This is from Britmouse:

And while we are at it, here’s another interesting graph from Britmouse:

Deflation is bad if it comes from the demand side, and causes firms to cut output because they see falling profits as prices fall.  Thus if you focus on inflation (not a good idea!), at a minimum you should be looking at prices net of VAT.  In Europe the austerity has involved VAT tax increases, which cause the ECB to tighten policy, driving NGDP even lower.  You see the demand shock in the inflation rate net of VAT.

Note that I’ve always argued fiscal austerity can reduce output if the central bank is stupid, for all you people who think I’ve been an ideologue on the issue.

HT:  W. Peden

From The Hollywood Reporter:

Royal Baby to Boost British Economy by $400 Million

Festivities-related expenses will lead the way with an estimated $131 million (£87 million) in additional business thanks to the royal baby, according to the research. That includes increased spending on alcohol ($94 million, or £62 million), with the group predicting three million bottles of champagne and sparkling wine will be opened across the country, mostly in informal celebrations, to celebrate the baby.

Let’s hope Mark Carney doesn’t spoil all the fun by making the Brits pay for their celebration with less consumption in other areas. No need to take away the punch bowl when there are unemployed Brits capable of producing more punch.

John Taylor has a new piece in the Wall Street Journal that tries to lay out a conservative critique of recent Fed policy:

A growing number of economists, former central bankers and senior government officials””including Martin Feldstein, Paul Volcker, Allan Meltzer, Raghu Rajan, David Malpass and Peter Fisher””have now concluded that the Fed’s policies are not working. Critics want the Fed to return to a more rules-based monetary policy.

I’m all for a rules-based approach to policy. But unfortunately Taylor fails to make his case. You’d think a fan of rules-based policy would provide a razor sharp critique of Fed policy, but Taylor’s critique is anything but clear, as Paul Krugman indicates:

I mean, if anyone can find a coherent argument in Taylor’s latest, please tell me. My quick summary: Current monetary policy is just like in the 1970s, except for the lack of inflation thing. It’s completely ineffective, which means that we must stop it immediately, or else this ineffectual policy will somehow have vastly negative effects on something or other (not clear what). But the trouble is that people think stopping it would be too costly, whereas in fact it would have no cost, as illustrated by the really bad things that just happened when the Fed indicated that it might indeed stop the policy.

Also, the sluggishness of the recovery somehow proves that money has been too loose.

I have to admit that at this point the arguments against quantitative easing have become unanswerable “” because they’ve become incomprehensible, and there’s nothing to answer.

If one accounts for the hyperbole in Krugman’s attacks on conservatives, I think he’s basically right. Then Taylor shifts to a discussion of the 1970s and suddenly he makes a lot of sense. The reader is reminded how the conservative critique of monetary theory and policy during the 1970s turned out so successful. But then he tries to link the two; his critique of the policy of the 1970s with his critique of current policy. And it just doesn’t work. NGDP growth averaged 11% from 1972 to 1981, whereas it’s averaged barely over 2% during the past five years, the slowest nominal growth over five years since Herbert Hoover was in office. The problems of today are nearly the opposite of the problems of the 1970s.

Taylor is deeply frustrated that the Fed has moved away from the rules-based approach of the Taylor Rule. I get that. Taylor’s conservative audience is convinced that QE will lead to hyperinflation. I get that. Conservatives not named Milton Friedman instinctively equate “bad monetary policy” and “dollar debasement.” I get that. But Taylor is too smart to try to sell a simplistic “hyperinflation is coming” story and so ends up with a grab bag of unrelated possible problems that might or might not be a consequence of continuing or not continuing current policy.

If I can’t understand Taylor’s argument, I’m quite sure that bright young conservative econ students won’t be convinced. So does conservative monetary economics have a future? In my view the young will look for a clear and analytically powerful story. I’d obviously like to think that will be market monetarism, but I suppose it could end up being Austrianism or the Fiscal Theory of the Price Level, or something else.

Over the years I’ve enjoyed reading papers by Taylor, Meltzer, Feldstein, etc. But as I’ve warned over the past four years their current analysis of monetary policy is simply not persuasive. With the death of Milton Friedman in 2006, conservative monetary economics is both leaderless and rudderless.

Lots of commenters tell me that the left is better than the right on monetary policy. Yes, they doubt the effectiveness of monetary stimulus at the zero bound (so the argument goes) but a least they favor monetary stimulus.

But do they? What makes anyone think that Fed policy over the past four and a half years is different from the policy Obama favored? Six of the seven board members are Obama appointees, and the last Bush appointee leaves next month. It’s Obama’s board, and he never showed the slightest interest in money policy, even when the GOP had no ability to block his picks. Why shouldn’t we blame Obama for current Fed policy? And let’s not forget that Larry Summers was Obama’s chief economic advisor.

The only people who ever dissent in favor of a less contractionary policy are regional Fed presidents like Bullard and Evans. The Obama appointees NEVER dissent.

And now we have Massachusetts Senator Elizabeth Warren endorsing Paul Volcker for Fed Chairman. Seriously.

Yes, Paul Krugman favors additional monetary stimulus. But does the left agree with him? I’d like to see the evidence.

BTW, over the past five years the market monetarists have been the strongest supporters of monetary stimulus; no other group even comes close.

PS. Evan Soltas also did a post on John Williams’ recent article. I like Evan’s take better than my own.

HT: Yichuan Wang, TravisV

TravisV asked me about a paper by John Williams of the SF Fed. The paper is a defense of moderation in monetary policy, and will be seen as a defense of recent Fed passivity. That may be unfair to Williams, as it’s not clear that he opposes more aggressive stimulus.

I can’t imagine anyone favoring moderation in monetary policy more than I do. Yet I was deeply frustrated when reading the paper, as Williams kept missing the bigger picture. He argues the economy was hit by negative “demand shocks” in 2008, then again in 2009, then again in 2010, then again in 2011, and then again in 2012. In a sense that’s true as NGDP growth was below trend during all 5 years. But Williams misses the bigger picture, those “demand shocks” were contractionary Fed policy. More specifically they were caused by the failure of the Fed to do NGDP level targeting. The Fed set the wrong target in each year, and this caused the vast majority of the “demand shocks”. With a policy of NGDPLT along a five percent trend line, the recession would have been far milder, with unemployment probably peaking at 6 to 7 percent.

A digression for people of the concrete steppes. No, it wasn’t just “errors of omission”. After growing at 5 percent per year during the Great Moderation, the Fed brought growth in the base to a sudden halt from July 2007 to April 2008. Yet the Fed saw itself as a valiant knight fighting off recession by cutting the Fed funds rate, as if interest rates were a reliable measure of the stance of monetary policy. They aren’t. But even if they were, the Fed drove real interest rates sharply higher in the second half of 2008, a time when they weren’t at the zero bound. So there were plenty of affirmative actions taken by the Fed to drive us into a deep slump. BTW, the base isn’t a reliable indicator either, only NGDP expectations count.

Williams discusses “moderation” in terms of two “instruments” of Fed policy; the fed funds rate and QE. Williams argues for “gradualism in shifts in the stance of policy” such as QE, but doesn’t really define what that means. Is “tapering” a shift in policy, as the markets seem to believe? Or is changing the Fed’s stock of assets a shift in policy, as Bernanke seems to believe? Any answer is completely arbitrary as neither QE nor fed funds rates are a useful way of characterizing the stance of Fed policy. Only NGDP expectations are informative.

Over the last five years the Fed has been like a slave master relentlessly whipping the economy. At times it eases up, and whips less aggressively. The slaves, I mean the markets, are grateful during those periods of less whipping. But if you read the financial press they see the Fed as a hero giving the lazy, ungrateful economy one shot of stimulus after another. Until we (including the Fed) see the situation clearly, there is little hope for the implementation of sound policies.

PS. In the previous post I referred to an unnamed commenter who discussed the relationship between stock prices and the taper talk. It was probably this excellent post by Andy Harless.