Asking too much of a central bank
Here’s an article discussing Bill Gross’s views on monetary policy:
Bond guru Bill Gross, who has long called for the Federal Reserve to raise interest rates, urged the U.S. central bank on Wednesday to “get off zero and get off quick” as zero-bound levels are harming the real economy and destroying insurance company balance sheets and pension funds.
In his October Investment Outlook report, Gross wrote that the Fed, which did not raise its benchmark interest rates at last week’s high-profile policy meeting, should acknowledge the destructive nature of zero percent interest rates over the intermediate and longer term.
“Zero destroys existing business models such as life insurance company balance sheets and pension funds, which in turn are expected to use the proceeds to pay benefits for an aging boomer society,” Gross said. “These assumed liabilities were based on the assumption that a balanced portfolio of stocks and bonds would return 7-8 percent over the long term.”
But with corporate bonds now at 2-3 percent, Gross said it was obvious that to pay for future health, retirement and insurance related benefits, stocks must appreciate by 10 percent a year to meet the targeted assumption. “That, of course, is a stretch of some accountant’s or actuary’s imagination,” he said.
Not only are Bill Gross’s views wrong, they aren’t even defensible. Let’s look at several perspectives:
1. Money is neutral. In that case the Fed can only impact nominal returns. If it wants higher nominal returns then it needs to adopt a more expansionary monetary policy. That’s the opposite of what Gross is proposing.
2. Money is non-neutral. In that case the Fed can raise nominal returns on debt with a tight money policy, but only in the short run. And Gross says the problem is that long-term returns are too low. However to raise them you need to raise NGDP growth, which means easier money. Even worse, a contractionary monetary policy that raises the return on T-bills will reduce the return on stocks.
Why is there so much confusion on this point? Perhaps because people forget that most central bank decisions are endogenous, on any given day or week the Fed usually follows the market. Here’s a perfect example of why people get confused, look at the first paragraph of a recent Reuters article:
Euro zone government bond yields dropped by more than 10 basis points on Friday after the U.S. Federal Reserve prolonged the era of nearly-free money amid concerns about a weak world economy.
Most readers probably think there is a connection between these two events. And there may be one. But it’s not the connection you might assume at first glance. It’s obviously not that case that the Fed deciding to keep rates steady on Wednesday caused eurozone bond yields to fall on Friday. That makes no sense. Instead both the Fed and the bond market are reacting to the same facts—a weakening global economy. People see short and long-term rates rise and fall at about the same time, and draw the erroneous conclusion that Fed policy is causing those changes.
The Fed can’t magically produce strong long run real returns on investment for insurance companies, especially with tight money. That’s far beyond their powers, according to all models I’m aware of (monetarist, Keynesian, Austrian, etc.) If Bill Gross has a new model, I’d love to see it. In the 21st century, insurance companies will have to learn to live with lower returns. They may have to raise the price of insurance. If they lose business, then . . . well, tough luck!
Off topic, Tyler Cowen recently noted that China’s September PMI fell to 47, and then asked:
How quickly do services have to be expanding for the entire Chinese economy to be growing at anything close to six percent?
Since I’m on record predicting 6% RGDP growth, I’ll address this question. First we need to determine how fast industrial production is growing. Here’s a graph of the growth rate of IP since 1990:
Other than the post-Tiananmen crash, China’s industrial production has maintained a strong upward trend. However there are three notable slowdowns. The slowdown in the late 1990s was caused by China’s currency being overvalued due to its peg to an appreciating dollar, at the same time the emerging markets were struggling and devaluing, and at the same time the US and Europe were growing. Sound familiar? And notice that the gradually slowdown since 2012 looks a lot like the late 1990s. And then there was a sharp but brief slowdown during the global recession of 2008-09.
The most recent figures show 6.1% growth (YOY) in August, and September may show further deterioration. After than I expect Chinese IP growth to begin recovering, although the YOY figures may worsen for some time.
So to answer Tyler’s question, if industry is growing at 6%, then services would also need to be growing at roughly 6%, in order to produce 6% GDP growth. Is it plausible that China’s industrial production could be growing at 6% with such horrible manufacturing PMIs? See for yourself, here’s the PMI index as far back as I could find:
The recent numbers are a bit worse than usual, but as you can see the PMI often dipped to 48, with no obvious ill effects on the China boom. I believe that this time China is slowing a bit more than usual, which explains my bearish forecast of 6% growth in 2016, vs. the consensus of 6.7% by China experts. So like Tyler I’m currently bearish on the Chinese economy, just not as bearish. My bearishness comes from the fact that I believe China experts are underestimating the impact of the strong dollar, which is making China’s currency overvalued.
I’m also more bearish than the Fed on the US economy, for much the same reason.
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23. September 2015 at 08:08
Long-time reader, first time commenter.
I’m feeling especially uncharitable today – I think it’s plainly obvious Gross wants bond prices to appreciate as dollars move from equities and into fixed-income from a rate hike. Thus, he can claim for himself a bigger bonus from investors in his bond fund. Hanlon’s razor doesn’t seem to apply in this circumstance.
23. September 2015 at 09:02
Care to speculate on why Bill would say such a thing?
23. September 2015 at 09:19
I almost e-mailed that article to you, myself, when I saw it. It’s a statement about EMH and the “homoeconomicus” critique. Even the guy who is considered the king of fixed income doesn’t seem to have a coherent viewpoint about fixed income. Yet, fixed income markets are probably our best example of market efficiency.
23. September 2015 at 09:24
Tom, Don’t know. Tyre thinks he has a hidden agenda, I’m more likely to attribute these things to ignorance of the fact that low rates means money has been tight.
Kevin, Fortunately the markets are far smarter than any individual.
23. September 2015 at 09:28
[…] the middle of this post you will find Scott Sumner on China’s […]
23. September 2015 at 09:46
[…] the middle of this post you will find Scott Sumner on China’s […]
23. September 2015 at 10:01
Scott,
Why call it the hidden agenda? With any private citizen recommending public policy, it is wise to understand where their paycheck comes from. Bill Gross is television bond salesman so of course he is going to think raising rates is a good thing. (Does not matter if you agree with the policy? It would be good policy to end export restrictions on US drilled oil but its economic impact at this time point is small.)
Otherwise, I think Jamie Dimon statements on the US economy are the most correct. Right now it is the cleanest shirt in the laundry hamper and we are looking at some decent (not great) growth. Although the job market is tight but it is for the ‘wrong’ reasons as the US labor supply has dropped and companies can ill afford to lay people off. (Jobless claims are lower than anytime before the 1970 Stagflation.) Additionally, there is limited growth in other global nations so companies growth depend upon US profit growth. (Especially since growth in oil pumping nations collapsed.)
23. September 2015 at 10:17
I get the sense that Gross, and many who just know that zero is a problem and needs to end, start from a belief of what interest rates “should” be. Either what they think is normal or what they think is fair or something.
Which seems like a strange way to approach a price for money. Although, I guess people seem to have strong views about the “fundamental” prices for things like stocks and houses and things, so maybe it’s not that strange here.
But it seems pretty obvious that rates “should” be whatever is consistent with the dual mandate.
23. September 2015 at 11:01
“Even worse, a contractionary monetary policy that raises the return on T-bills will reduce the return on stocks.”
You fool!
A contractionary monetary policy will in the short run reduce returns, but in the long run the real economy will be more coordinated, or at least less discoordinated.
More inflation will only make the real economy worse in the long run. Note that we are already in the long run from decades of far too much inflationary debt, and as a result the average standard of living is far less that it otherwise would have been.
23. September 2015 at 11:03
“Perhaps because people forget that most central bank decisions are endogenous, on any given day or week the Fed usually follows the market.”
More foolishness.
The Fed is not following the market, and the market is not following the Fed. The Fed is following what was a combination between its own past activity and hampered market forces.
23. September 2015 at 11:07
“That’s far beyond their powers, according to all models I’m aware of (monetarist, Keynesian, Austrian, etc.)”
Oh hey why not throw in ignorance of Austrian theory while you’re at it.
Austrian theory is quite clear that tight money after loose money reduces the extent of discoordination caused by above market debt and inflation rates which are themselves caused by central banks, and increases long run real returns by allowing a less distorted information set of prices, profit and loss.
Wow. Just wow.
23. September 2015 at 12:05
What if the Federal Reserve board sent out a press release declaring that it was not going to change interest rate policy and in fact it was not going to meet to discuss monetary policy until the yield on 10-year notes reached 5%?
Would the Federal Reserve board ever hold another meeting? When?
23. September 2015 at 12:14
I kind of wish the FOMC had raised rates by 1/4 point; not because it is good policy, but because it would end the water torture and expose certain members as knaves and fools once and for all.
Then we could get on with discussing changes to the policy regime. But I suppose this comment falls into the category of “be careful what you wish for.”
23. September 2015 at 12:15
Zero percent forever is where we are and I’m not sure anybody knows what will happen. Japan is a complete mystery to economists from all schools, for example.
But it’s fair to speculate about what might happen, as Gross does. Certainly zero percent is going to bankrupt many state and private pension plans, as we see in Chicago, which is proposing a very large property tax increase to cover the shortfall.
23. September 2015 at 12:19
The VW scandal is an interesting situation.
For EMH fans, note that the scandal has actually been public, but poorly disseminated for almost a year and a half. It wasn’t until this week that VW lost half its value.
http://www.huffingtonpost.com/entry/the-unassuming-engineer-who-exposed-volkswagen_5601e295e4b0fde8b0d05376
Also, am I crazy to think that this is a macro positive? By wrecking the German export industry, the ECB will choose easier monetary policy for all of Europe (assuming the ECB implicitly targets German NGDP). Plus, maybe Greeks will trade in VWs for Fiats.
23. September 2015 at 12:20
Bill Gross- “Zero destroys existing business models such as life insurance company balance sheets…”
Scott Sumner- “In the 21st century, insurance companies will have to learn to live with lower returns. They may have to raise the price of insurance. If they lose business, then… well, tough luck!”
I hope the Fed thinks more like Sumner than Bill Gross.
23. September 2015 at 13:08
About half a dozen years ago, the investment banker who posts under the handle “Mindles H. Dreck” offered an opinion on Mr. Gross: “Believe me, Bill Gross is always talking book.” Mr. Gross is telling you current Fed policy is bad for his business.
23. September 2015 at 14:15
Tom, Don’t know. Tyre thinks he has a hidden agenda, I’m more likely to attribute these things to ignorance of the fact that low rates means money has been tight.
Don’t be so charitable. I’m sure Gross (or at least his economists) knows where the Wicksellian rate of interest is right now and the Fed’s relation to it. But all he cares about are his clients who have a 7% FI bogey that he can’t possibly get right now. So he rails against the Fed, saying it is their fault, not his, that returns are so lousy.
Have to agree with Art Deco here. Everybody talks their book.
23. September 2015 at 16:12
Gross has been making the same argument for years:
http://modeledbehavior.com/2011/12/24/zero-rate-confusion/
23. September 2015 at 16:14
Excellent blogging. How do insurance companies survive in Japan?
23. September 2015 at 16:42
Scott,
I don’t see how Gross’s statements can be interpreted as anything other than blatant self-aggrandizement. As you said yourself in the post, there’s no rational model that would justify a rate increase to achieve his stated goals.
So let’s apply the lens of public choice theory.
Oh look, he stands to personally benefit. I’m shocked. /sarc
It’s just rent-seeking, really.
23. September 2015 at 17:05
Steve, You asked:
“Also, am I crazy to think that this is a macro positive?”
Yes.
Njnnja and tyre, After 7 years of blogging I’ve concluded that almost everyone is ignorant. I see no reason to start assuming otherwise. I see ignorance all around me, even with people who have no axe to grind.
I’m sure there are lots of Nobel Prize winning economists who favor a rate increase. Is Gross smarter than they are? Obviously not. I’ll assume ignorance until proven otherwise. BTW, I thought Gross made a fortune when rates fell? Is that wrong?
More generally, I assume people are honest until I have evidence otherwise.
23. September 2015 at 18:03
First of all, Bill Gross did not write the article cited by Yahoo.
It is not in his style, and you would know that if you read his stuff. He did sign it, but he did not write it.
Both of your point 1 and point 2 are wrong.
#1 is contradicted by actual (very) expansionary monetary policy pursued by the FED for 7 years now and extremely low rates at the same time.
#2 is contradicted by Volcker’s policy in the early 80’s. Increasing the interest rates did not require NGPD growth.
Thus, the input going into your models is misrepresented at best.
Accordingly, the output is entirely meaningless.
Model based economics and social policies are dangerous even when the data used is accurate. With cooked data they may kill us all.
23. September 2015 at 18:10
Minority, You said:
“First of all, Bill Gross did not write the article cited by Yahoo.
It is not in his style, and you would know that if you read his stuff.”
Hmmm, maybe that’s why I never said he wrote the article.
Idiot.
Your other two comments are silly. Fed policy has clearly been tight since 2008, and NGDP growth during 1979-81 was extremely rapid. Peaking in late 1980 and early 1981 at 19.2%.
23. September 2015 at 19:41
Another quote from CNN Money I saw earlier today:
“Gross, who is known for his colorful quotes, said ordinary Americans with 401(k)s are behind hurt by the low-interest rate environment.
“They are on a revolving spit, being slowly cooked alive while central bankers focus on their Taylor models and fight non-existent inflation,” Gross wrote, referring to an economic model that sways monetary policy.”
http://money.cnn.com/2015/09/23/investing/bill-gross-federal-reserve/index.html
So Fed policy can be currently describe as fighting inflation even though it is low, which I don’t really disagree with completely seeing that inflation has been below target for so long. The Fed hasn’t been super loose given the circumstances (I know you prefer NGDP, but still). However, what does he think is going to happen to inflation if they raise rates?
Geez I didn’t think neofisherism was catching on that much.
24. September 2015 at 02:10
Talking his book: raising rates decreases the current value of a bond. In other words, Gross’s bond funds would have a lower value, and lower reported return, in the short run if the interest rates on their bonds were to increase. Over time, the higher interest rates would overcome, and more than make up for, this shorter term loss of market value, but that could take a while. The magnitude of these effects depends on the duration of the bond fund, any hedging, etc.
24. September 2015 at 03:26
Off-topic (but not so much)
I think market monetarists have something to say about this article …. https://www.project-syndicate.org/commentary/federal-reserve-end-of-monetarism-by-anatole-kaletsky-2015-09 …
24. September 2015 at 04:46
Sumner: “Money is neutral. In that case the Fed can only impact nominal returns. ***If it wants higher nominal returns*** then it needs to adopt a more expansionary monetary policy. That’s the opposite of what Gross is proposing.”
Notice the sleight of hand that Sumner the magician uses. If money is neutral, why would the Fed want higher nominal returns? Why not settle for lower nominal returns? And what exactly does Sumner mean by ‘returns’? Surely if money is neutral, the Fed has no impact on the real economy. So what returns are these?
24. September 2015 at 05:27
@ssumner:
Gross was initially one of the “Everyone should be shorting Treasuries” crowd at the beginning of QE, and lost a lot of money on that trade. Note that he decried the risks of QE after selling off pretty much his entire Treasury holding – at that point if he was wrong he couldn’t easily change the direction of his $270 bn bond fund so it was all just talk.
Once he realized that didn’t work (by the end of 2011), he went to a “don’t fight the Fed” position of long Treasuries and mortgages (the stuff QE is made of). He shut up about how inflation was right around the corner, and instead talked about how the Fed was going to be at ZIRP for years. Yes he made a lot of money but absent from his talk was any warning about the evils of ZIRP (like you heard in 2011 and you hear from him now).
After 7 years of blogging I’ve concluded that almost everyone is ignorant.
After reading your blog for almost all of those 7 years I think you are probably right. But after 20 years of finance I’ve concluded that, ignorant or not, everyone who has a book to talk talks their book :).
Of course one could also argue that investors take a position because they believe in it, and therefore only are saying what they believe. But other times they are stuck in a position that they can’t trade out of (like PIMCO was in 2011). Bill Gross is an FI guy (*the* FI guy) and if FI is an unattractive asset class and gets deallocated, there’s no way for him to trade out of that position.
So he can either say “With low inflation and lots of assets chasing few real opportunities, nominal returns on my (your) portfolio are going to be low as far as the eye can see. Please invest!” or he can say “The Fed’s ZIRP is ruining the economy, and as soon as they recognize that they will raise rates and your (my) returns will be back to normal. PS China stocks suck.” Regardless of what he really believes, what do you think The Bond King is going to say? I find his investment outlooks entertaining and as good an indicator of his positions as SEC filings on TROR, but they shouldn’t be used for macroeconomic prediction.
24. September 2015 at 09:18
I work in investments for a medium sized US life insurance company and Gross’s statements reflect very commonly held opinion in the insurance industry. I’m fully in Scott’s camp in macroeconomic terms, but Gross isn’t wrong when he says, “Zero destroys existing business models such as life insurance company balance sheets…”
Insurance contracts can be very long term and usually include either explicit or implicit guarantees of nominal returns. Contracts issued during the 70’s and 80’s guaranteed returns of 4, 5, 6% or even higher returns. Even contracts written in the 90’s and 00’s have guarantees which are potentially unsupportable if the FI environment of the last 7 years persists.
Benjamin Cole’s question about Japanese insurers is a good one. I think some reasonably large Japanese insurers did in fact go under or were forced to suspend their insurance businesses. I have some vague memory that policyholders also took haircuts to keep insurers solvent, but I could be wrong.
24. September 2015 at 10:53
Here’s another possibility: By calling for higher rates, Gross is not primarily trying to influence the direction of policy, he is mainly gaining for himself free advertising. He gets his name in the news and he is seen as taking a position which is attractive to a certain type of individual who is likely to have money to invest in a bond fund. As Krugman has talked about in his blog, the permahawk stance on rates can be seen as a type of affinity fraud which is attractive to a certain demographic, primarily moneyed and approaching retirement age, ie., exactly the demographic a bond fund would like to appeal to.
24. September 2015 at 12:37
Ray, You said:
“And what exactly does Sumner mean by ‘returns’? Surely if money is neutral, the Fed has no impact on the real economy. So what returns are these?”
This is especially comical given that you quoted me saying “nominal returns” and then a sentence later ask what kind of returns I am talking about. Well done!
Njnnja, If most people lie, then why should I believe anything you say? Why shouldn’t I assume that you are lying when you claim that most people lie? What’s your hidden agenda into making me into a cynic?
24. September 2015 at 13:30
Dear Professor Sumner,
Thank you for your thoughtful reply (reproduced below) to my post.
“ssumner
23. September 2015 at 18:10
Minority, You said:
“First of all, Bill Gross did not write the article cited by Yahoo.
It is not in his style, and you would know that if you read his stuff.”
Hmmm, maybe that’s why I never said he wrote the article.
Idiot.
Your other two comments are silly. Fed policy has clearly been tight since 2008, and NGDP growth during 1979-81 was extremely rapid. Peaking in late 1980 and early 1981 at 19.2%.”
Your comment regarding to Bill Gross’ style would be more believable if you linked to the actual Bill Gross article. But you didn’t. Instead, you linked to a yahoo article, which does say: “In his October Investment Outlook report, Gross wrote…”
This makes me an idiot in your eyes.
Your assertion that “Fed policy has clearly been tight since 2008” may perplex the uninitiated, who might think that several years of extremely low interest rates and multiple Quantitative EASING programs are anything but ‘tight’.
I sure hope that the algorithms used in your models can better differentiate between cause and effect than your statement above suggest regarding the relationship between Volcker’s interest rate policies and NGDP. Do you really think that those interest rate hikes were the result of extremely rapid NGPD growth? How much of that NGPD growth was simply due to price inflation? Was that a good thing?
Time will tell who is an idiot, hopefully before too much damage is done to the actual (as opposed to the model of the) economy.
What is your learned opinion of the Misery Index (inflation + unemployment)?
All the best.
24. September 2015 at 13:42
Indeed, “there is no way for a central bank to control where its newly created money ends up.” And since money tends to circulate, as opposed to “ending up” somewhere–i.e., going there and staying put–the phrase “ends up” is inappropriate. The monetary authority *can* control who is the *first possessor* of new money, by buying something from this person rather than from that one; but this is of negligible economic importance *so long as they are not overpaying for what they buy*.
24. September 2015 at 15:18
Thought experiment: what if the fed raised rates like prescribed and the economy contracted. Then stock market returns would be well under that 7 or 8 percent threshold and if the rate hikes don’t give bonds enough juice then the returns will still fall short. So it doesn’t seem to make sense either way. The solution is NGDP growth that will allow stocks and bonds to return enough. Or am I missing something?
24. September 2015 at 18:12
@Minority – “I sure hope that the algorithms used in your models can better differentiate between cause and effect than your statement above suggest regarding the relationship between Volcker’s interest rate policies and NGDP.” – you’re new here. Sumner does not have any algorithms, nor any model. He just has a word picture that he distorts as he goes along…
25. September 2015 at 06:19
Minority, I have no idea what you are talking about regarding Gross. I did not say he wrote the article I quoted from. You said I did. What exactly is your problem?
As for low interest rates implying easy money, that’s why Joan Robinson said the Germany hyperinflation couldn’t possibly be caused by easy money—interest rates were not low. Is that your view as well?
Philo, Good comment.
Benny, I agree, it’s silly to think that a rate hike will raise returns on investment.
25. September 2015 at 14:02
@Ray Lopez,
Thanks very much.
27. September 2015 at 10:48
Sumner wrote:
“Fed policy has clearly been tight since 2008.”
No, what has been clear since 2008 is your personal definition of tight money.
Given that a free market would almost certainly have had far less money expansion since 2008, and given that a market based definition is not my own personal definition, but an accommodation of every individual to act upon their own definition without infringing on anyone else’s definition, which is maximally useful, it follows that money has been loose since 2008.
Extremely loose in fact.
Oh, you might protest, if money was so loose, why haven’t capital goods prices and consumer goods prices risen by some percent you equate to the meaning of “loose”? The answer is that a significant portion of the money supply that was inflated for the benefit of the “made” member banks, has not translated into a sufficiently high aggregate money supply owned by the public at large, and thus has not translated into a sufficiently high aggregate spending to force prices upwards in the way you claim must be the case from the definition of “loose” money.
Loose money is not useful defined in terms of the absolute results of a higher supply of money on prices or spending. We don’t define the supply of hoola hoops that way, or the supply of Ford Pintos that way.
No, the economic definition of the extent of the supply of anything, is based on what individuals in a market context actually value in their actions. Economics doesn’t say the supply of hoola hoops or potatoes is “tight” on the basis that the supply of them, or even more absurd the exchange of them, isn’t rising this year by some percent you pretend to know the market should want.
Economics tells us that the supply of a good is too high or too low by virtue of the market based signals of profit and loss.
We lack conclusive information pertaining to the investment in and production of money itself, so we can’t know based on any statistic observed since 1913 whether money is too tight or too loose. So we must make an educated estimate, and unfortunately for Sumner, his malinvestment in monetarist education is biasing him away from market based definitions that are inclusive. His definition is exclusive. It excludes everyone throughout the country and world, except himself and the small group of violent thugs with badges and their ivory tower justifier intellectuals.
A utilitarian definition, a pragmatic definition, a useful definition would be one that every individual can act upon without infringing upon other individual’s definitions. That would seem to suggest that the most utilitarian, most pragmatic, most useful definition of tight money and loose money is one that presumes a market based money.
A market based money would not necessarily result in continually expanding NGDP. And even if it did, that does not imply that a central banking system that targeted NGDP would be “close” to a market. This is because the very existence of a central bank would affect the world in such a way that stable NGDP is no longer always a reflection of efficiency. Goodhart and Lucas referred to this dilemma, which Sumner is lying to himself and others as not relevant to NGDPLT.
If in a free market there is a stable growth in population of people, that does not mean that should a state take over population control, that 2% population growth through eugenics and proceation laws is “close” to a market. For the very existence of statist population control would change the circumstances of efficient population growth which could lead to drastically inefficient population numbers that are against the values of the people being forced to procreate in accordance with state laws. It is quite possible for a 2% population growth forced by the state to be massively too many people compared to whaw people actually want GIVEN the new conditions brought about by the population control itself.
This is what Sumner and monetarists in general do want to grasp. They do not seem to even want to understand that attempts to “mimic” the market are themselves distorting activities that require correction by way of activity that leads to off-target statistics.
A central bank that continually targets NGDP growth of some “reasonable” percentage, would not be mimicking the market closely in such a way that it can be made permanent. Such an activity would adversely affect the market in such a way that a massive off-target statistic would be required to fix the distortions that the intervention caused.
Sumner seems to really dislike the truth. It is why he occasionally writes that truth is “what most people believe”, or “what people can get away with.” He has to go irrational because he cannot find a way to make true what he might now be regretting as a poor choice in educational investment.
His views are idiotic, but they are amusing.