Are the doves dishonest?

During the 1970s, the doves were consistently wrong, and for the most part denied they were wrong, even after the fact.  Inflation (they said) was caused by “non-monetary” factors.  Now we all know that was hogwash; NGDP was rising at 11% per year.  And non-monetary factors like oil shocks and strong unions have no impact on NGDP.

Since 2008 it’s been the exact opposite, the hawks have been consistently wrong.  There is no shame in being wrong, but it is shameful not to admit you were consistently wrong in the past, when the facts clearly suggest you were.  Oddly, Benn Steil and Dinah Walker now think it’s again the doves who are at fault.

Do Fed doves and hawks get their aviary classifications based on their cold, hard analysis of data, or is it the reverse – do they select data points to justify their dovish or hawkish perspectives?

The history of the Fed’s post-crisis focus on unemployment suggests the latter.  After June of 2013, as the figure above shows, the Fed’s estimate of the natural long-term unemployment rate begins declining in sync with the decline in the actual unemployment rate.  This suggests that FOMC members are lowering their estimates of the natural rate of unemployment to justify keeping interest rates at zero longer than they could if they stuck by their initial estimates, the 6% consensus upper bound of which is now above today’s actual 5.9% rate.

We cannot test this hypothesis directly, by checking each member’s estimate history, because the estimates are anonymous.  But we can check whether the phenomenon can be explained merely by a change of FOMC composition: it cannot. The distribution of participants’ estimates shows conclusively that some of them have indeed revised their estimates lower.  Given that these are supposed to be estimates of the long-term natural unemployment rate, this is more than curious.

With core PCE inflation, the Fed’s preferred inflation measure, running at 1.5%, still comfortably below the Fed’s 2% long-run target, there is little compelling reason to begin hiking rates immediately.  But given its upward trajectory from 1.2% at the start of the year, there is surely now reasoned cause for bringing forward the Fed’s old September 2012 calendar-guidance of zero rates through mid-2015 – which the Fed doves are still strongly wedded to.

Our observations suggest that monetary dovishness and hawkishness are often fixed states of mind, rather than artifacts of a consistent approach to data analysis.  If so, there is reason to fear that the Fed’s exit from monetary accommodation will be too late and too tepid – with the result being higher future inflation than the market is pricing in right now.

Obviously it’s possible they are right, but it seems extremely unlikely.  The doves have good reason to delay their estimate of the optimal time to raise rates; the markets are suggesting that we are not approaching the Fed’s multiple policy targets as quickly as the unemployment numbers would suggest.  If 5.4% really was the natural rate of unemployment, then there is no way the 5-year TIPS would be plunging rapidly below 2%, and the 10 year T-bonds would be 2.3%.  After all, we will be at 5.4% unemployment in about 5 months.  Once we fall below the natural rate, the standard model (i.e. the Fed’s model) says inflation should rise.  But there are no signs that inflation will rise.  Steil and Walker cite historical data, but market inflation expectations are much better.  It’s not a good idea to try to steer the car by looking in the rear view mirror.  It’s not wise to second guess market forecasts.

Unfortunately we lack a NGDP futures market, which would have made it much easier for me to make this argument.  The government and the economics profession deserve ridicule for the fact that this market does not exist.

I do agree with the first sentence of their final paragraph, and have a new post on that topic over at Econlog.  But I draw the opposite conclusion—it’s the hawks we need to fear.

Great minds think alike

This is me back in 2010:

The EMH is approximately true; indeed it’s almost impossible for me to imagine any other model of financial markets.  But it’s not precisely true, again, just as you’d expect.  After all, if the EMH were perfectly true then no one would have any incentive to estimate fundamental values.  We know people are imperfect and hence that any real world human institution, including markets, will be at least slightly imperfect.

A smart person like Eugene Fama should have been able to come up with both the EMH, and its limits, by just sitting in a room and thinking.  Much as David Hume got the QTM by imagining what would happen if everyone in England woke up one morning with twice as much gold in their purses.  Or Fisher’s theory of inflation and nominal interest rates.  Or Cassel’s purchasing power parity.  Or Friedman/Phelps’ natural rate hypothesis.  Or Muth and rational expectations.  Certain ideas are simply logical, and that’s why I have no doubt that despite all those economists on the left arguing the EMH has been discredited, it will still be taught in every top econ/finance grad program 100 years from now, whereas fiscal stimulus will be long gone from macro textbooks.

PS.  Why will fiscal stimulus be gone?  Because even Krugman admits it only makes sense at the zero bound.  And we are rushing headlong into a world of all electronic money–probably within 50 years.  There is no zero lower bound with electronic money, and hence the Taylor Rule is all you need.  Old Keynesian economics will vanish, leaving only new Keynesianism.

And here’s my doppelganger Noah Smith 4 years later:

Now, the analogy between the EMH and Newton’s Laws is far from perfect. Newton’s Laws are wrong in a finite set of ways, under conditions that are predictable and well-known. The EMH, in contrast, is wrong in an infinite number of ways, and the set of the most important ways in which it’s wrong is constantly changing, as old anomalies are traded away and new ones crop up. Also, the EMH is actually a family of hypotheses, since you need a model of risk to specify it properly.

But like Newton’s Laws, the EMH is deep and fundamental. If you went through a wormhole and visited an advanced alien civilization, what would they think about financial markets? Chances are, they wouldn’t use the Capital Asset Pricing Model, or the Fama-French 3-Factor Model, or the Shiller CAPE. But I bet they would have some version of the Efficient Market Hypothesis.

This is because the EMH doesn’t emerge from any peculiarity of the way our market system is set up, or the way human beings behave. The EMH comes from something much deeper than that, something that probably has to do with information theory. It comes from the fact that when you exploit information to make a profit in a financial market, you decrease the amount that others can exploit that information. In other words, the financial value of information gets used up. That sounds simple and obvious, but so are the principles that give rise to Newton’s Laws.

In any case, the anomalies that make the EMH not quite right may also have deep explanations, but we don’t know what those are yet. When we do, that will be a big advance in finance theory. But the EMH will still be the jumping-off point for any theory of financial markets, on this planet or any other. It will always be wrong, but never useless.

Noah reached this insight 4 years after I did.  But don’t be fooled, he’s much more than 4 years younger than me.  He reached enlightenment at a younger age because he’s also much smarter than me.

Our great, horrible, indifferent labor market

The Great:

The 4-week moving average of layoffs came out today at 287,750.  Total civilian employment in September was 146,600,000.  The ratio of the two, i.e. the chance of being laid [off---ouch that might have been my most embarrassing mistake ever] during a given week if you had a job, was below 2 in 1000.  That’s only happened once before in all of American history–April 2000.  (We don’t have data going all the way back, but the ratio was considerably higher in the booming 1960s, and I’m confident layoffs were much more common in earlier decades for which we don’t have data.  (“Gilded Age” bosses could lay off workers whenever they wanted.) And it seems very likely that we will soon break the April 2000 record, maybe this month.

Update: a bit higher than 2 in 1000 because not all layoffs put in unemployment claims.

The Horrible:

Total employment has barely budged in 7 years, while the employment population ratio has plunged much lower.  We are even seeing a lower employment/population ratio in the key 25-54 demographic, compared to seven years ago.  The U-6 unemployment rate is a very high 11.8%

The Indifferent:

The unemployment rate (U-3) is 5.9%, slightly above the Fed’s 5.6% estimate for the natural rate.

Thanks President Obama, you’ve given us a European labor market.  Workers with good jobs need not fear layoffs; the rest will have to be satisfied with part time work or unemployment.

Of course I’m half joking about Obama.  But just how good is his economic record?  The Washington Examiner has an article that quotes me.

The newest talking point of President Obama and his supporters, such as Paul Krugman, is that we are doing better at job creation than other developed countries.  I don’t think we are doing as well as Australia/New Zealand/Canada/Britain, but it’s surely true overall for one very obvious reason.  The eurozone.

Let’s examine that Obama/Krugman claim more closely.  Everyone seems to agree that since 2010 the US has done considerably more austerity than the eurozone.  No debate there.  And the huge divergence between the US and the eurozone has occurred since 2011.  The initial recession and initial recovery were quite similar in the US and eurozone.

The GOP Congress did exactly the opposite of what Obama wanted on austerity, and the result was that we grew dramatically faster than the eurozone.  That’s Obama’s success?  The big difference was of course monetary policy.  Obama’s comparing us to a region ruled by a central bank that is more incompetent that the central banks of the 1930s (Krugman has some graphs on that point.)

So yes, we are doing better than the eurozone.  Does Obama deserve credit for the fact that our monetary policy was less incompetent than the ECB?  That doesn’t even pass the laugh test.  Even Obama supporter Matt Yglesias says he’s been horrible on monetary policy.  He left multiple seats empty, when he had 60 votes in the Senate in 2009.  He’s doing the same today.  He never appointed a single person to the board who favored the sort of expansionary monetary policy that I favor, that Yglesias favors, that DeLong favors, that Krugman favors, that Christina Romer favors, and that any progressive with half of brain favors.  He almost picked bubblephobe Summers to head the Fed, and had to be stopped by a storm of protest that began here and then spread through the progressive blogosphere.  (Yes, some progressives always opposed him for other reasons; I’m talking about his monetary policy views.)

President Obama may or may not be a good President.  I think he’s been above average on foreign policy.  I’m willing to concede the Obamacare (which I opposed as a missed opportunity) did some good things like the Cadillac tax on health plans and helping the uninsured.  I think the financial reform was a missed chance, but others disagree. I’m disappointed with his record on drugs and civil liberties.

But there can’t be any serious question about the fact that he did NOTHING effective to help the economy.  The US recovery is less than the old trend rate of growth.  Has that ever happened before?  The Fed’s been less inept than the ECB—that’s all.

And the supply-side?  Even his supporters would admit he did nothing there.  They might disagree with the view that a heavy dose of extra regulation, higher MTRs, and no Keystone pipeline slowed the recovery.  But no one claims those actions sped up the recovery.  And the fracking boom (“drill baby drill”) fell on his lap.

Just a few months ago Obama called for an “emergency” unemployment benefit of up to 73 weeks, much longer than during the President Clinton recovery, all because the labor market was doing so poorly nearly 6 years after he was elected.  And now a few months later they are touting their success in creating jobs—unbelievable.

It will be interesting to see how many liberals agree with him.

HT:  TravisV

A perplexing survey confirms all my priors

In the past I’ve pointed to New Hampshire as a sort of neoliberal model.  No income taxes, no sales taxes, very high levels of income, and less inequality than almost all other states. Indeed they have the richest poor of any state.  Even adjusting for ethnicity it does well, easily outpacing other mostly white states.  Now the OECD has come out with regional rankings of “well-being” measured “holistically.” In other words, just the sort of ranking liberals love.  And New Hampshire comes in number one in the US, at 77.6/90.  I don’t know how it ranks at the global level, but it seems to score above all other countries, but below certain regions like Canberra.

Speaking of Canberra, Australia seems to be number one among countries, at 76.5/90. (I’m not quite sure because I saw no totals, and quickly did math in my head.)  It’s one of my favorite countries, with just about the lowest level of government spending of any developed country (outside East Asia.) Small government may not produce high living standards, but sure it doesn’t prevent them.

The second highest state was Minnesota (76.2/90), which of course has a large Scandinavian population. Many progressive commenters tell me that the Nordic system is better than the American system because they have less inequality.  But Minnesota does much better than Sweden 68.7/90.)  Let’s be honest; Swedes are likely to do pretty well under any reasonable democratic system, and third world immigrants to Sweden don’t do very well at all.

So all my priors were confirmed.  Most bloggers would stop there.  But then I started digging into the data.  What does “civic engagement” mean?  I would expect ultra-democratic and ultra-decentralized Switzerland to easily lead the world.  Instead they scored 1.1 out of 10.  Turkey scores 8.8.  Perhaps credit is given to the “engagement” of Kurdish rebels.  I don’t think I’ve been to a cleaner country that Switzerland, which scores only 3.5 out of 10 on the environment. Austria only gets a 3.3.  In contrast, spotlessly clean Istanbul gets a 3.9, and Mexico an astounding 5.3.  Is this like golf, where a low score is better?

In other words, I have no idea what the OECD did to come up with these numbers. But since they confirm my priors I should probably just collect my chips and go home. 

Men with two feet on the ground

[Everyone:  Here's where we are on the NGDP project.  I anticipate it will take about a week to determine the best way of transferring funds to New Zealand, and whether they are tax deductible in the US. We are considering 6 contracts per quarter instead of 5.  The 6th would be a linear contract with a payout proportional to the percentage change between the first NGDP announcement (30 days after the quarter ends), and the level of one year NGDP earlier, as estimated on the very same day (thus using identical methods when changes like adding R&D to GDP have occurred.)  We are moving away from a focus on interest rate-bearing margin accounts, and toward ideas of reducing transactions costs, and/or perhaps a subsidy for winners. International money transfers to traders can be costly, are there any newer systems that are ideal?]

Nick Rowe recently pointed out that it’s not at all clear that we would even know how to recognize a central bank that was paying for government spending by printing money.  I can already anticipate some of the objections from practical men, those who earn a living in the real world. These are what Nick calls “people of the concrete steppes.”  They believe actions speak louder than words. They are scornful of all this talk of “confidence fairies,” expectations, guidance, signaling, etc., by pointy-headed intellectuals like Nick and me, working in our ivory towers.

OK, but here’s something else that all practical men of the world believe; helicopter drops “work.” Not that they necessarily create real GDP growth, but they at least create inflation.  Practical people are bored by endless debates over fiscal vs. monetary policy.  ”Look you people; just get on with the job of doing a combined fiscal/monetary expansion, everyone agrees that that will work. No one doubts that if you drop a trillion dollars out of a helicopter it will create inflation.”

There is just one problem with this practical view of the world.  It’s wrong.  Not possibly wrong. Not probably wrong.  It is certainly wrong.  And we know it is wrong because Japan did drop a trillion dollars out of a helicopter and it didn’t work.  They did an almost unbelievably large money-financed fiscal expansion over the past 20 years, and got DEFLATION, something any sane economist in 1994 would have said was impossible in a modern fiat money regime with a growing money supply and big fiscal deficits.  

Japan has increased its national debt to over 240% of GDP, and even about 140% in net terms (still among the largest in the developed world.)  And while doing so they increased their monetary base enormously.  For most of the period they weren’t even paying IOR, this was truly “printing money” to pay the government’s bills (or at least looked like it.)  You want “concrete steppes?”  The paved over much of the beautiful Japanese countryside with unneeded roads, and bridges to nowhere.  Larry Summers’ dream.  The reason they got deflation is that while the people of the concrete steppes think it’s easy to tell when a government has paid for spending by printing money, it’s actually very hard.

The “tell” here showing that the Japanese government was not permanently increasing the money supply to pay for spending occurred in 2006, a relatively good year in the otherwise bleak two decades.  Inflation had risen to zero and real GDP growth had been OK for about 4 years.   The BOJ (wrongly) feared inflation, and thus began raising rates.  With higher interest rates the bloated monetary base could cause high inflation.  So at the same time the BOJ reduced the monetary base by 20%.  Japanese investors understood that the BOJ would not allow inflation.  The money supply increase had been temporary.  What looked like “concrete steppes” were actually massive fiscal stimulus accompanied by temporary currency injections.  The fiscal stimulus was real, but it’s monetary policy that drives NGDP.  And temporary monetary injections are not effective.

So all you practical men of the world who believe in concrete steppes, I ask you the following question.  Which cherished belief are you going to give up?

1.  Concrete steeps are what matters, not expectations fairies.

2.  Huge helicopter drops will always create inflation.

PS.  Perhaps I was unfair to Nick when I lumped him in with me as a pointy-headed intellectual. He does know how to fix cars.  And even I’ve spent many thousands of hours doing construction, which is more than many Boston economists.