Recessions are not forecastable

I’m seeing too many people assuming that a recession will occur within the next year or so. That’s certainly possible, but let’s not lose sight of the fact that recessions are not forecastable.

This looks like a trend, doesn’t it?

I’ve argued that long term interest rates reflect NGDP growth.  That’s presumably still true, but the linkage seems to be weakening in recent years.  NGDP growth since the mid-1990s has not slowed anywhere near as much as the decline in 30 year bond yields:


For most of the 1990s, 30-year bond yields were in the 6% to 8% range, despite NGDP growth running only about 6%. Now the yields have fallen to 2%, despite NGDP growth of roughly 4%.

The inflation trends are even more startling. Core PCE inflation hasn’t slowed at all in the past 20 years (which surprised me), and thus real interest rates have fallen especially sharply. Here’s 12-month core PCE inflation:

The 5-year TIPS spread is running about 1.35%, which implies about 1.1% PCE inflation (as PCE inflation is at least 0.25% below the CPI inflation used to adjust TIPS.) That just seems weird. Obviously the TIPS spread is not measuring inflation expectations, as it seems very unlikely that PCE inflation will average only 1.1% over the next 5 years. (I’d guess about 1.8%.) I’m told by people who work on Wall Street that investors simply don’t like TIPS. Thus I believe that real interest rates on conventional bonds have probably fallen by even more than the decline in 30-year yield TIPS yields

The interest rate situation is certainly weird, but that doesn’t tell us much about whether they’ll be a recession. In a month or so there’ll be a new NGDP prediction market, which will add a useful forecasting tool.

PS. I used core PCE inflation, as most economists believe that core inflation is a better predictor of future headline inflation than is headline inflation itself.

A proposed three team trade

Here’s my proposed trade:

Denmark sends Greenland to the US, along with a future second round pick.
The US gives Alaska back to Russia.
Russia sends Kaliningrad and two star hockey players to Denmark.

The US (i.e. Trump) gets bragging rights as the second biggest country, surpassing Canada. Plus a neat new vacation spot. Alaska cruises are getting boring—Greenland’s a new toy to play with.  With global warming, it might eventually become as interesting as Iceland.  And there’s oil!

Russia gets to reverse the embarrassing decision to sell Alaska to the US.  Russia gets even bigger (macho Putin will like that.)  And they aren’t really giving up any Russian territory, as Kaliningrad is actually the old German city of Konigsberg.

Denmark gets to dump an area that is heavily subsidized, and was falsely marketed to them as being “green”. In any case, the Danes are probably too environmentally progressive to ever exploit the oil. And they get to recreate the really neat Hanseatic League, creating a free port that will become the Singapore of the Baltic.

PS.  Japan might want to get involved, to get its islands back from Russia.

PPS.  I stole this idea.

The Fed thinks it’s smarter than the markets

We’ll see . . .

PS. I have a post on low rates over at Econlog. The good news is that the post suggests that money’s not quite as tight as it might look based on bond yields. The bad news is that money is still too tight.

PPS.  Here’s a Paul Krugman tweet, discussing the Fed rate increases of 2017-18:

If you wonder what a negative fiscal multiplier caused by excessive monetary offset looks like, Krugman is describing it. I actually don’t quite agree, I believe the rate increases were appropriate, except perhaps the last one. But even in that case the main problem was bad forward guidance after the December 2018 meeting. Once that was corrected, things were OK. Until they weren’t.

In other words, on this particular fiscal stimulus issue I’m slightly more “Keynesian” than Krugman.

PPPS. As far as I can tell from the tweet thread, I pretty much agree with Krugman on the recession risk. Significant, but perhaps less than it looks.

PPPPS. America’s never had a soft landing, and (at least since WWII) we’ve never had a mini-recession. Other countries experience these sorts of events. Because we are in uncharted territory, with the longest expansion ever, we need to consider the possibility that one of these unusual events might occur.

(Trade) war, children, it’s just a tweet away

When I listen to the Rolling Stones, I often cannot understand the lyrics. But then the lyrics don’t matter, at least in terms of “information content”. All that matters is whether they sound good when Mick Jagger sings them. And they often sound very good.

When I listen to Trump, the information content often makes no sense. He’s going to pay off the entire national debt in 8 years? And he’s going to do so with tariff revenue? Well . . . that does sound good.

It sounds good when Trump announces that he’ll declare a trade war on big bad China, using higher tariffs. And it sounds even better when he reassures us that the tariffs won’t raise prices because they’ll be paid for by the Chinese. And it sounds even better when he announces that the tariffs will be delayed so that they won’t hurt our Christmas shoppers.

In a world where voters paid attention to information content, Trump might run into problems. But voters see no inconsistency here, because the tweets consistently sound good.

It looks like I was wrong in my earlier post about Trump’s tariff announcement signaling a desire to get an agreement.  Either he never intended that strategy, or China’s tough response made it impossible.  (Maybe the Chinese read my blog.)

Obviously if Trump is frightened of the political consequences of 10%, his previous threat of 25% on the consumer imports is completely off the table.  The Chinese called his bluff, and he backed off like a dog with its tail between its legs.

I must say that I am really enjoying seeing the US lose the trade war.  For years (even before Trump) we’ve been pushing other countries around.  It’s nice to see someone finally stand up to American bullies. That’s doesn’t mean I’m “pro-China” (whatever that means), as I hope the Chinese government loses its battle with pro-democracy forces in Hong Kong.  I’m pro-neoliberalism, which I’ll support any time and any place in the world.

Speaking of neoliberalism, this FT editorial is another sign of the decline and fall of Western Civilization:

It’s sad to see former neoliberal media outlets such as the FT and The Economist move in a statist direction.  A younger generation seems to have forgotten all the lessons of the final 3 decades of the 20th century.  I suppose some people would cite a quote attributed to Keynes:

When the facts change, I change my mind. What do you do, Sir?

So let’s consider the facts:

1. Market economies did better than statist economies before the Great Recession.

2.  Market economies did better than statist economies during the Great Recession.

3.  Market economies did better than statist economies after the Great recession.

In the same edition of the FT is another headline, a reminder of what statist policies do to an economy:

Argentine peso falls sharply for a second day

Turmoil continues to rock currency after strong showing by populist candidate in primary vote

I hope Tyler Cowen will hurry up and write his book entitled “The Great Forgetting.”

We’ve forgotten that monetary policy drives NGDP, and that fiscal policy is a fifth wheel.  We’ve forgotten that trade deficits are not a problem and budget deficits are.  We’ve forgotten that industrial policies don’t work.  We’ve forgotten that price, rent, and wage controls don’t work.  We’ve forgotten that saving is a virtue.  We’ve forgotten that low interest rates don’t mean money is easy.  We’ve forgotten how to build infrastructure. We’ve forgotten that nationalism is one of the great evils of world history.  We’ve forgotten that socialism is another of the great evils of world history.

Here’s Mick:

Oh, a storm is threat’ning

At least I think that’s what he said.

PS.  Brian asked me to talk about monetary policy.  Hey Fed, cut rates by 50 basis points.

HT:  Stephen Kirchner

Greg Ip asks an interesting question

David Beckworth linked to this tweet by Greg Ip:

1/ Random thought: maybe we could defeat lowflation by returning to the gold standard – at $3,000 per ounce.

There are some follow-up tweets. In the late 1990s, I wrote a long paper discussing FDR’s gold buying program, which was an attempt to create inflation by targeting gold at ever-higher prices.  (It’s a chapter in my Midas Paradox book.)  It turns out that this is a very interesting and very confusing issue.  But hey, it’s monetary policy, what else do you expect?

The simple answer to Greg’s question is “yes”, for the same reason that Japan could defeat lowflation by pegging the yen at 210 to the dollar, instead of the current 105/$.

To simplify things, let’s start with the “small country assumption”.  Lets say the Swiss saw this Greg Ip tweet, and were thinking about whether it could help them to achieve higher inflation.  From the Swiss perspective, it would be clear that this policy is basically equivalent to cutting the foreign exchange value of the SF in half, say from roughly one US dollar to roughly 50 cents.  Yes, that would create lots of Swiss inflation, no doubt about that.

[Here I am assuming that gold is currently $1500/oz., and that the Swiss action doesn’t impact the dollar price of gold—i.e. the small country assumption.  That’s why it’s effectively the same as currency depreciation.]

Could the Swiss successfully depreciate the SF?  Sure, if they offer to sell unlimited SF at the new target exchange rate, then that will become the new effective market exchange rate.  Are they willing to buy enough assets to make this new exchange rate stick?  This is the hard question.  It’s not even clear they’d have to buy any assets, as people might sell SF out of fear of imminent Swiss hyperinflation.

Obviously in the real world the Swiss would not want to depreciate the franc so sharply.  In that case they might have to buy a lot of assets to depreciate the franc.  And that might lead to worries about central bank balance sheet risk.  Now we are back to the longstanding debate about QE.  Not so much “does QE work”—a meaningless question—rather how much do you have to buy in order to assure that QE works?  As long time readers know, I don’t accept the standard view that more expansionary policy regimes require more QE.

The basic point is that pegging gold at $3000 will work, but the things you might need to do to make the peg stick could very well work even without bringing gold into the equation.  You could simply do all the QE without buying any gold.

If you were serious about doing something like this, wouldn’t it make more sense to peg the price of CPI futures contracts, not gold?  After all, we have a pretty good idea as to what sort of CPI futures price is likely to lead to roughly 2% inflation, but we have absolutely no idea as to what sort of gold price is likely to lead to 2% inflation.

If we go beyond the small country assumption, things get more complicated.  The US is so big that an attempt to peg gold prices at $3000/oz. could lead to a sizable increase in the global demand for gold.  In that case, the inflationary impact would be smaller than in the Swiss case, as the real value (i.e. purchasing power) of gold would rise.  Even so, it would still “work” in the sense or raising the price level, just a bit less dramatically.

These are not good policy ideas, but they actually are quite useful thought experiments.  They allow us to better understand the real issues at stake here.

PS.  If we were to return to the gold standard, presumably it would involve a gold price peg that increased by 2%/year.  That would give us the 2% long run trend inflation we seem to want, not the 0% long run trend under a true gold standard.