Archive for the Category Forecasting


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.

Hard data beats sentiment in Q1

For the past 3 months there’s been a raging battle between the Atlanta Fed and the New York Fed.  The Atlanta Fed relies mostly on hard data when predicting GDP growth, whereas the New York Fed puts relatively more weight on consumer sentiment.  Republicans became much more optimistic after Trump was elected, so the sentiment indicators pointed to much stronger growth than the hard data indicators.  The following graph shows the huge divergence that developed in recent weeks:

Screen Shot 2017-04-28 at 10.14.15 AMThe actual growth was only 0.7%, which was much closer to the bearish Atlanta Fed’s 0.2%, than the New York’s Fed’s bullish 2.8%.  This reminds me a bit of the post-Brexit vote growth in the UK.

I don’t like either hard data or sentiment; I like market forecasts.  Unfortunately we lack a NGDP futures market (I’m working on setting one up again, and will have an announcement soon), but we do have some market indicators.  The preceding graph and the following quotation were from an April 12 article:

Tying in with the earlier point, the rally in the ten-year bond is consistent with the Atlanta Fed’s forecast for low growth in Q1.

So the bond market seemed to sense that growth was weakening.

Is it too early to attribute any of this to Trump?  I’d say so.  But the Trumpistas all crowed in early February when the strong January jobs report came in.  This was attributed to the magic powers of Trump, despite the fact that he had not even taken office when the January survey was conducted.  I don’t know how they’ll reconcile this GDP report with their dreamy predictions of 4% growth as far as the eye can see, but I’m sure they’ll think of something.

There’s likely to be some bounce back in Q2 (poorly measured seasonality depressed Q1), but I’m sticking with my view that America’s new trend RGDP growth rate is 1.2%, or 1.5% if Trump succeeds in getting his supply-side reforms passed.

PS.  Core PCE is up 2% over the past year, so the Fed is hitting both its price and employment targets.  For the moment, they are fulfilling their dual mandate. That’s a problem for Trump, who needs some Arthur Burns-style recklessness to paper over his personal incompetence when it comes to developing supply-side policy reforms.

Update:  I got the core PCE inflation data from the FT.  Ant1900 points out the true figure is 1.7%, still below target.

PPS.  I have a new post at Econlog explaining job shortages.

Print the legend

As I get older, I become increasingly interested in the mythological folktales that are believed by most economists.  For instance the idea that LBJ refused to pay for his guns and butter program, ran big deficits, and kicked off the Great Inflation.  All you need to do is spend 2 minutes checking deficit data on FRED to know that this is a complete myth, but apparently most economists just can’t be bothered.

Screen Shot 2016-05-04 at 10.23.16 AMDuring the 1960s, the budget deficit exceeded 1.2% of GDP only once, in fiscal 1968 (mid-1967 to mid-1968.  LBJ responded with sharp tax increases in 1968, and the deficit immediately went away.

The LBJ guns, butter and deficits story is too good to drop now, it’s in all the textbooks. It would be like admitting that the textbooks were wrong when they tell students that the classical economists believed that money was neutral and that wages and prices were flexible.  We can’t do that, it’s too confusing.

Another one I love is that monetary policy impacts the economy with “long and variable lags”.

I’ve talked about this before, but today I have a bit more evidence.  The idea that monetary policy affects RGDP with long and variable lags has three components, one or more of which must be true for the theory to hold:

1.  Monetary policy affects NGDP expectations with a long and variable lag.

2.  Changes in NGDP expectations affect actual NGDP with a long and variable lag.

3.  Changes in actual NGDP affect actual RGDP with a long and variable lag.

All three are false.  The third claim is obviously false; NGDP and RGDP tend to move together over the business cycle.  So the entire theory of long and variable lags boils down to the relationship between monetary policy and NGDP.

The first claim is also obviously false, as it would imply a gross failure of the EMH. Now the EMH is clearly not precisely true, but it’s also obvious that market expectations respond immediately to important news events.  Even EMH critics like Robert Shiller don’t claim that an earnings shock hits stocks two week later; it hits stock prices within milliseconds of the announcement. That part of the EMH is rock solid.  There is no lag between policy shocks and changes in expectations of future NGDP growth.

So the entire long and variable lags theory rests on the second claim, that NGDP responds with a lag to changes in future expected NGDP.  Unlike the first and third claim, that’s possible.  But it’s also highly, highly unlikely.  While we don’t have an NGDP futures market, the markets we do have strongly suggest that markets (and hence expectations) move with the business cycle, not ahead of the cycle.

Perhaps the best period to test this theory is the 1930s.  That decade saw massive RGDP and NGDP instability, which was clearly linked to asset price changes.  Put simply, the Great Depression devastated the stock market.  Here’s the correlation between stock prices and industrial production, from my new book:

Screen Shot 2016-05-04 at 10.42.33 AMThe stock market is clearly not a leading or lagging indicator; it’s a coincident indicator.  And that’s not just true in the 1930s; it’s also true today:

Screen Shot 2016-05-04 at 10.48.03 AMThe onset of the recession lines up, as does the steep part of the recession.  The stock recovery in 2009 did lead by a few months, but the recent slump in IP led stocks by a few months.  In any case, there are no long and variable lags; it’s basically a roughly coincident indicator when there are massive changes in NGDP.

If there actually were long and variable lags between changes in expected NGDP and changes in actual NGDP (and RGDP), then forecasters would be able to at least occasionally forecast the business cycle.  But they cannot.  A recent study showed that the IMF failed to predict 220 of the past 220 periods of negative growth in its members.  That sounds horrible, but in a strange way it’s sort of reassuring.

Suppose that the business cycle is random, unforecastable, as I claim.  And suppose that declines in GDP occurred one out of every five years, on average.  In that case, the rational forecast would always be growth.  As an analogy, if I were asked to forecast a “green outcome” in roulette, I never would.  Each spin of the wheel I’d forecast red or black.  I’d end up forecasting 220 consecutive “non-greens” outcomes.  And yet, there would probably end up being about 11 or 12 green outcomes during that period, and I’d miss them all.  A 100% failure to predict greens.  Because I’m smart.

Of course if there really were long and variable lags, say 6 to 18 months, then there would be occasions where the IMF would notice extremely contractionary monetary policy, and accurately predict recessions a year later.  I’m not saying they’d always be accurate. The lags are “variable” (a cop-out to cover up the dirty little secret that there are no lags, just as astrologers cover their failures with the excuse that their model is complicated, and doesn’t always work.)  No, they would not always be successful, but they’d nail at least some of those 220 recessions.  But they predicted none of them. And that’s because there are no lags.  Because recessions begin immediately after the thing that causes recessions happens.

That’s the message the markets are sending loud and clear.  But economists can’t be bothered; they have their comforting stories. Who can forget this line from The Man Who Shot Liberty Valance:

Ranson Stoddard: You’re not going to use the story, Mr. Scott?

Maxwell Scott: No, sir. This is the West, sir. When the legend becomes fact, print the legend.