No one likes to be contradicted.  But I must admit that the markets are increasingly pointing to the likelihood that I’ve been too pessimistic about both the prospects for growth, and the likelihood that ultra-low interest rates would persist for longer than most people assumed.  What do they see that I don’t?

We know that the recent spike in US 10 year bond yields occurred after the strong jobs report this morning.     But the upside surprise seemed rather modest, and the headline unemployment rate (which figures into the Evans Rule) stayed at 7.6%.  Also note that the recent move toward easier (or less tight) policy in Japan, Britain and the eurozone would tend to raise global growth, putting upward pressure on global real yields.

One possibility is that the jobs data is somehow flawed.  In my post this morning there was a story about a dealership in Denver that couldn’t find sales people.  I tend to discount those anecdotal stories, preferring aggregate data.  But there is always the possibility that lots of people who are on disability/UI/food stamps, etc., are actually working in the underground economy.  Some economists claim the retail sales data are too strong relative to the official unemployment data.  On the other hand, that explanation would create an even bigger mystery, why has RGDP lagged the jobs data?  I suppose the argument would be that RGDP is also understating actual growth, as lots of goods and services are not being measured by the government.

Note that changes in the underground economy tend to occur fairly gradually over time, so if this is an issue (and I still have my doubts), it’s a far bigger problem for monetary policy regimes like the Taylor Rule, which depend on accurate measures of the output gap, than a policy like NGDPLT, which doesn’t require any estimate of the output gap.

Also note that nominal hourly wage growth was also quite strong in June (suggesting a tightening labor market), but on the other hand that’s only one month.

EMH fans like myself can’t get too depressed about being wrong in market forecasts, as we are ALWAYS WRONG when any asset price changes significantly in a short period of time.  That’s because in most asset markets the current price is quite close to the expected future price 6 or 12 months forward.  All big changes are unexpected.  I get a little more uneasy, however, when I can’t quite see the reason for the change, even after it has occurred.  I’d guess that in a few years this will all become clear.

My best guess is that two things have happened in recent months:

1.  Growth is stronger than the markets (or I) expected.

2.  The Fed will respond to any given level of growth with more aggressive “tapering” than expected.

That one-two punch seems to have driven 5 and 10 year bond yields much higher than I expected.

I use the term “tapering” because I don’t mean to suggest than monetary policy will gradually become more contractionary, indeed I expect just the opposite.  But it will look more contractionary to most people.

Also note that the idea we are in a liquidity trap, which never made any sense to me, has now become completely laughable by any standard.  If 5 and 10 year bond yields recently rose by 100 basis points, then there’s clearly that much room for the “liquidity effect” to reduce them again.  If people keep talking about a liquidity trap, then you should just laugh in their face.  (Not really; one should always be polite—but at least chuckle to yourself.)

Update:  Tyler Cowen just added the following good news on Twitter:

With the liquidity trap now over, dogs no longer impregnate cats, whew!,

PS.  Just to be clear, I’m not claiming that the Fed could definitely cut 10 year bond yields by 100 basis points, I don’t know that.  What I do know is that if they failed it would obviously be because of the income and inflation effects, which of course means there’d be no liquidity trap.  So let’s PLEASE stop talking about the “zero bound.”

PS.  Mark Sadowski really needs to get his own blog.  Here’s an excerpt from a great comment:

Assuming the major model type estimates are correct, then in the absence of the tax increase and the sequestration 2.144 million jobs would have been created which is over 50% more than in any other two quarter period this recovery and over double what was created in the previous two quarters. It would also have been the most jobs created in any two quarter period since the 2.251 million created in 1984Q1/1984Q2.

David Glasner makes an interesting observation:

So, if the ability of the central bank to use its power over the nominal rate to control the real rate of interest is as limited as the conventional interpretation of the Fisher equation suggests, here’s my question: When critics of monetary stimulus accuse the Fed of rigging interest rates, using the Fed’s power to keep interest rates “artificially low,” taking bread out of the mouths of widows, orphans and millionaires, what exactly are they talking about? The Fed has no legal power to set interest rates; it can only announce what interest rate it will lend, at and it can buy and sell assets in the market. It has an advantage because it can create the money with which to buy assets. But if you believe that the Fed cannot reduce the rate of unemployment below the “natural rate of unemployment” by printing money, why would you believe that the Fed can reduce the real rate of interest below the “natural rate of interest” by printing money? Martin Feldstein and the Wall Street Journal believe that the Fed is unable to do one, but perfectly able to do the other. Sorry, but I just don’t get it.

Some of my commenters will insist that monetary stimulus can cause all sorts of distortions in the economy, misallocation of capital, etc.  But monetary contraction would be just fine (they say) if only the government would keep out of the way.  After all, wages can be quickly reduced to restore equilibrium.  Easy money badly distorts an economy, but not tight money.  Go figure.

The US economy continues to slide into double dip recession under the savage austerity of income tax increases, payroll tax increases, and deep spending cuts.

Not.

But like the pain in a phantom limb that his been removed by surgery, the press has a hard time refraining from blaming the austerity for a slowdown that never happened:

Payrolls rose by 195,000 workers for a second straight month, the Labor Department reported today in Washington. The median forecast in a Bloomberg survey projected a 165,000 gain after a previously reported 175,000 increase in May. . . .

Revisions to the prior two months’ payrolls reports added a total of 70,000 jobs to the employment count in April and May. . . .

Retailers added 37,100 jobs in June, with most of the increase coming from more hiring at motor vehicle dealerships and home-improvement outlets.

Automakers are one standout in the recovery, enjoying gains in sales fueled by improved confidence and cheap credit. New cars and trucks sold in June at the fastest pace since 2007 as American drivers replaced aging vehicles and a rebound in housing construction moved trucks off dealer lots. That helped new car sales beat estimates last month, giving a lift to General Motors Co. (GM) and Ford Motor Co. (F) Brisk sales are boosting hiring at dealerships.

‘It’s Crazy’

“We would take 10 sales people in a heartbeat,” said Don Hicks, owner of Shortline Auto Group in Aurora, Colorado, which employs about 150 people at four dealerships. “If they were available and trained, or trainable, we’d take another five or six technicians. It’s crazy trying to find people.”

Industry sales climbed to a 15.9 million annualized pace, exceeding the 15.5 million median estimate of economists surveyed by Bloomberg. That’s the best monthly pace since 16.1 million in November 2007 and compares to 14.3 million a year earlier, according to data from Ward’s Automotive Group.

“We’re a little island of prosperity,” Hicks said. “We’re leading the country out of recession.”

Other manufacturers aren’t doing as well as the recovery continues to struggle against crosscurrents. Americans are feeling the effects of a two percentage-point increase in the payroll tax that took effect in January and growth is being restrained by weakness overseas and federal budget cuts that began in March.  [italics added.]

Jobs growth in 2013 (201,800/month) continues to run ahead of the 2012 pace. Average weekly hours are steady at 34.5.  Hourly wages continue to rise about 2% per year. All this data suggests roughly 4% nominal income growth.

And it’s interesting to note that the US economy’s headwinds included not just fiscal austerity, but weakness in both Europe and the emerging markets.  The acceleration in job growth in 2013 is a testament to the power of “monetary offset.”

PS.  After the first quarter I predicted second quarter growth would slow somewhat, as monetary offset cannot surgically target a specific quarter, and the sequester kicked in in Q2.  Job growth did slow from 207,000/month to 197,000/month, but that’s less of a slowdown than even I expected.

PPS.  Oh, and about that UK “double dip recession.”  Never happened.  New data revised it away.  And notice that the UK jobs data never showed a double dip recession.

Macro:  It’s all about employment, hourly nominal wages, and aggregate nominal income.  Forget about the dodgy RGDP data.

Here is Chris Giles in the FT:

The UK Treasury has asked the BoE to comment on the economic variables it could use as intermediate thresholds, while keeping to its ultimate 2 per cent inflation target. The BoE is likely to use some measure of slack in the economy, connecting a future tightening of policy to the moment spare capacity is judged to have fallen sufficiently as the recovery progresses.

Sadly, measures of UK slack are erratic at the moment. There is no possible way to be polite: all are useless for the task of guidance.

Inflation – the ultimate measure – is forecast to be above the 2 per cent target for the next two years, suggesting no slack, which no sensible person believes. Unemployment is no better as a measure. Its relationship to the rest of the economy has broken down since 2008, so following the Fed’s guidance would involve linking policy to a variable we do not understand. That makes no sense.

The output gap cannot be observed and a range of cyclical indicators, once preferred as markers of slack by the Office for Budget Responsibility, have behaved so strangely that they provide no help either. Since we have no idea whether the pre-crisis trend of output was sustainable, the gap between real or nominal output today and a continuation of pre-crisis trends is also useless.

The lack of a reliable measure of UK slack should not spell the end of Mr Carney’s ambitions. He just needs to go back to first principles and provide some certainty on policy related to the variables that matter for Britain’s economic health.

There is little mystery. The economy has been chronically short of growth in spending on British stuff. I could use the technical term, nominal gross domestic product growth, but the colloquial shorthand is better and easy for households and companies to understand.

Sensible policy should therefore continue with loose monetary policy until spending on UK-produced goods and services has risen to an annual rate of at least 4.5 per cent for two years. An inflation backstop is required to prevent any wage-price spiral, but given the weakness of pay growth, it is highly unlikely to be a constraint. Policy guidance is a good idea, whose time has come. But it must be linked to an economic variable that matters. In the UK, that is spending growth.

Excellent.  My only suggestion here is that an inflation backstop is not necessary to prevent a wage/price spiral, as wages follow NGDP growth, not inflation.

This comment from Noah Smith caught my attention:

But even in the case of experts, I think you need to be very, very confident in the expert’s record before you give special weight to that expert’s opinion. For example, Michael Boskin is legendary forgetting every major macroeconomic prediction wrong since the beginning of time. Paul Krugman is somewhat ahead of the average of pundits, though it’s a small sample. Robert Shiller has an impeccable record of bubble prediction, but that sample is even smaller.

Of course it’s just as hard to be 100% wrong in (binary choice) predictions as 100% right. Indeed I’d pay a small fortune for the advice of someone who was 100% wrong in predicting the future. Unfortunately when I followed the chain of links back to the source, I found that Noah had exaggerated Michael Boskin’s skill at prediction; his record is nowhere near as impressive as it sounds. Barry Ritholtz linked to a Jonathan Chait post that made the following claim:

If you are an investor, Boskin’s doomsaying is a sure sign of a coming bull market. Four years ago, Boskin penned a Journal op-ed whose thesis was captured in the headline, “Obama’s Radicalism Is Killing The Dow.” That was the signal for the Dow to go on a tear, doubling over the next four years. As Kevin points out, the Dow’s current “high” is an overstated artifact of dumb, unweighted statistics, but the underlying reality remains that the stock market has enjoyed an incredibly good four years under Obama’s radicalism.

I hope I’d never be silly enough to claim that Obama’s “radicalism” was killing the Dow. But if I was, you can be 100% certain my statement would not be a prediction about future movements in the Dow. After all, I do believe in the EMH. Don’t know if Boskin does, but I’d think Chait would need to find out before making that claim.

The post also criticizes Boskin for predicting the Clinton tax increases would lead to less extra revenue than forecast (note Boskin did not predict less revenue).  And also that the Bush tax cuts would cost less revenue than forecast.  These are reasonable claims. Then Chait assures us that these predictions turned out wrong.  Maybe so, but has he corrected for business cycle effects?  I doubt it.

My first editorial was published back in 1993 in the Boston Herald.  I’m still quite proud of that essay, although I don’t doubt that if someone could find it they could make me look like a fool, as the general tone was very similar to the Boskin piece that Chait ridiculed.  I claimed that Clinton was not governing as the centrist he promised to be in the campaign, and that his policies would not be successful.  But the bottom line, and the part I’m most proud of, was my prediction that Clinton would tack to the center.  Of course the famous Clinton/Gingrich administration of 1994-98 brought us much lower taxes on capital gains, welfare reform, trade liberalization, serious spending restraint, abandonment of health care “reform,” an HMO boom, privatization, widespread deregulation, etc.  And whereas the sluggish recovery of 1993-1994 led to a massive GOP sweep in 1994, the years 1994-98 produced a major economic boom, with low inflation.  So I was right that Clinton would change course, and I was right that the new supply-side policies would produce much better results.

Even so, I’m sure Chait would regard my editorial as laughably wrong.

So the bottom line is that we should pay no attention to Boskin’s predictions.  I wish I could tell you that Smith was right, or that investors could make a fortune using Boskin as a reverse indicator.  But once again we learn that painful lesson, there’s no free lunch.

PS.  Shiller’s predictive ability is also wildly overrated.  Count yourself lucky if you haven’t followed his stock market advice since March 2009.  And don’t forget his “irrational exuberance” claim of 1996.

PPS.  For what it’s worth I share Tyler Cowen’s skepticism regarding betting on beliefs.  Asset prices are the only “betting data” that I care about.  I don’t doubt that anti-Keynesians would have lost a bet on high inflation resulting from stimulus in recent years, just as Keynesians who signed that letter in 1981 predicting Thatcherism would result in disaster looked like fools 10 years later. Those bets don’t really tell us much about the validity of various models, but rather that highly fallible individuals often misuse their models. I think market monetarism is the true heir to Milton Friedman’s monetarism, and thus am not surprised than many of my fellow conservatives/libertarians have looked like fools.

HT:  Tyler Cowen.