Archive for the Category Forecasting


How many times?

Here’s Tim Duy at Bloomberg:

It was supposed to be easy. When the Federal Reserve started hiking the federal funds rate, longer-term interest rates would rise. After all, they were at very low levels, restrained by a low-term premium. The “Greenspan conundrum” of the past two cycles, when long rates failed to respond in line with higher short rates, couldn’t happen a third time in such circumstances. But it didn’t work out that way. Short rates continue to gain on firming expectations of tighter Fed policy while long-rates stubbornly track sideways.

How many times does this have to happen before people stop assuming that higher interest rates represent tighter money?  In fact (as Duy suggests) a tighter monetary policy will often put downward pressure on longer term rates (relative to short rates):

We shouldn’t be surprised by the flattening yield curve. That is what typically happens during tightening cycles and there was no reason to think it would not be the case this time.

Longer term bond yields tend to track expected long-term NGDP growth, although of course other factors also play a role.  But expected NGDP growth is by far the most important factor, and largely explains why long-term rates are much lower than during 1972-81, when NGDP was growing at double digit rates.  And tighter money tends to slow expected NGDP growth.

The yield curve is one of the better predictors of the business cycle, but it’s not perfect.  The current yield curve is flatter than usual, but not flat enough to predict a recession.  (Research suggests that it would need to be substantially inverted to signal a recession is more than 50-50.) Given that stocks are doing quite well, I’d say that the consensus view of the financial markets is that a recession is unlikely during the next few years, but not impossible.

Duy also points to the continued undershoot of inflation:

Arguably, though, the Fed only reinforces expectations that 2 percent is a ceiling with its commitment to rate hikes even as inflation remains below that level. In fact, monetary policy makers appear dead set to continue rate hikes next month, and into 2018. The message sent is that they stand ready to snuff out any expansion that threatens to push inflation above 2 percent.

It’s difficult to evaluate Fed policy in isolation; one needs to consider the regime over an entire business cycle.  Thus the current sub-2% inflation rate is entirely consistent with the dual mandate, assuming that inflation is appropriately countercyclical (which is what the mandate implies.)  But in the past inflation has tended to be procyclical (in violation of the dual mandate), in which case current policy is inappropriately tight.

So how do we know if the Fed policy today is appropriate?  We don’t know, and won’t know until the next recession.  If inflation rises during the next recession, then current policy will have been appropriate—even though inflation is now under 2%.  If inflation falls during the next recession then current policy will have been inappropriately tight. Based on past experience, the latter assumption is more plausible, but again, current policy is exactly right if the Fed were taking its dual mandate seriously.  That mandate calls for slightly above 2% inflation during periods of high unemployment, and slightly below 2% inflation during periods of low unemployment.  And right now unemployment is well below average.  The dual mandate calls for sub-2% inflation at this point in time.

The crybabies who blamed economists for not predicting the financial crisis

Back in 2008, it seems like everyone from the Queen of England on down was blaming economists for not predicting the financial crisis.  I seem to recall that Bob Lucas pointed out that economic theory explains why economists cannot predict financial crises, so our failure to do so was a feather in the cap of modern economic theory.  I also seem to recall that lots of people rolled their eyes at his seemingly too clever excuse.

In the past I’ve argued that Lucas was exactly right, but in this post I’ll assume he was wrong.  I’ll assume the EMH is wrong.  Even in that case I’m going to argue the complaints were silly, just a bunch of crybabies.

So how do I respond to those people who are moaning that we didn’t warn them that a crisis was coming?  One answer is that some economists, such as Nouriel Roubini, did issue warnings.  But then the crybabies might respond, “But most economists didn’t warn us.  How were we to know that he was the one to listen to? The economics profession as a whole should have issued a warning, so that it was unambiguously clear to the public that a financial crisis was coming.”

To summarize, a few economists did warn the public, so the crybabies’ lament only makes sense if you assume that these people wanted the profession as a whole to offer a clear credible warning to the public.  Something that would be believed.

Were you the sort of person who believed in Santa Claus, and thought he would bring you a fairytale castle floating on a cloud, with unicorns prancing about in front?  If not, why would you make such a patently unrealistic demand of the economics profession?

You wanted us to warn you that a big financial crisis was coming so that you could sell all your stocks before they went down?  I ask this because a prediction of a severe financial crisis is implicitly also a prediction of a massive asset price collapse.  So the people complaining that economists didn’t predict the financial crisis are (whether they know this or not) effectively complaining that economists didn’t warn them that their 401k plan was about to lose a few hundred thousand dollars.

Let’s suppose we have a time machine and economists from October 2008 can go back 6 months in time, to April 2008.  They are told to warn the public that a massive financial crisis is coming in the fall.  They warn the public that Lehman won’t be bailed out, and its failure will trigger a rush for liquidity and a Great Recession.  What exactly would that warning have done, other than move those events up 6 months in time?  Then the crybabies would have asked why we didn’t warn them in October 2007 (assuming they didn’t lynch the economists for causing the crash.)

And as for those stocks you were going to sell if economists had warned you of the crash—just who did you plan to sell them to?  And at what price?

A better argument is that the economics profession didn’t warn the public that public policy was creating excessive lending, as Fannie and Freddie and FDIC and TBTF were creating moral hazard.  In fact, I did warn people I met about this problem (but I completely failed to forecast the financial crisis.)  Some other economists also warned about moral hazard, but not all.  But no one wants to listen to a bunch of killjoy economists on public policy questions.  It would be like blaming economists for tariffs, or rent controls.

When I explain to non-economist commenters what economic theory tells us about some public policy, they almost universally blow off my advice, unless it coincides with their pre-existing view on that particular public policy.  No one cares what economists think, so don’t blame us for areas where we have no control.  (Monetary policy is a different case; there the economics profession actually deserves far more blame than it’s gotten from the public.)

PS.  I see that Trump threw a temper tantrum when his aides told him that Iran had been adhering to the nuclear agreement.  We now have an administration with no ability to negotiate because no one trusts them to keep their word.  The focus of his top aides is not dealing with foreign crises but rather managing unnecessary crises created by an out of control and mentally ill president.  North Korea knows we’ll renege on any agreement we sign with them, and so a nuclear deterrent is their only option.  Meanwhile they show their population images of Trump threatening to destroy their country.

Meanwhile Trump has abandoned the utilitarian approach of the Obama administration and the slaughter of innocent civilians has been skyrocketing:

Airwars reports that under Obama’s leadership, the fight against ISIS led to approximately 2,300 to 3,400 civilian deaths. Through the first seven months of the Trump administration, they estimate that coalition air strikes have killed between 2,800 and 4,500 civilians.

Trump seems like excellent black comedy to me, but unfortunately there are lots of dead women and children for whom he is no joke.

PPS:  New Flash:  Americans horrified to discover Hollywood producer behaving like a President of the United States.  Hillary and Fox News particularly disgusted by this behavior.

PPPS:  Another gem:

Speaking over the phone, Mr Reich said he asked his friend whether other Republican senators were preparing to follow Senator Bob Corker and “call it quits with Trump”.

His source told him: “Others are thinking about doing what Bob did. Sounding the alarm. They think Trump’s nuts. Unfit. Dangerous.” . . .

“Tillerson would leave tomorrow if he wasn’t so worried Trump would go nuclear, literally,” he added.

“Who knows what’s in his head? But I can tell you this. He’s not listening to anyone. Not a soul.

“He’s got the nuclear codes and, well, it scares the hell out of me. It’s starting to scare all of them. That’s really why Bob spoke up.”

Trump ran for President as a crazy man, and we are shocked to discover he is governing as a crazy man?

In the long run we’re all rich, free and peaceful

It’s intellectually fashionable to be pessimistic, so let me push back with one of my occasional contrarian posts.  I’ll try to defend Fukuyama’s “End of History” hypothesis one more time.  Let’s start with peaceful:

1. A new study shows that the Kellogg-Briand Pact (1928), which outlawed war, has been highly effective. If you took history in high school, you might recall your teacher make fun of the touching naiveté associated with this utopian treaty.  Well it looks like Kellogg and Briand might get the last laugh.  First a bit of background.  The act was intended to change the rules of war.  Previously, countries were allowed to keep territory they conquered.  It was wars of aggression that were outlawed, not civil wars, not wars to prevent proliferation of WMD, not wars aimed at preventing genocide.  And wars of conquest (which were common throughout almost all of human history), have almost stopped happening (with Russia’s recent acquisition of the Crimea a notable exception, and even that was not particularly violent.)

So the world is getting more peaceful.

2.  It’s fashionable to say that freedom is a western concept, and Fukuyama’s prediction doesn’t apply to the rest of the world.  People point to China’s one child policy, or Saudi Arabia’s unwillingness to let women drive.  I’m with Zhou En Lai; it’s too soon to say.  China recently abolished its one child policy, and today Saudi Arabia granted women the right to drive.  Maybe progress will stop and no more freedoms will be achieved in the non-Western world.  But my hunch is that modern technology will gradually make the world more liberal, by beaming images of successful western societies to everyone who has a smart phone.

So the world will get freer, even if the past decade has been a mixed bag.

3.  Here’s Tyler Cowen expressing pessimism about economic progress in poorer areas:

Increasingly, it seems that many parts of the Western world might never “catch up,” including Greece, southern Italy, much of the Balkans and much of Latin America, in addition to Puerto Rico. One of the pleasing features of the 1990s, in retrospect a delusion, was the notion that proper policy and good multilateral institutions would bring most of the world into consistent, steady-state growth at a higher rate than what the wealthier countries could manage.

I agree with most of what Tyler said about Puerto Rico, including his view that’s it’s future currently looks quite bleak.  But I find this paragraph to be far too pessimistic, and not even consistent with the data:

a.  Since 2000, the developing world has grown faster than the rich world.  Yes, that’s partly China, but it also includes lots of other populous Asian countries.  And Asia is perhaps 70% of the developing world.  Parts of Africa have also done pretty well since 2000.  But what makes this claim especially dubious is his reference to “proper policy”.  Most of the developing world rates far below the US in economic freedom (including freedom from corruption).  And those few countries that score high on the good policy scale (such as Chile and Estonia) have had a pretty good couple of decades.  If you want an African example, compare the growth rate of Botswana and Zimbabwe in recent decades.

b.  Yes, there are good reasons (including culture) to be pessimistic about the near term prospects of Greece and southern Italy.  But in 1970 there were good reasons (including culture) to be pessimistic about Ireland.  You might say that the Irish were always capable of much better, as evidenced by their success in America.  But Greeks and southern Italians have also been quite successful in America.  You might argue that corruption will keep Greece and southern Italy poor.  Yes, but for how long?  China is much more corrupt than Singapore, and much poorer.  But Singapore is also ethnically Chinese, and rooted out corruption through a determined effort of the government.  Corruption is not baked into the genes of the Chinese people.  Might the Chinese government be able to root out corruption? I don’t know, but the current leadership seems to be making an effort.

My point here is that “never” is a really long time.  If Tyler had said that Greece and southern Italy would remain relatively poor for another 80 years, I’d have no reason to disagree.  But another 80,000 years?  Who knows?

In the early 1940s the Kellogg-Briand Pact look like a pathetic failure.  Now it looks like a success.  Yesterday, it looked like Saudi women would remain oppressed.  Today there seems to be hope that they might start achieving more equality.  The arrow of history is still pointing toward more wealth, freedom and peace.  The real risk we face is not stagnation, but rather a sudden crisis that catches us unaware, like terrorists getting a WMD.

HT:  Scott Alexander, who also linked to this mind-boggling article:

The number one food exporter in the world is the United States. The number two food exporter in the world is the Netherlands, 1/270th the size and mostly urban.

Update:  Maybe not–check out comment section.

No workers = no growth

Today’s jobs report showed the unemployment rate falling to 4.3%.  That’s lower than at any time during the housing boom.  It’s almost as low as the peak of the tech boom.  Indeed, other than during a brief period around 2000, it’s the lowest unemployment rate since the 1960s.  Even the U-6 rate is back to the levels of the summer of 2006.

So we must be producing lots of jobs, right?  No, payroll employment rose by just 138,000 in May, well below the pace of the previous 7 years.  Yes, one month is not significant, but job growth over the past three months has averaged only 121,000. Companies cannot find workers.

In 2018, we’ll look back on these job gains as boom numbers, as things are going to get even worse.  And if Trump cracks down on immigration, growth will slow to a near standstill.  The second quarter GDP numbers are expected to be strong, but don’t be fooled by that (seasonal) head fake—we are entering a very slow growth period.

After Trump was elected there was a big “reflation trade” and the 10-year bond yield rose to over 2.6%,  Today it’s down to 2.17%, as the yield curve gets flatter and flatter.  At the time, I thought people were forgetting about monetary offset. But even I missed the fact that Trump was too incompetent to get his supply side package through Congress.  I expected a few tenths of a percent more RGDP growth, now I doubt even that.

So why are stocks doing well?  In my view it’s the same story as what we’ve seen since 2009:

1.  Markets are gradually realizing that ultra low interest rates are the new normal.

2.  In the “FANG” economy, American corporations don’t need fast growth to make big profits.


1. This will end up being the longest economic expansion in American history.

2. This will end up being the weakest economic expansion in American history.

3.  Interest rates will stay low.

4.  Unemployment will fall to 4%.

5.  Inflation will stay low (because the Phillips Curve model is wrong.)

6.  Janet Yellen will end up producing the most stable rate of NGDP growth of any Fed chair in American history.

PS.  Unlike during 2008-14, there’s nothing wrong with the current stance of monetary policy—the problem is the regime.


Lars Christensen’s new market monetarist newsletter

Lars Christensen has a new newsletter called the Global Monetary Conditions Monitor, which I highly recommend for people interested in international monetary policy.  It is by subscription at this link, but Lars is allowing me to quote from the newsletter.  (There is a discount for academic users and think tanks.)

Lars has constructed a monetary conditions index for a wide range of currencies. This basically measures whether the current stance of monetary policy is too easy or too tight to hit the target.  (A value of zero means right on target.)

On pages 8 and 9 of the May issue there is a discussion of policy credibility:

The approach here is to evaluate a central bank’s credibility based on our monetary conditions indicators.

We consider a central bank to be credible if it succeeds over time in keeping the monetary indicator close to zero. This can be measured by how long each central bank keeps the indicator within a range between -0.25 and 0.25 over a rolling five year period. This also means a central bank’s credibility can and will change over time.

By this criterion, the central bank of New Zealand has the highest credibility:

This can be illustrated by looking at developments in New Zealand over the past five years.

If monetary policy is (highly) credible, we would expect monetary conditions to be ‘mean-reverting’ – meaning that if the monetary conditions indicator is above (below) zero, we should expect it to decline (increase) in the subsequent period.

This is precisely the case for New Zealand. The graph below shows monetary conditions in New Zealand six months ago and how they changed over the following six months.

The line should go through zero, with most of the points being in the upper left and lower right quadrants.  To give you a sense of what a lack of credibility looks like—consider Turkey, one of the least credible central banks:

Maybe Lars will eventually incorporate the Hypermind NGDP forecast into his analysis.