What should we expect from Fed officials?

I occasionally see comments from people who have an unrealistic set of expectations for Fed officials.

An institution like the Fed will tend to reflect the consensus view of economists. Back in late 2008, I was among perhaps a few dozen people in the entire world who blamed the Great Recession on a tight money policy of the Fed. Even today, that view is only slightly more popular, mostly due to the effort of market monetarist bloggers. It’s entirely unrealistic to expect Fed officials to reflect the views of market monetarists—that’s now how our system works. Nor will they reflect the views of other obscure groups, like MMTers or fans of the fiscal theory of the price level. That’s why I favor NGDP level targeting, it’s a regime that will lead to pretty good results under almost any competent leadership.

I’m not saying the people appointed to the Fed don’t matter at all. Bernanke did better than Volcker or Greenspan would have done (based on their public comments during the Great Recession), and better than the average economist would have done. Mario Draghi did better than Trichet. But for the most part, Fed policy merely reflects the consensus view of economists and financial market pundits. Don’t expect anything more than that.

David Beckworth recently interviewed Neil Irwin, who pointed out that Bernanke was under a lot of pressure to adopt a more contractionary policy.  He also noted that while Trump has criticized the Fed for raising rates, he has also appointed Marvin Goodfriend to the Fed, a relatively hawkish economist.  Obama also appointed several people who were more hawkish than Bernanke.  If Trump wants dovish policies then he might try appointing doves.

Over at Econlog, I have a “Ted talk” on the future of money.

Is populism popular? Has it peaked?

I don’t know the answer to these questions, but Simon Kuper presents an interesting contrarian view:

Sometimes, our street is so packed with protesters that you can hardly open the front door. But last Saturday, I gingerly stepped outside to encounter only a few hundred marchers in gilets jaunes (yellow vests). Later, on TV, I watched the tear gas and shoving on the Champs-Elysées. But the odd aerial camera shot revealed that the Champs was mostly empty. Friends abroad asked if we were safe. We were: I spent half the weekend freezing on suburban touchlines watching my kids play football.

About 10,000 gilets jaunes marched in Paris and 125,000 across France, says the government. That same day, the green “march for the climate” drew about twice as many protesters in Paris

His observation on the US election is also interesting:

Populist movements may be the past, not the future. In November’s midterms, Trump’s Republicans lost the popular vote for the House of Representatives by 8.6 per cent — the biggest defeat for a majority party since records began in 1942. Meanwhile, as Brexit becomes increasingly hilarious, polls consistently show that most Britons now oppose it. Approval of the EU across the rest of Europe is the highest since 1983, says the European Commission’s polling wing.

Don’t assume that “the populists” are equivalent to “the people”.  Hillary got millions more votes than Trump.  The French gas tax increase was defeated, but worry about climate change is extremely widespread:

The new obsession with white-working-class politics misses much else. If you’re worried about poverty, look at very poor non-whites. And if you want to identify movements of the future, try the greens. For a so-called elitist movement, they seem pretty broad-based. About two-thirds of French people say they support the gilets jaunes, but 85 per cent worry about climate change, according to pollsters Ifop. In Germany, the much fussed-over far-right Alternative für Deutschland party now polls at 14 per cent; the Greens are six points higher. German anti-immigrant rallies (like Tommy Robinson’s British versions) are typically dwarfed by protests against them.

Scott Alexander has a post showing that Trump’s views on trade and immigration are becoming less and less popular.  I made a similar observation about 20 months ago.

Speaking of Alexander, another of his posts provides an almost perfect example of how commenters misinterpret my views:

Imagine the US currently devotes 100% of its defense budget to countering Russia. Some analyst determines that although Russia deserves 90% of resources, the Pentagon should also use 10% to counter China. Since no one person can shift very much of the defense budget, this analyst might spend all her time arguing we need to counter China more, trying to convince everyone that China is really very dangerous; if she succeeds, maybe the budget will shift to 99-to-1 and she’ll have done the best she can. But if she really spends all her time talking about China, this might look to other people like she’s an extremist – that crazy single-issue China person – “Why are you spending all your time talking about China? Don’t you realize Russia is important too?” Still, she’s taking the right strategy, and it’s hard to figure out what she could do better.

Because I’m trying to talk the US out of starting a foolish cold war with China, I’m seen as an apologist for Xi Jinping’s authoritarian policies.  In fact, I view almost all countries as being too authoritarian (think of the 400,000 Americans in jail for drug violations), and China as being far too authoritarian, much worse than the US.

What’s the problem?

The problem isn’t the recent decline in equity prices; the stock market tends to be more volatile than the underlying economy.  Nor is it the recent increase in the fed funds rates (2.4% isn’t very high in an economy growing at 5.5% in nominal terms.)  Rather, the problem is two-fold:

1. Unrealistic forward guidance, which ignores market forecasts.

2. Too much inertia in adjustments in the fed funds rate.

Elsewhere I’ve argued that the second factor may explain the strange absence of mini-recessions in postwar US history.  And this absence is really, really strange.  Just imagine how perplexed geologists would be if the Earth had no small earthquakes, only large ones.  What model could possible explain that? I’ve argued that the sluggishness in the response of interest rates might explain why it is that when we start to slide into a recession we never seem to stop halfway, with the unemployment rate rising by only 0.9 to 2.0 percentage points.

The fed funds rate is currently around 2.4%, and the market forecasts a rate of 2.3% out in July 2020.  That forecast is down sharply in recent months, although still not in recession territory.  Unfortunately, the Fed is forecasting two rate increases next year, and the markets seemed to react poorly to Powell’s attempt to explain this forward guidance.  Even worse, the Fed is often reluctant to change course, because of a perception that it reduces credibility.  Just the opposite is true.  The credibility that matters is the Fed hitting its macro targets, not its interest rate forecasts.

Earlier I suggested the following reform:  Each day, have every FOMC member email their preferred IOR rate, calculated to the nearest basis point.  Set the IOR at the median vote.  Tell the market that the rate will likely follow something close to a random walk, with an increase on one day often followed by a decrease the next.

Looking further ahead, my preference would be to have the Fed entirely cease its targeting of interest rates and let the market determine the appropriate rates.  Instead, the Fed would give the New York open market desk the following instructions:

1.  A range for one year NGDP growth–say 3.5% to 4.5%.

2.  Instructions for the New York Fed to take unlimited short positions on NGDP futures contracts at 4.5% and unlimited long positions at 3.5%.

3.  Instructions to do open market purchases and sales (with Treasury securities) in such a way as to avoid losses in their trading of NGDP futures contracts.

That’s all.  Let the market set interest rates; they are much better able to determine the appropriate fed funds rate.

OK Fed, you’ve got a landing. Now let’s make it “soft”.

PS.  As I contemplate the Fed’s current (flawed) policy regime, I feel sad and blue:

Screen Shot 2018-12-25 at 12.59.20 PMTyler Cowen recently linked to an article on the Chinese industry of copying famous oil paintings. This is a detail from an oil painting I purchased in China, for about $15 dollars.  It hangs in my office.  In downtown LA, people spend thousands on paintings by hip new artists.  I can get better art in China for a tiny fraction of the price. You might argue that they aren’t really buying art, they are buying a story.  And “I support hip young artists” is more appealing than “I buy Chinese knockoffs of famous paintings.”  Fortunately, I don’t care what other people think of my taste in art.

Merry Xmas and Happy New Year

PPS.  You want a Christmas theme?  Here’s an even better painting (by Titian), recently restored to its former glory:

Screen Shot 2018-12-25 at 3.54.49 PM





Where are people moving? And why?

Over at Econlog, I have a post discussing the slowdown in US population growth, to 0.6% in 2018 (the slowest growth rate since 1937.)  A WSJ article also had some interesting data on state growth rates:

Screen Shot 2018-12-20 at 7.49.53 PMThe footnote on Puerto Rico is rather striking, as its population fell by 4% last year.  That was partly due to hurricane Maria, but its population has been plunging for many years, down about 14% since 2010.  Who’s going to pay off that enormous debt, and will the last Puerto Rican please turn out the lights? Hawaii is also losing people, as are Mississippi and Louisiana.  So the “Sunbelt” phenomenon is more complex than advertised.

Other trends:

1.  Mormons have lots of kids.  The four fastest growing states are all in the top five in terms of percentage of the population that is Mormon, although only in Utah and Idaho are they numerous enough to dramatically impact population growth.  (The other top five Mormon state (Wyoming) is losing people.)

2.  Illinois has been losing about 40,000 people each year, while other Midwestern industrial states like Michigan and Ohio keep growing (albeit slowly).  What makes this surprising is that Illinois is dominated by one of the few Midwestern industrial cities to successfully reinvent itself.  Chicago has a thriving lakefront area full of high paying jobs, while Detroit, Flint, Cleveland, Akron and Dayton have languished.  This Illinois underperformance may reflect the extraordinary incompetence of the Illinois state government, which is driving the state toward a fiscal crisis.  Illinois is dominated by Cook County, which has a corrupt political culture.

3.  As recently as 2013, New York had more people than Florida.  Now Florida has 1.75 million more than New York.  Indeed 35% of US population growth now occurs in Florida and Texas.

4.  The sunny, oil-rich states that border Texas continue to do very poorly, either falling in population or growing much more slowly than the national average.  Texas probably benefits from a mixture of no state income tax, lax zoning, and business friendly regulations.  While other inland states also have cheap housing prices, Texas has cheap housing prices in big urban areas.

5.  It now seems like the lack of a state income tax doesn’t provide much gain to states without a big city, such as Alaska, Wyoming and New Hampshire.  The exception is South Dakota, which is doing modestly better than its neighbors.  In contrast, states with big cities and no state income tax (Texas, Florida, Nevada, Washington, Tennessee (on wages)) tend to grow faster than their neighbors.  I think that’s because the lack of a state income tax is especially attractive for the sort of high paid professionals that live in big cities.

6.  The recent federal tax reform will raise the effective top rate on the California state income tax from about 8% to 13.3%.  Many rich people (like me) will continue to choose California, due to its amenities.  But at the margin, a few more will make the switch to Austin or Seattle or Vegas.  California always used to grow faster than the US as a whole.  Even when whites started leaving for other states, the overall California population kept growing at a good clip due to international migration.  But now its growth rate (0.4%) has fallen below the national average.  Eventually, California may begin losing Congressional seats.

7.  Today, most of our population growth is in three areas.  The southeast (Raleigh to Miami), four big Texas metros, and the non-California west (the Denver/Seattle/Phoenix triangle.)

What are the odds that the world’s two richest guys would live in the same medium size city, in the only liberal state without a state income tax?


A very subtle distinction

It will be easier to understand this post if you first read the previous post.  The Fed delivered two monetary shocks today.  The first occurred at 2:15pm, and caused yields on 2 and 5 -year bonds to increase.  The second occurred about 30 minutes later, and caused yields on 2 and 5-year bonds to fall back, and end the day slightly lower.  And yet both shocks seemed “contractionary” in some sense.  Obviously there are some very subtle distinctions here, which require an understanding of Keynesian and Fisherian monetary shocks. More specifically, the first shock was Keynesian contractionary and the second was Fisherian contractionary

At 2:15 the Fed raised its target rate as expected, and also indicated that another two rate increases are likely next year.  This announcement was a bit more contractionary than expected, especially the path of rates going forward.  As a result, 2 and 5-year yields rose, while 10-year yields fell on worries that the action would slow the economy, eventually leading to lower rates.

Later, the markets became increasingly worried that the Fed was not sufficiently “data dependent”, that it would plunge ahead with “quantitative tightening” and that the Fed stance on rates (IOR) would be too contractionary.  Watching the press conference, I had the feeling that Powell might have wanted to be a bit stronger in emphasizing that no more rate increases are a clear possibility, but felt hemmed in by his colleagues at the Fed.  But perhaps I was reading into it more than was there.  In any case, Powell said “data dependent”, but didn’t really sell the markets that he was sincere, or as sincere as the market would wish.  This monetary shock probably reduced NGDP growth expectations, and drove 2 and 5 year yields lower.

Do you see how utterly inadequate it is to talk about monetary policy in terms of interest rates?  Even the “sophisticated’ new Keynesian view that it’s the future path of rates that matters is nowhere near adequate.  The 2 and 5-year yields can go up with tightening, or they can go down with tightening.  Today they did a bit of both, within one hour.

If you insist on using Keynesian language, you might say the 2:15 action tightened primarily by raising expected future rates relative to the natural rate, by raising the expected path of the policy rate.  In contrast, the press conference impacted the gap by depressing the natural interest rate by depressing NGDP growth expectations.

PS.  The discussion on CNBC involved lots of people dancing around the “circularity problem”, i.e. the Fed looking at markets while the markets look at the Fed.

PPS. I laughed when a CNBC person suggested Trump might use the Fed as a “scapegoat”.  Hello, who appointed all the top Fed officials?  Has scapegoating the Fed ever worked for any President, even when they weren’t his appointees?

Update:  I forgot to mention Powell’s most interesting comment.  He says the Fed reappraisal of policy techniques planned for this summer in Chicago will look at the zero bound problem in monetary policy.  I view that as really good news.