An inflection point?

Matt Yglesias and Dean Baker suggested the following was very important news:

TOKYO “” Hoping to win its long-futile battle against falling prices, Japan’s central bank on Tuesday said it would try to kindle inflation, setting a goal of 1 percent, by pumping tens of billions more dollars into the economy.

While central bankers usually worry more about keeping inflation in check than trying to stoke it, Japan’s economy has labored for more than two decades against the stagnating effects of falling prices, or deflation.

The Bank of Japan on Tuesday said it would expand a program of buying government bonds as a way to inject additional money into the economy. And it set a goal of continuing the effort until inflation had reached 1 percent.

.   .   .

Politicians and economists have long criticized the Bank of Japan for not doing enough to combat falling prices. That criticism became louder after the United States Federal Reserve “” facing economic pressures of its own “” set a 2 percent inflation target last month. Adding to the concern has been the gloom that Europe’s debt crisis continues to cast over the global economy.

At its policy meeting Tuesday, the Bank of Japan’s board showed a more explicit commitment to ending deflation, voting to set consumer inflation at an annual rate of 1 percent as its price goal, at least for the time being. The bank had previously defined 1 percent only as its “understanding” of a desirable rate of inflation.

Prices in Japan have not risen at an annual pace above 1 percent since 1997, when deflation set in.

.   .   .

Tokyo stocks rose modestly, yields on Japanese bonds fell and the yen weakened against the dollar on the news.

.   .   .

Mr. Shirakawa has long argued that monetary policy alone cannot bring an end to deflation in Japan, a situation that he says is caused by a lack of demand. Economists say the bank is running out of options, since interest rates are already effectively at zero and because it has little leeway to expand its asset-buying program.

I have mixed feelings.  On the one hand there’s no reason to expect a dramatically different outcome in Japan.  You still have no level targeting, which means the BOJ is not held accountable for its mistakes.  You have the head of the BOJ saying that monetary policy cannot address deflation because it is caused by “a lack of demand.”  Hmmm, I’ve been teaching my students that monetary policy determines AD.  Does it determine aggregate supply in Japan?  It’s clear that the BOJ was pressured to do this, and that it doesn’t represent any sort of dramatic change in policy.  Bond yields fell, so the bond investors are certainly not expecting much inflation.  I think we can safely dismiss the argument of people like Volcker that a little more inflation is like giving a sip of wine to an alcoholic.  The BOJ is not about to become addicted to inflation.  Nor is the Fed or ECB.

But equities did rise and the yen fell.

Here’s why I think Yglesias and Baker might be right.  Between 1920 and 1933 the world economy was on a deflationary cycle.  Central banks switched toward inflation way too slowly, because they are big conservative institutions, slow to adapt—like generals always fighting the last war.  Then we had an inflationary cycle from 1933 to 1981.  By 1968 inflation was already too high, but it took 13 more years for central banks to make a serious effort to bring it down.  Since 1981 the world has been in a disinflationary cycle.  By late 2008 there was an obvious need to switch to policies aimed at aggressively boosting inflation–recall the US experienced deflation in 2009.

Now we may be seeing the first tiny signs of a momentous move out of this disinflationary cycle.  There is certainly nothing dramatic that one can point to, but important straws in the wind:

1.  The new ECB president is clearly more interested in boosting AD than Trichet.  That’s still not very aggressive, but it’s something.

2.  The Fed had been hinting at a vague desire for 1.7% to 2.0% inflation.  Now they have a firmer target, and they dropped the 1.7%.  It’s just 2.0% inflation, period.  And at his press conference Bernanke gave strong hints that the Fed needs to do more to raise both inflation and employment.  As in Europe it’s still far too little, but it’s something.

3.  Now the BOJ adopts a formal 1% inflation target.  Again it’s not that dramatic a change.  A cynic could argue that they already had a vague target in the general area of 1%.  But a firm target does slightly increase accountability.  The Japanese GDP deflator has fallen by 15% since the mid-1990s.  With a target of one percent inflation, the BOJ will be embarrassed if a decade from now the price level is down another 10%.  They will also be criticized if they raise interest rates when inflation is below 1% (as they did in 2000 and 2006.)  So it’s not a game changer, but it’s baby steps toward easier money.

Put all these together and it’s becoming increasing likely that we’ve reached an inflection point.  The damage from tight money has become so severe that the pressure for monetary stimulus is gradually building.  Recall that in late 2008 and in early 2009 almost the only people who insisted that the Fed could and should boost AD were a few unknown market monetarists.  Some Keynesians also argued it was worth a try, but their skepticism about the efficacy of monetary stimulus blunted their message.  People remembered the pessimism, and since it matched their prior belief that the Fed can do nothing at zero rates, these statements had the effect of pushing monetary policy off the radar screen.  So much so that President Obama didn’t even appoint anyone to fill two empty Fed seats for well over a year.


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27 Responses to “An inflection point?”

  1. Gravatar of Morgan Warstler Morgan Warstler
    17. February 2012 at 07:56

    Scott this is just OUTRIGHT dumb:

    “Put all these together and it’s becoming increasing likely that we’ve reached an inflection point. The damage from tight money has become so severe that the pressure for monetary stimulus is gradually building.”

    Marcus had this post up, it is frigging great:

    http://online.wsj.com/article/SB10001424052970204792404577225301719346924.html?mod=WSJ_Opinion_LEADTop

    “The centerpiece were labor-market reforms designed by a former human-resources executive at Volkswagen AG. The power of unions and craft guilds was curtailed, making it easier for unskilled youth to enter the job market and easier for employers to hire and fire at will. Germany’s lavish unemployment benefits were sharply cut back. An unemployed person in social-democratic Germany today can draw benefits for only about half as long as his counterpart in capitalist America.”

    Then this:

    “Prime Minister Monti in Italy, and Spain’s new prime minister, Mariano Rajoy, are deeply committed to this vision, and they are well on their way to implementing it. It won’t be easy. They’re up against what Mr. Monti calls “the blocking powers of lobbies and special interests.” Read: unions.

    In Spain, Mr. Rajoy’s government has already legislated new rules allowing companies to drop out of collective-bargaining agreements. Lavish statutory requirements for severance pay, making it financially impossible for businesses to fire workers as competitive conditions change, have been slashed.

    With unemployment already at 23%, and youth unemployment at 49%, this would seem to be political suicide. But Mr. Rajoy was elected promising to implement these reforms, which originated with his predecessor José Luis Rodríguez Zapatero. The electorate seems to realize that, as the German experience shows, businesses will only dare to hire when they know they have the option to fire.

    In Italy, Mr. Monti has raised the retirement age and is shaking up labor markets””crushing barriers to entry in previously protected professions from pharmacy and baking to taxi-driving. He isn’t loved by incumbent pharmacists, taxi-drivers or bakers, but he’s wildly popular with the electorate that realizes that more competition means more jobs and a higher standard of living.

    Similar pro-growth reforms are taking place in Portugal. The dynamic Irish economy doesn’t need them””it’s still the Celtic tiger; all it needs is to shake off the shock of its banking crisis. Greece? That one is probably beyond reform. But a tiny nation with a GDP the size of Boston’s won’t hold back Europe’s growth.

    The transformation of Europe is being made possible””as serious reform is everywhere and always””by crisis. For all the strikes and protests and backlash (which Reagan and Mrs. Thatcher faced), Europe seems to know now that its tax-spend-borrow-and-protect social democratic past cannot be its future.

    The discipline of debt is driving Europe to closer political integration, too. And this, in turn, feeds back into Europe’s growth potential. It’s not just that closer integration would realize economies of scale, accelerating those already begun by adopting a common currency. It’s that if Europe’s squabbling nations could only erase their political boundaries, its debt problems would vanish.

    Consider Italy and Spain. Italy has a lot of debt, but the second lowest deficit-to-GDP ratio in Europe, after Germany. Spain has a large deficit, but the lowest debt-to-GDP ratio of the large European economies, even Germany. If Spain and Italy were to become a single country””let’s call it Spitaly””its fiscal profile would be almost identical to that of France. If all the 17 countries that use the euro were to combine into a single nation””call it Europa””its fiscal profile would be better than that of the U.S.

    This is more than a thought experiment. Already Germany and France have bilaterally negotiated the beginning of a fiscal partnership, with harmonized tax rates and joint budgeting. And there are multilateral treaty changes being formalized now, among all 27 European Union members except for the recalcitrant U.K. and Czech Republic, that will enshrine stronger joint fiscal discipline and oversight”

    —–

    1. these things ARE happening because of the Euro crisis

    2. these things are good.

    Look, even Matty is smart enough to at least pretend argue that inflation is the way to cut people’s wages…. note he’s not really for their wages being cut, he just uses it to promote inflation.

    BUT YOU really BELIEVE inflation is a good way to cut down their wages.

    Moreso, your NGDP plan is far more brutal on the public sector than even the above – but you won’t talk about it.

    Either way, it is dumb to say the damage is so severe, when you REDUCE labor costs and you make it easier to fire people, you increase the likelyhood of ongoing future success…. see Germany or see southern US states.. or see your own beliefs.

  2. Gravatar of Bonnie Bonnie
    17. February 2012 at 08:55

    Morgan,

    I somewhat agree with what you’re saying, the economic reforms taking place are the silver lining. But, they come at what cost? Take a look at what’s happening to the people in Greece. Their suicide rate has increased 40% in just the last two years and orphanages are filling up. Many cannot afford the rent/property surcharges, the additional taxes, and are being evicted or having utilities turned off. The people of Greece can’t afford to pay the debt their government racked up, even after it’s been slashed, and it is shattering their society. As a result there is so much turmoil going on there, it is really difficult to say whether they will be better off coming out the other side of this.

    I’m not saying that Greece didn’t need reform, they most certainly did. But what’s going on there has been going on too long, and purposeful tight money to meet that end at this point is nothing short of inhumane. I do not blame Sumner for not out right supporting it, because I sure cannot.

  3. Gravatar of Benjamin Cole Benjamin Cole
    17. February 2012 at 09:00

    Scott Sumner is the Best Economist.

    Crickey Almighty! BoJ, ECB and fed: Print more money, print a lot more money, and keep printing money until you see robust growth. Let that go for a few years, and hen, and only then, worry about inflation—or better yet, become Market Monetarists.

    Meanwhile, China and India have been following expansionary monetary policies. Yes, they have some inflation, but they also have dynamic real growth and rising living standards.

    Oh that? Rising living standards? Remember the reason to have economies? It is not to pursue the chimera of price stability. It is to raise living standards.

    Keep your eye on the ball.

  4. Gravatar of Cthorm Cthorm
    17. February 2012 at 09:30

    @Bonnie

    Greece will default. It has to default. There is no way whatsoever that it can self-finance it’s debt obligations. Once Greece defaults the situation for Greeks will get better, but the country is such a noncompetitive basket case that it will need substantial reforms if it is going to stay in the Euro. I happen to think the Germans and the rest of the Eurozone WANT Greece to stay in the Euro, because they fear contagion and loss of confidence in periphery sovereign debt.

    I’m not feeling a lot less critical of the ECB. They played a mean game of chicken, but each time fear started spiraling they provided liquidity. In exchange they’re leveraging this pain into difficult to force reforms. With more easing the Eurozone’s debt problems will be much lighter and growth faster than would otherwise be possible.

  5. Gravatar of Greg Ransom Greg Ransom
    17. February 2012 at 09:58

    Britain had an insain forces deflation policy between 1925 – 1931.

    But what about Germany? Inflationary policy to back expanded government spending & union wages.

    Austria? Inflation.

    In the United States — a _massive_ productivity explosion, Massively input costs and output prices — IF the Fed didn’t expand the mney supply — which the Fed DID.

    If you factor in productivity e U.S. inflated in the 1920s.

    So much for yournp cycle — which turns out just to be the Depresssion / disequilibrium causing masive deflationary mistake of Britain.

  6. Gravatar of Greg Ransom Greg Ransom
    17. February 2012 at 10:05

    Scott, as an instrumentalist / pragmatist you are compelled to be an advocate of the theory that housing booms and busts control the rate of unemployment — Calculated Risk has the chart:

    http://ow.ly/1hsdZ4

    Nothing works better as a tool for predicting the future course of reality laid out in a stream of numbers — your only justification for belief, as you profess.

  7. Gravatar of Cthorm Cthorm
    17. February 2012 at 10:15

    Ransom,

    Reading your comments gives me a profound sense of vertigo. It’s like I’m staring into an event horizon. Ph’nglui mglw’nafh Cthulhu R’lyeh wgah’nagl fhtagn.

  8. Gravatar of dwb dwb
    17. February 2012 at 10:59

    I strongly disagree that its a good thing that Europe has been “forced” into reforms due to the “debt crisis.” Reforms should be undertaken for their own sake. For the countries being forced into reforms (due to tight money, not debt) there is easily the possiblity that the reforms will “fail” (actually perceived to fail) because they are not backed up with appropriate monetary policy. 23% unemployment has a cancerous and malignant way of morphing into a social crisis and backlash – with the net result being a total rejection of the reform package or worse (lets not forget the to rebuke to democracy going on in Hungary). Sure, some countries in Southern Europe were in need of reform – but at some point they need to see the payoff from these reforms or they will reject them thinking things were really not that bad before they started them. Don’t be fooled into thinking there is something special about Germany either. they export a lot to the rest of Europe and will suffer just as bad if the Euro breaks, the Deutchmark climbs, and/or trade barriers go back up. Or worse.

  9. Gravatar of Mark A. Sadowski Mark A. Sadowski
    17. February 2012 at 11:01

    Scott wrote:
    “A cynic could argue that they already had a vague target in the general area of 1%.”

    That’s rather cryptic. What do you mean by that? At least if one goes by Japanese CPI prices have fallen by 3.3% since September 2008. (In fact the latest index was lower than it was in March 1993, nearly 20 years ago.)

    Morgan, the article was cowritten by Donald Luskin which means it should be taken with a rather large grain of salt. Marcus points out that although structural reforms are always welcome, our problems (and Europe’s problems) are primarily a lack of aggregate demand. More importantly, structural reforms are far easier to implement in the context of steady growing NGDP.

    http://thefaintofheart.wordpress.com/2012/02/17/is-a-supply-side-revolution-possible-amidst-disappearing-demand/

  10. Gravatar of dwb dwb
    17. February 2012 at 11:14

    @Cthorm

    I would use the present tense (“are” not “will”): if a “voluntary” debt restructuring where holders redeem for 30% NPV – and the remainder are forced through collective action clauses – is not a default, i don’t know the meaning of the word. greece IS defaulting.

    the jury is still out in my mind whether a greek govt default will improve things. there is still the matter of household debt and bank recapitalization. I dont know how they are implementing a 15% private sector pay cut (i read they are eliminating the 13th and 14th “monthly paychecks”). A greek govt default will not do much if household debt is still not serviceable at current levels of nominal income. It’s very very hard to coordinate the kind of internal devaluation they are attempting. inflation would be a heck of a lot easier….

  11. Gravatar of Morgan Warstler Morgan Warstler
    17. February 2012 at 11:18

    Yes Mark, I like Luskin. Very much so. Marcus was wrong.

    Boonie, at what cost?

    Screw that thinking, do you know how badly entrepreneurs have suffered in Greece???

    The very best people, the smartest cowboys, they have been living through a life that rivals blacks and Jim Crow.

    Life is the free market. And those most adept at winning at the free market are being denied their BIRTHRIGHT.

    America exists because the best and brightest have fled places like Greece.

    SCREW THE LOSERS! Who cares if they suffer – let them change!

    Mundell’s genius is that is sped up the course of human history, the damage done to my brothers who deserve to run Greece for the next 20 years while we waited around for you system is FAR MORE TRAGIC than a bunch of fat lazy no show job human scum being driven into the street for nightly lamentations.

  12. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    17. February 2012 at 11:26

    ‘The Fed had been hinting at a vague desire for 1.7% to 2.0% inflation. Now they have a firmer target, and they dropped the 1.7%. It’s just 2.0% inflation, period.’

    Which is where we are, according to this;

    http://2.bp.blogspot.com/-8Dzk_bucdeY/Tz5neksduuI/AAAAAAAAH4M/Clxjf9_Te_c/s1600/fredgraph-2.png

  13. Gravatar of Cthorm Cthorm
    17. February 2012 at 11:30

    @dwb

    I’m definitely FOR looser monetary policy for Europe. I’m just saying that the moves towards a more flexible labor market throughout the Eurozone is going to improve the economies therein ceteris paribus. Does it get them out of their debt traps on its own? Absolutely not. Once they allow higher inflation, does it make their economies stronger? Absolutely.

  14. Gravatar of Mark A. Sadowski Mark A. Sadowski
    17. February 2012 at 11:40

    Patrick,
    Actually I think the FOMC pays much more attention to core PCE than core CPI. Currently it is 1.85% yoy (exactly halfway between 1.7 and 2.0).

    https://research.stlouisfed.org/fred2/graph/?graph_id=66313&category_id=0

    Which suggests that if 2.0% is their new target there is now some room to inflate.

  15. Gravatar of ssumner ssumner
    17. February 2012 at 13:52

    Morgan, Thanks, that’s worth a post.

    Thanks Ben.

    Greg, Between 1920 and 1933 the US price level fell roughly in half. Ditto for NGDP. I’d call that deflation.

    I’ll bet the correlation between RGDP and NGDP is even closer than for housing.

    Mark, I mean that they talked about wanted “stable prices” and “zero inflation or slightly more.” They tended to be rather vague.

    Patrick, Yes, but recall they have the dual mandate, so inflation should be above 2% when unemployment is this high.

  16. Gravatar of ssumner ssumner
    17. February 2012 at 13:53

    Mark, I should add that of course they ACTED as if they opposed any inflation at all. So in that sense it is a change.

  17. Gravatar of Bonnie Bonnie
    17. February 2012 at 20:29

    @Cthorm

    Thanks for the response. I agree, Greece needs an ability to grow at least a little. I’m really am not a bleeding heart liberal, I just think that if there is a lesson to be learned from all the big government in Greece, they’ve likely learned it.

    @Morgan
    Everyone over in Greece is losing, entrepreneurs and working class, especially with the level of unrest, and that is my point. If you think that kind of social disaster can go on all across the south of Europe in a sustained fashion without there being serious political issues and associated destruction of the decent people along with the ones who aren’t as productive, you really should share some of what you’re smoking so we can all just shrug it off and wait until our kids lie stretched out dead on some battlefield in Europe. That is what happened during the deflationary cycle with the rise of fascism and Hitler. If we can’t learn from history, we are doomed to repeat it.

  18. Gravatar of Mark A. Sadowski Mark A. Sadowski
    17. February 2012 at 20:47

    Bonnie said:
    “Everyone over in Greece is losing, entrepreneurs and working class, especially with the level of unrest, and that is my point. If you think that kind of social disaster can go on all across the south of Europe in a sustained fashion without there being serious political issues and associated destruction of the decent people along with the ones who aren’t as productive, you really should share some of what you’re smoking so we can all just shrug it off and wait until our kids lie stretched out dead on some battlefield in Europe. That is what happened during the deflationary cycle with the rise of fascism and Hitler. If we can’t learn from history, we are doomed to repeat it.”

    Brilliant. I wish I had said it.

  19. Gravatar of Morgan Warstler Morgan Warstler
    17. February 2012 at 21:13

    Bonnie, I am unconcerned with WWIII over Greece or any such noise.

    Those pear shaped public employees will just get LESS. And they will eat it, and they will accept it, and that will be that.

    But soon enough, some growth will pop up its head, and it will all flow to one set of people – the important competent people who figure out how to take a bunch of unproductive Greeks, get to pay them accordingly, and actually make low-cost labor, low regulation competitive products.

    If you think this wasn’t worth it, you simply weren’t previously angry enough about the suffering of my peeps – the very best people Greece has to offer.

    And that’s sad, Bonnie 🙂

    It is unacceptable to not raise up entrepreneurs over all others. If it any other system is fighting this fact, then ANY METHOD of hacking it, of weaking it, is acceptable.

    If they didn’t want to suffer like this, they should have gotten out the gd way.

    Bonnie, it is coming over there, over here, public employees are gong back down to the bottom half of the pile, and staying there.

    Govt. doesn’t get to be an agent for its own interests. it gets to serve the people who actually foot the bills.

    Bonnie, have faith. Estonia figured out the facts of life, trust the Greeks to figure it out too.

  20. Gravatar of Mark A. Sadowski Mark A. Sadowski
    17. February 2012 at 21:32

    Morgan wrote:
    “Estonia figured out the facts of life, trust the Greeks to figure it out too.”

    After five years Estonia’s RGDP is still below its previous peak. On the other hand Poland’s RGDP is estimated to be 27.8% above what it was in 2007.

    If those are the facts of life leave me out.

  21. Gravatar of Morgan Warstler Morgan Warstler
    17. February 2012 at 21:58

    Mark, BOTH of those countries have figured out the facts of life.

    They have learned to let entrepreneurs run free, free, free.

    My argument is over whether monetary works.

    My argument is that austerity to force Greece to learn the facts of life too – is worth it.

    There can be denial of the facts.

  22. Gravatar of Morgan Warstler Morgan Warstler
    17. February 2012 at 21:58

    My argument ISN’T over whether monetary works.

  23. Gravatar of Morgan Warstler Morgan Warstler
    17. February 2012 at 21:59

    There can be NO denial of the facts.

    -ahem

  24. Gravatar of Mark A. Sadowski Mark A. Sadowski
    17. February 2012 at 22:09

    Morgan,
    Structural reforms *are* important. But what you are claiming is extreme.

  25. Gravatar of Morgan Warstler Morgan Warstler
    17. February 2012 at 22:28

    Mark, scream to deliver the structural reforms – once all those public employees are put in their place, I’ll feel their pain.

    I promise, I will feel it. I will let out low moans for their plight.

    But you know deep down, that when the right folks are at the bottom, and the right folks are at the top, then getting Greek debt forgiven will be easy as pie, because Greece will be living on its tax receipts.

  26. Gravatar of Mark A. Sadowski Mark A. Sadowski
    17. February 2012 at 22:45

    Morgan,
    “But you know deep down, that when the right folks are at the bottom, and the right folks are at the top, then getting Greek debt forgiven will be easy as pie, because Greece will be living on its tax receipts.”

    Who are the right folk? Who are the wrong folk? This is pure baloney. In my opinion based on my cursorey inspection you are definitely “the wrong folk.”

  27. Gravatar of Morgan Warstler Morgan Warstler
    18. February 2012 at 06:07

    I thought you wanted to be an economist?

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