Archive for June 2013


How’s the economy been doing over the past 6 months?

Studies show that GDI is a better measure of GDP than GDP itself.  In most cases the gap between the two is relatively small.  But over the past 6 months a huge gap has opened up.  (It’s useful to look at 6 month figures as the 2013:1 data are hugely distorted by big 2012 year-end bonuses to beat the Obama–GOP tax increases.)

Over the past 6 months NGDP has grown at an annual rate of 2.19%, whereas NGDI (which measures exactly the same thing!) has grown at a rate of 5.06%.  I suspect the truth is somewhere in between but closer to the 5.06%.  Here’s why:

1.  The labor market has been fairly strong over the last 6 months, with job creation accelerating from the middle of last year.

2.  All sorts of asset markets (stocks, house prices, bonds, etc) suggest stronger US growth.

3.  US consumer confidence has been strengthening.

4.  I am not aware of any data confirming an ultra-low 2.19% NGDP growth rate.  At that rate there shouldn’t have been any jobs created over the past 6 months.

BTW, if you look at growth by components (which is not a useful exercise) the huge negative over the last 6 months has been military spending.  Yay!!

PS.  Just to anticipate some comments:  I am not suggesting we focus on NGDI instead of NGDP, NGDI is NGDP.

PPS.  Yes, I know, the NGDI figures do provide a bit of support for Bernanke.  But he still needs to do more.

PPPS.  Thomas Raffinot sent me a graph showing that NGDP and NGDI do tend to track each other pretty well over the longer term.  (Looks like 4 quarter MA)

Screen Shot 2013-06-26 at 9.35.01 AM



Market monetarism in the news

Here’s Ramesh Ponnuru at

To return to reality for a moment: The Fed isn’t hitting its 2 percent inflation target now, let alone coming close to 4 percent. People who think the economy remains depressed — and think it’s depressed largely because money is too tight — have to urge the Fed to do something different. In some sense, we have to push the central bank out of its comfort zone.

Avoiding Backlash

It may be that a nominal-spending target is further outside that zone than a higher inflation-rate target. But remember that inflation is extremely unpopular. A deliberate Fed policy of raising inflation rates, especially permanently, seems likely to yield a backlash — or even a frontlash that keeps it from happening in the first place. A Fed policy that seeks to raise incomes and spending seems likely to meet less resistance.

And it seems to me that higher incomes and spending are what we should really want in today’s circumstances. Faster inflation is valuable to the extent that it produces higher nominal spending, and higher nominal spending would be valuable even if it didn’t involve more inflation.

The inflationists generally argue that the Fed needs a better communications strategy. They should take their own advice.

2.  And this is a link to a Bloomberg interview I did yesterday.

3.  Here’s the New York Times on (market) monetarism:

The prescription fits the worldview of some “monetarist” economists, who argue that the Fed should set a higher target for the nominal gross domestic product, to be met through real economic growth and inflation. Conservative pundits like Josh Barro of Business Insider have welcomed inflation as the right’s answer to fiscal stimulus “” a way to juice the economy without increasing government spending.

But it is hardly a conservative idea. Paul Krugman, a Nobel laureate and liberal columnist for The New York Times, has been writing about the benefits of higher inflation, arguing that policy makers should be using any available tool “” fiscal or monetary “” to try to reduce an unemployment rate stubbornly stuck at more than 7.5 percent for over four years.

4.  And here’s Ambrose Evans-Pritchard in The Telegraph:

They are gambling that the US economy will shake off the effects of fiscal tightening of 2pc to 3pc of GDP this year, arguably the biggest squeeze in half a century. It may indeed do so, but it may not, and the costs of making a mistake before the US recovery is safely established are asymmetric.

Scott Sumner, the spiritual father of the Market Monetarists, says the errors made by the Fed in 1937 and the Bank of Japan in 2000 did serious damage, while the US suffered little lasting effect when the Fed delayed too long in 1951.

Are we to conclude that Ben Bernanke has lost his nerve and joined the Austro-nihilists?

The Godfather?  Eminence grise?  Spiritual father?  What will they think of next?

It’s interesting that the NYT just calls us “monetarists.”  The old monetarists sort of faded into the background after the new Keynesians stole all their best ideas (monetary stabilization policy trumps fiscal, nominal interest rates unreliable, natural rate hypothesis, high trend rates of inflation caused by rapid money growth, etc), and their other ideas (target the money supply) lost popularity.

Here’s my question:  When people talk about “the monetarists” in 2020, which variant do you think they will be referring to?  Market monetarists?  New monetarists?  Old monetarists?

HT:  Chris Beseda, CA

Rising long term rates are usually a bullish indicator

Arnold Kling recently made the following claim:

I would add myself to the list of economists who have some ‘splainin’ to do. I am always willing to be counted among those who doubt the Fed’s power over interest rates, especially long-term real rates. By the way, Scott Sumner used to say that a rise in long-term interest rates could be a bullish indicator. Would he say that now? UPDATE: No.

The correlation between nominal interest rates and NGDP (or RGDP) growth is overwhelming positive.  Nothing that happened this week contradicts that.  Indeed nothing that happened this week contradicts what I’ve been saying for the past 4 1/2 years:

1.  Never reason from a price change.

2.  Interest rates are a lousy indicator of the stance of monetary policy, because they reflect both liquidity effects and longer term effects.

I’ve made these points dozens of times.

As far as “bullish indicator,” suppose you were allowed one quick look into a crystal ball, at the level of interest rates in 2016.  You are told ahead of time that the yield on Treasuries will be either 2% or 5% in 2016.  If you are Paul Krugman, and are rooting for a strong recovery, which is the number you hope to see?

I hope I don’t even need to answer that question.  And nothing that has happened this week in any way changes the answer.

So what have we learned this week? To me this is one data point, indicating tight money is slightly more likely to raise long term rates than I had previously assumed. But there is still the enormous stock of previous long term rate changes in response to previous Fed moves. Previous data points. January 2001, September 2007, December 2007, etc. etc. Should we suddenly throw all those observations away?

PS.  The fact that Krugman, Cowen, Kling, myself and many others were surprised by the surge in rates over the past few weeks actually speaks well of our understanding of macro.  It shows that we’ve been paying attention, that rates don’t usually behave this way.  As for those who “got it right,” you have some “splaining to do” about the surging yields in Japan in response to more QE.

The best solution is to remove interest rates from macro, and focus on the three variables that matter; NGDP, nominal wages, and hours worked.

PS.  Unlike Kling, I think the central bank has enormous influence over long term rates, but mostly via the income and inflation effects.

Murder by the Orient Economies?

Evan Soltas has a new post that examines two competing theories of why interest rates have recently been rising:

There are two theories of why interest rates are rising. In the first, they are rising because of an improved economic outlook, which leads investors to anticipate a swifter exit for monetary policy. In the second, they are rising because of a change in investor expectations of the monetary exit, independent of economic conditions.

Fortunately, statistics has a way of answering these questions: correlation. (Or at least, helping us answer these questions.) I downloaded the daily time series data of the 10-year Treasury note yield and the S&P 500 stock index from June 2008 through the present. If on days that rates are rising, the stock index also rises, then we can assume that both are driven by changes in the economic outlook. If on days that rates are rising, the stock index is falling, then the “economic outlook” story doesn’t hold up — and a “monetary policy” story fits.

I calculated the 90-day correlation coefficient of their daily percentage changes. I find that it has been plummeting since May, which is when interest rates began to jump. See how it’s falling off a cliff at the right end of the chart? That means the first story (“happy days are here again”) is wrong, and the second story (“the Fed is tightening”) is right.

.  .  .

If the Fed doesn’t intend for all of its talk since the start of May to be perceived as pushing forward the schedule for monetary tightening, independent of the economic recovery, it needs to start clarifying its intentions. Now.

It seems plausible that part of the rise in rates since May has been driven by positive economic news, but I agree with Evan that the recent sharp increases in interest rates mostly reflect expectations of tighter Fed policy.  And I think he’s provided the most persuasive evidence in the blogosphere for that view.

A couple days after I wrote this post (but before posting it) I started to have second thoughts.  Lars Christensen sent me the following by email:

This is not the doing of Bernanke. This in my view is nearly 100% driven by tighter Chinese monetary conditions – and the spike in US yields is driven by a flow story. There is a sharp rise in money demand in China, which is causing Chinese investors to sell everything to get liquidity – including US Treasuries. That is causing US bond yields to spike and it is also causing the collapse in inflation expectations in the US (and everywhere else).

And then in a later email (with permission):

> I believe my “story” fits actual market events much better than a story about tapering. Just look at the magnitude of the movement in US yields – up 100bp in less than 2 months. That [would be] a major move based on Bernanke stating the obvious – “we will scale back if the economy is better and step up if it worsens” Should he had said anything else? I would have understood that yields would have risen if he had said “The economy is much better and NGDP is likely to grow by 6% year, but hell to that we will just continue QE no matter what”
> If “tapering” really was a monetary tightening – why did the dollar WEAKEN until a couple of days ago? And why do US stocks continue to outperform basically any other stock market with the exception of the Nikkei?
> Lars

Lars has been doing post after post on the China story, but I wasn’t paying much attention until today.  As anyone who follows the market knows, the sharp fall in stocks and rise in bonds yields today was widely attributed to problems in China.  Furthermore there was no news on US monetary policy.

So does that mean Evan was wrong?  I don’t think so, because we know that the big move up in yields after the Fed meeting, and again after the Bernanke speech, were linked to Fed policy.  And the fact that stocks broke sharply on the news suggests that the market viewed it as new information, and as a contractionary surprise.

But I also find Lars’ argument to be persuasive.  So I see two smoking guns, Bernanke and China.  Then you could add in the BoJ getting cold feet a few weeks back, which also sent US markets lower.  It’s starting to look like Murder on the Orient Express.

I’d like to say that interest rates don’t matter, only NGDP matters. And I often do say that. But unfortunately as long as central banks insist on targeting interest rates, a fall in the Wicksellian equilibrium interest rate and/or a rise in the Fed target rate impact expected NGDP growth.  And it looks like the events of the past few weeks have raised the expected future fed funds rate and (more recently) lowered the Wicksellian equilibrium rate.  Both shifts are contractionary.

Tyler Cowen also has some interesting posts on this topic (here and here).  Like Tyler (and Paul Krugman) I didn’t expect an end to the flow of T-bond purchases to have a big impact on T-bond yields.  I’m still not sure exactly how large the impact was, but Evan’s results, combined with the real time moves on last week’s Fed news, convinces me that if I did know it would probably have been larger than I expected.

One final point.  At the risk of sounding like a broken record, we really, really, really need an NGDP prediction market.  The sort of speculation you see in the posts that Tyler links to is intriguing, but the linkages are far too complex to figure out the implications for US aggregate demand without market signals.  We are still flying (half) blind.

Exit is easy: Pt. 2

Gavyn Davies has an overly pessimistic column in the FT.  Here’s the intro and conclusion:

On Wednesday, the chairman of the Federal Reserve announced that the greatest experiment in the history of central banking might be nearing its end.  .  .  .

The exit from quantitative easing was always going to be long and arduous. There is no historical playbook for the central banks to follow. Like a fighter pilot who has experienced combat only in a flight simulator, the real thing might be very different. The central bankers are confident that they have the technical tools to finish the job but, as Mr Bernanke admits, it will be like landing that plane on an aircraft carrier, and possibly in stormy seas.

This is all wrong; it’s easy to exit monetary stimulus.  And indeed Davies shows this, even as he thinks he is showing the exact opposite:

The last big unwind – a much smaller one – started almost exactly a decade ago. On June 25, 2003 the Federal Open Market Committee met amid expectations of a cut in the interest rate from 1.25 per cent to 0.75 per cent.  .  .  .

Alan Greenspan was chief wizard at the Fed that day. Mr Bernanke, more radical than he is now, was there, but mostly stayed silent. The committee was fully aware of the dangers ahead when it decided to cut the federal funds rate by only 0.25 percentage points. The market concluded that the Fed was preparing to tighten policy sooner than expected, and sharply adjusted expectations for where it thought rates would be in the years ahead. The same thing happened this week.

Yes, and the economy was fine.  Davies continues:

The previous big Fed exit, announced on February 4, 1994, was even more dramatic. It was a day that triggered such turbulence that it is etched in the memory of all bond traders. Working as a Goldman Sachs economist, I was on the bond trading floor when the Fed released an innocuous-sounding statement. The FOMC had decided “to increase slightly the degree of pressure on reserve positions”‰.”‰.”‰.”‰which is expected to be associated with a small increase in short-term money- market interest rates”. Pardon? After a few moments, there was an explosion of noise as realisation set in.

The market was unprepared for the Fed change, Investors were over-leveraged and knee-deep in Mexican debt and mortgages. Equities emerged relatively unscathed. But before the bloodbath ended that November, the survival of the US investment banks was at stake.

The tipoff is the “equities emerged relatively unscathed” remark.  I’ve been around for 58 years and can’t recall a more boring and uneventful year than 1994.  That means Fed policy was working.  Boring is good!  Yes, there was some turmoil in the bond market, but bond markets don’t matter, what matters is NGDP.  And that was fine.

The sooner we remove finance from monetary economics the better.  All it does is lead to fuzzy thinking, as we also saw in my previous post.

Davies also discusses a botched exit, the Japanese monetary policy tightening of 2006.  But that wasn’t because exit is hard, but rather because they tightened policy after ten years of steady deflation.  The technical term for that policy approach is INSANE.  Why would you tighten monetary policy when prices have been falling for 10 years, and the bond market show no signs of inflation going forward?

And why would the Fed tighten monetary policy with 7.6% unemployment, 1.05% core PCE inflation (0.7% headline) and the TIPS markets showing 1.7% inflation over the next 5 years.  That’s also insane.

And let’s not even talk about the ECB in 2011.