sheets. The easier fiscal policy would be covered by QE Infinity.

“Politically it is difficult for central banks to outright endorse monetization of government debt, but faced with another slump and armed with ineffective policy tools, we expect that central banks will quickly give the wink and nod to fiscal measures,” Englander said in a report to clients last week.

The upshot would be greater purchasing power would be injected straight into the economy, increasing activity and inflation. Long-term bond yields would rise, yet short-term yields adjusted for inflation would turn negative.

Give him credit for recognizing that easier money can end up raising long term bond yields.  And “cold fusion” sounds pretty cool. But otherwise this makes no sense. What does it mean to promise the injections will be permanent?  That suggests you are targeting the monetary base, which could have catastrophic results.  You need to make just enough of the injections permanent to hit your NGDP target.  But if you do that, then the fiscal stimulus is pointless.  Even Paul Krugman claims that monetary policy ineffectiveness occurs when central banks cannot make credible promises to make monetary injections permanent.  But if you assume the promises are made and believed, then the fiscal part of the policy does nothing other than increase the national debt, worsening a problem that is already becoming increasingly worrisome as the population ages.

The case for tightening is getting weaker and weaker

The recent plunge in TIPS spreads is reaching frightening proportions:

5 year  =  1.09%

10 year  =  1.42%

30 year  = 1.61%

Yes, I know they can be distorted by illiquidity, but they are not THAT far off market expectations. And don’t forget they predict CPI inflation, which runs about 0.3% above the Fed’s preferred PCE.  In essence, the Fed has a 2.3% inflation target.  They aren’t likely to hit it.

Also recall that since 2007 the Fed’s been consistently overly optimistic about future growth in AD—the markets have been more pessimistic, and more accurate.

Also recall that Fed policy has a big impact on the global economy.

Also recall that the global economy seems to be moving into a disinflationary cycle.

Given that Fed tightening has the potential (and I emphasize the potential, maybe a 1 in 6 chance) of driving the global economy into a recession, and given there is basically no upside from tightening now, the Fed’s got to ask itself one question:  “Do I feel lucky today?

PS.  And if China is far worse than I assume, then . . . well, look out below.

PPS:  I have a new post on libertarianism over at Econlog

Further thoughts on Thursday

I’ve seen a lot of interpretation of Thursday’s money supply announcement.  But it’s important not to overreach, just because we might find a particular theory attractive:

1.  The theory needs to be consistent with what we know about past reactions to Fed announcements.

2.  The theory needs to be consistent with the timing of the reaction.

3.  The theory needs to be consistent with the other market responses.

For instance, some argue that the market responded as if the Fed knew more than they do.  But that’s not the reaction we typically observe.  Why would that be the case this time, but not other times?  On the other hand I see why this theory is attractive, as the secondary (negative) reaction after 2:50 pm. does look like a response to bearish news about the economy—stocks, bond yields and the dollar all fell.  But I’m still reluctant to accept that interpretation unless someone can find a plausible explanation as to why the market would believe the Fed knew more this time, but not other times.  And also explain what new information about the Fed’s view of the economy came out after 2:50.

Here’s a graph showing the stock market reaction to the 2pm announcement:

Screen Shot 2015-09-19 at 9.56.41 AM
























I highlighted 2:35, which is about when the Yellen press conference began. Both the sharp (almost 1%) increase and the even bigger subsequent decline occurred during the press conference.  But I have trouble seeing what Yellen said that would have made markets more bullish around 2:40 made more bearish after 2:50.  Still, just because I don’t see it, doesn’t mean the market didn’t see something meaningful.  Despite my skepticism, I still think Yellen’s comments were the most plausible cause of the market swings.

If you look at the forex markets, you see an interesting pattern.  The commodity currencies like the Australian and Canadian dollars rose sharply on the announcement, and then even further when the US stock market rose sharply during the early part of Yellen’s talk.  Then both currencies immediately plunged almost all the way back down just a few minutes later, in tandem with the fall in US stocks.  Risk on, then off?  Here’s the Aussie dollar:

Screen Shot 2015-09-19 at 11.38.58 AM























In contrast, currencies like the euro and yen rose sharply and stayed higher for the rest of the day.  (Although the euro did fall the next day, but it’s hard to see how that relates to the Fed.)

You might wonder why I don’t just accept:

1.  It was already priced in.

But if that were true, why did other markets respond so strongly?

2.  The stock market didn’t much care either way.

That’s more plausible.  But stocks usually respond strongly to unexpected monetary policy announcements.

3.  Yes, the stock market usually cares, but with unemployment at 5.1% the market thought the risks were balanced in this case.

That’s an even better argument (and essentially what Tyler Cowen suggests).  But I still have this nagging feeling that stocks would have fallen on a .25% rate increase, partly because in the lead up to the announcement stocks often seemed to swing significantly on news about whether the Fed was going to raise rates—things like statements by key Fed officials.

Here’s an analogy.  A few months back US stocks were very volatile during the Greek crisis.  Suppose that on Monday the Greek government announced it had printed up currency in secret and was leaving the euro.  And suppose the US stock market did not react.  Wouldn’t you be surprised, even if you thought there was no valid reason for stocks to respond?  Even if you thought the stock market had been foolish to respond to the Greek crisis in July, wouldn’t you expect another response if they actually left the euro?

And finally, don’t forget that the other markets did provide useful information.  For instance, we know that the TIPS spreads remained quite low, which I believe supports Kocherlakota’s claim that we need a rate cut.  People laugh at how far behind Kocherlakota is on the dot graph, like the little boy that can’t keep up with his Boy Scout troop:

Screen Shot 2015-09-19 at 11.49.40 AM

Only 1% interest rates in 2017?  Yes, that’s probably too low, but it wouldn’t surprise me all that much if Kocherlakota had the last laugh.  His 1% forecast is certainly far more plausible than the official who predicts 4% in 2017.  Consider that Japan and probably even the eurozone are still going to be at zero in 2017.  How plausible is it that the US has 4% rates when the rest of the developed world is at zero? Especially given that we are growing at just over 2% in a period of rapidly falling unemployment, and the unemployment rate will stop falling by 2017, and hence RGDP growth will slow sharply from the current pathetic levels.  We might even have another recession, recall that America has never had an expansion that lasted 10 years.

PS.  Frederic Mishkin really hit the nail on the head.  I wish he were still on the FOMC.

The Fed’s wise decision

I thought yesterday’s policy announcement would offer a nice natural experiment, but instead it served up perhaps the most muddled stock market response I’ve ever seen.  Indecision, then a big move upwards, then an even bigger move downwards.

One problem is that it’s harder to interpret market responses when the more likely outcome occurs.  The response to “new information” will be much smaller.  But even so, there was some genuine uncertainty.  And if you look at other markets you could see a clear response.  Indeed it almost looks like Wall Street was hit by two shocks—easier than expected money, and then (an hour later) slower than expected RGDP growth.

I still believe a 1/4% rate increase would have reduced stock prices, but of course the response to yesterday’s announcement doesn’t really provide any support for that.  One alternative is that the announcement didn’t matter at all.  But then why did the other markets clearly respond?  Most likely, the various markets were hit by two shocks, easier money and weaker expected growth.  In the equity markets those two shocks worked as cross purposes, whereas in the bond and forex markets they both pushed in the same direction. Both shocks tended to depreciate the dollar and also reduce bond yields.

And it doesn’t even end there.  European markets plunged today, and the dollar regained the ground lost yesterday.  Go figure.

The only thing I have some confidence in saying is that it was a wise policy decision.  Even today the bond markets are clearly signaling the Fed will fall short of its inflation target; next year, next 10 years, next 30 years.  Money is still too tight, and Kocherlakota (who called for a rate cut) is the only one who got it right.  As usual, the VSPs laughed at him like he was your crazy uncle, hid away in the attic—the usual reaction when someone points out that the conventional opinion in monetary policy is wrong.

Although money is too tight to hit the Fed’s goals, it’s not necessary too tight for a well functioning US economy, and that also might help explain the muddled response.

Off topic, a commenter directed me to a very interesting podcast on Chinese data.  The five China data experts all seemed to think the Chinese data was not manipulated for political reasons, and that the statisticians in Beijing do the best job they can under difficult circumstances.  I learned that a lot of what you read in the press is misinformation.  For instance, this LA Times story on bad Chinese data is based on interviews with one of the people in the podcast, but totally mischaracterizes her views—making her seem much more of a China skeptic than she actually is.

Over at Econlog I have another post on Chinese data accuracy, for those who aren’t sick of the subject.  (I tried to inject some humor this time.)

And I highly recommend this Lars Christensen post, which discusses the echoes of the 1930s in the current political environment.

China’s retail boom

In my view many pundits are excessively pessimistic about the Chinese economy, focusing too much on the weakness in heavy industry and exports. Offsetting that weakness is booming growth in retail sales, as Chinese incomes rise very rapidly. BTW, if China really is doing so poorly, then precisely WHY are Chinese incomes growing so rapidly?  There are possible answers — fast rising unemployment or fast rising inflation — but I see no evidence of either.  Here’s a recent report from Forbes:

Beijing’s National Bureau of Statistics reported that retail sales in China jumped 10.8% in August compared to the same month last year. That was substantially better than every consensus estimate. Analysts had predicted sales would come in at 10.5%, the same increase as July’s.

Most observers are bullish about consumption as the next driver of the Chinese economy. The dominant narrative tells us China is in a transition from investment-led growth to growth propelled by consumer spending. The oft-cited Andy Rothman, now at Matthews Asia, calls the country “the world’s best consumption story.”

The evidence supporting that proposition looks compelling. Apple, from the first indications of a few hours ago, immediately sold out its iPhone 6S and iPhone 6S Plus in China. Express parcel deliveries were up 47% in July compared to the same month in 2014. Box office revenues? For the first eight months of this year, theyskyrocketed 48.5% from the corresponding period last year.

Consumption contributed 50.2% of growth of gross domestic product in 2014. In the first half of this year, it accounted for 60.0% of GDP.

In recent years it has become trendy in China to buy goods online.  Alibaba is by far the largest online retailer, so I thought I’d take a look at its numbers:

Screen Shot 2015-09-15 at 8.50.45 AMThat graph is a bit misleading for two reasons.   First, the latest figures are actually 2015:2, not 2016:1 (their fiscal year ends in March.)  And second, growth is expected to slow modestly in Q3 due to the stock market plunge.  But clearly the trend is very strong, and other online retailers show the same pattern:

Three Chinese Internet companies—Alibaba, Tencent Holdings Ltd. and Baidu Inc.—are now among the world’s largest in market capitalization. The industry’s rise has come even as China’s economic growth has slowed from its double-digit pace of a decade ago.

Some other competitors are expressing caution, though many are signaling still-strong growth. Executives at Alibaba rival Inc. said last month that they expect third-quarter revenue growth of between 49% and 54%—compared with a year-earlier 61%—reflecting a “conservative outlook in light of the recent Chinese stock-market correction and the slowing macroeconomic conditions.”

Of course just as in America, some of this growth is coming at the expense of brick and mortar firms, and there are indications that sales are flat for many ordinary retailers.  But don’t underestimate the importance of online; Alibaba alone now sells more than $100 billion dollars per quarter.  If we assume the entire online sector is around $150 billion per quarter, then growth in that sector (year-over-year) is probably on the order of $50 billion per quarter, or $200 billion per year. Thus online growth alone can explain about half of the growth in China’s $4 trillion retail sector.

This relatively sunny view of Chinese retailing is one argument in favor of the Fed raising rates in September, although on balance I still think that would be a mistake.  (Of course if China were actually sliding into recession, a rate increase now would be a mistake of epic proportions.)  I strongly agree with Ray Dalio’s recent take:

Ray Dalio, the founder of the world’s largest hedge fund Bridgewater Associates, said the firm believes the next big move by the Federal Reserve will be to loosen U.S. monetary policy, not tighten it.

In a client note sent out on Monday, Dalio said the Fed is paying too much attention to the short-term ups and downs of the business cycle rather than the longer-term ramifications of central banks driving interest rates to zero, which now leaves them no room to act if worldwide deflation takes hold.

“The ability of central banks to ease is limited, at a time when the risks are more on the downside than the upside and most people have a dangerous long bias,” said Dalio, who helps manage $162 billion at Bridgewater. “Said differently, the risks of the world being at or near the end of its long-term debt cycle are significant.”

.  .  .

Dalio said the Fed has overemphasized the importance of the cyclical short-term business cycle in its desire to raise rates, but has been less attentive to the longer-term trend toward deflation.

He said the Fed will react “to what happens,” suggesting it should undertake more quantitative easing, or QE, but he isn’t positive of that, given Fed officials’ desire to raise rates.

Dalio warns of global disinflation, slow global economic growth, and the lingering risk aversion that is behind the proclivity to hold cash despite its significant negative real returns.

“Our risk is that they could be so committed to their highly advertised tightening path that it will be difficult for them to change to a significantly easier path if that should be required,” Dalio said.

That final comment is especially important.  This was precisely the mistake the Fed made in mid-2008, when many at the Fed assumed their next move would be higher.  It was really hard for them to re-orient their thinking to the need for a rate cut, and hence they did not cut rates during the May through September period, when interest rate cuts were desperately needed.  This effective tightening made the recession (which had already begun) much worse.

This time the probable consequences would be more benign, a slowdown in growth and undershooting the inflation target, not recession. But it would leave the Fed with fewer options when the next recession occurs.

HT:  Ben