Who just posted this right-wing market monetarist interpretation of recent events?

Well, the euro area has had a (slightly) shrinking population aged 15-64 since 2008, while the US has not (although our growth is slowing). How does this affect the picture, and what changes?

Europe still does badly, but not by as bad a margin as the raw numbers say:

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Furthermore, the shortfall doesn’t start right away. Things really go off track only in 2011-2012, when the U.S. recovery continues but Europe slides into a second recession. That’s also when the euro area inflation rate slips definitively below target, where the US rate doesn’t to the same degree:

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What was happening in 2011-2012? Europe was doing a lot of austerity. But so, actually, was the U.S., between the expiration of stimulus and cutbacks at the state and local level. The big difference was monetary: the ECB’s utterly wrong-headed interest rate hikes in 2011, and its refusal to do its job as lender of last resort as the debt crisis turned into a liquidity panic, even as the Fed was pursuing aggressive easing.

Policy improved after that, with Mario Draghi’s “whatever it takes” stabilizing bond markets and a leveling off of austerity. But I think you can make the case that the policy errors of 2011-2012 rocked the euro economy back on its heels, pushed inflation down by around a percentage point, and created enduring weakness — because it’s really hard to recover from deflationary mistakes when you’re in a liquidity trap.

Surprisingly, it was Paul Krugman. I’m thrilled, I just wish he’d given us credit for writing lots of posts almost exactly like this one.

And as far as all you Keynesian commenters who complained when I said we’d done as much austerity as Europe, and the real difference was monetary policy, what do you say now?

And all you Keynesian commenters who insisted the ECB could not have offset fiscal austerity because the eurozone was at the zero bound (it wasn’t) what do you say now?

Is Krugman just as clueless as we are?

PS.  People sometimes ask me if I’m depressed that I’ve been unable to get the Fed to do NGDPLT.  I try to be polite, but My God!  We MMs have succeeded beyond our wildest dreams.  An increasing number of famous economists favor NGDP targeting. An increasing number of people acknowledge that monetary policy was actually too tight in 2008.  The idea that the Fed offset fiscal austerity in 2013 has increasing support.  Japan switched policy in 2013, and their CPI is up about 4% (there’s much more work to be done, but previously they were in deflation.)  MMs developed the idea of negative IOR, and then major central banks start adopting it.  Even better, asset market responses to negative IOR announcement are consistent with MM predictions and inconsistent with the heterodox views you get in the financial press.  We predict 2 rate increases in 2016 when the Fed says there’ll be 4, and now the Fed predicts 2.  I could go on and on.  And remember, within the economics profession we are a bunch of nobodies.  If this is failure, I can’t wait for success.

HT:  Michael Darda

PS.  Here’s a screen shot of the PP presentation I’ve been giving for years (I believe I originally got the graph from David Beckworth.)

“Currency wars” are one of those topics about which almost everything you read is wrong.

1.  The media often confuses changes in nominal exchanges rates (determined by monetary policy) with changes in real exchange rates (determined by national saving/investment policies).

2.  The media often draws meaningless distinctions between policies explicitly aimed at reducing exchange rates, with other policies (such as QE and negative IOR) that have the effect of reducing exchange rates.  For instance, the US dollar price of euros rose from $1.31 to 1.37 on the day QE1 was announced in March 2009.  Is that currency manipulation?

3.  The media tends to assume a zero sum game, but currency depreciation by one country will often boost stock markets all over the world, by boosting global AD.

4.  The media has a “pro-international agreement” bias.  International agreements made by highly educated public servants seem like responsible policymaking.  If the media knows little about the issue, they’ll defer to the experts.  And “war” sounds like a bad thing.  But recall that these are the same experts who pressured the Japanese NOT to devalue in the 1990s, as they were sliding into deflation.  How’d that advice work out?

In my view, things get even worse if central banks are perceived to have run out of ammo.  (Put aside the question of whether they have actually run out of ammo, which seems impossible.)  Suppose the Fed has room to raise and lower interest rates, but the BOJ and ECB have no room. Of course, they can still devalue if they wish.  Now assume an international agreement to avoid “currency wars”.  So they can’t devalue either.  In that case, you’ve resurrected Bretton Woods, at the worst possible time.  The US becomes central banker to the world.  (David Beckworth has shown that the Fed is already a “monetary superpower”, and a currency agreement under these circumstances would make them even more of a superpower—controlling the fate of not just China, but also Japan and the eurozone.

I hope you can see the obvious problem here.  The Fed insists that its mandate is to control American inflation, not Japanese and eurozone inflation.  But if we have an agreement to ban currency wars, then the Fed has a moral obligation to stabilize the average inflation rate in the US, Japan, and Europe.  I think it goes without saying that current policy is too tight, under that mandate.

And this blog post suggests that there already may be an implicit currency stabilization agreement:

More so, what if central banks think they’re at the limits of monetary policy anyway? If you combine that thought with pressure from the G20 you get to de facto agreement anyway, right? Or at least the behaviour of central banks can be explained, and predicted to an extent, by assuming the existence of a de facto agreement.

Here’s Citi’s Steven Englander saying just that:

It is probably better to think of G20 as similar to Friedman and Savages’s billiards player (link, page 12,13), G20 may not have made a deal but they are behaving as if they did, so we may as well analyze the consequences from that perspective. One question to ask is why they would agree to setting aside currency as a macroeconomic weapon the likely answer is that the winners of the currency war battles may have decided that they were not benefitting enough to offset the negative impact of the ancillary asset market volatility that emerged. Basically they were acknowledging policy ineffectiveness or at least monetary policy ineffectiveness, and the Statement pretty much admitted that.

So we now find ourselves in a situation where G3 has trouble cutting rates. The ECB and BoJ are reluctant because of the strains it is putting on their financial institutions and political unpopularity. The Fed is reluctant for similar reasons and because it seems unlikely that one cut would do great things for the US economy and it would certainly raise a suspicion that negative rates were beckoning. An already unpopular institution would become politically toxic. Bottom line, easing is hard to do. An ECB or BoJ hike is unlikely, needless to say. The Fed has already indicated its reluctance to hike and is very unlikely to hike to defend the currency if anything they seem to be cheering any weakness the USD encounters.

Put this all together and you have an extremely high bar for any G3 central bank cutting rates and an extremely high bar to them raising (and an even higher bar to any of them raising rates in response to currency weakness).

The point being that the FX market is now discounting the chances of aggressive central bank reaction in opposition to short term directional moves. Like, you know, they would if a deal had actually been agreed.

The new reality is one in which FX is being dictated by market forces rather than central banks. Or more so, we suppose, one in which some market participants can push exchange rates around without coming up against a central bank pushing back.

Of course, this could all go out the window when Japan pulls the trigger at its next monetary policy meeting on April 27th. Or they could opt for intervention (since mon pol might be exhausted, goes the theory while another theory says any intervention would have to be short and sharp considering the G20 once again) and surprise our inboxes. Inboxes that have already been surprised by this move in JPY, of course.

I would add that it is not “market forces” pushing the yen much higher; it’s a dramatically tighter monetary policy out of Japan.  You might wonder, “How did that happen?”  Expectations fairies—people have stopped believing that Kuroda will ease as needed to hit the BOJ’s inflation target.  Even though the BOJ did nothing “concrete” in the past few weeks, the future expected path of BOJ policy has become much tighter.

Pay attention to the April 27 BOJ meeting, and then a few days later to the Q1 GDP for the US, which might be negative.

Over at Econlog I have a new post pointing out that negative IOR has had an unquestionably positive impact on asset prices, and yet much of the business press claims exactly the opposite.  This confused thinking makes it more likely that central banks will adopt bad policies in the future.

A similar problem occurred in late 2007 and early 2008, when the media adopted a Keynesian approach to monetary analysis, instead of a monetarist approach.

From August 2007 to May 2008, the Fed repeatedly cut interest rates, from 5.25% to 2.0%. The media treated this as an expansionary monetary policy, even though it was clearly exactly the opposite.  The monetary base did not change, and falling interest rates are actually contractionary when the money supply is stable.  Indeed it’s a miracle the economy didn’t do even worse.  NGDP growth slowed sharply, and I surprised there wasn’t an outright decline.

Here’s the monetarist approach:

NGDP = MB*(Base velocity), where V is positively related to nominal interest rates.

Thus if you cut interest rates without increasing the money supply, then V falls and policy becomes more contractionary. It’s monetary economics 101, but almost everyone seems to have forgotten this simple point.  Market’s responded favorably to larger than expected rate cuts, because they implied a bigger than expected boost to the monetary base, on that day.  But over time the base did not increase at all; the rate cuts were merely enough to keep it from falling.  So do more!!

Because the media wrongly thought money was getting easier, they became (wrongly) pessimistic about the efficacy of monetary policy, which led to President Bush’s failed fiscal stimulus of May 2008.  There is no economic model where Bush’s policy would be effective.  Interest rates were above zero, so monetary offset was fully applicable.  The Fed responded by putting rate cuts on hold, which drove the economy right off the cliff after June 2008.  By September the tight money caused Lehman to fail, as its balance sheet was highly leveraged, and exposed to asset price declines triggered by falling NGDP expectations.  Yet even Ben Bernanke inexplicably endorsed Bush’s tax rebates, even though there is no logical reason for him to have done so.  If more stimulus was needed in May, then the stance of monetary policy should have been more expansionary.  So do more!!

Bush’s policy was a lump sum tax rebate, which doesn’t even work on the supply-side.  And unlike more government spending, there isn’t even a New Keynesian argument that fiscal stimulus might boost aggregate supply by making people work harder.  It was really dumb policy, there’s nothing more to say.

So because the media and many economists wrongly though money was loose, we ended up with really bad macro policy. The recent backing away from additional negative IOR is more of the same.  Just as markets responded to unexpected rate cuts in late 2007 as if they were highly expansionary, markets responded to negative IOR in Europe and Japan as if it is expansionary.  But over longer periods of time the markets were more negative, because investors rightly perceived that central banks would not do enough.  So do more!!  In 2007-08 investors were pessimistic because they thought the Fed wasn’t cutting rates fast enough.  The Fed needed faster rate cuts to enable the monetary base to increase.  So do more!! Similarly, in recent months, markets in places like Japan have become pessimistic because the BOJ is not cutting rates fast enough, or is suggesting it may give up. But the media thinks the market is pessimistic because the BOJ is doing negative IOR, even though asset markets respond positively to negative IOR.

In both cases, people wrongly assumed that the problem was that the measures that were taken were not effective.  Instead of, “So do more!” it became perceived as, “So stop doing that, it’s not working.”  They ignored the fact that markets clearly indicated it was working, but that much more needed to be done.  Did I say, “So do more”?

Sometimes I think I’m going crazy—maybe everything I believe is wrong.  After all, almost everything I read is diametrically opposed to what clearly seems to be happening, or to what our textbooks teach us about monetary policy.  But then I look at the asset markets, and am reassured.  I’m not really losing my mind. Monetary stimulus is effective, and it’s needed in Japan and Europe, and was needed in 2007-08 in America.  No matter how many times the press tells us that the markets hate negative IOR, each new IOR news shock confirms once again that the markets prefer even more negative IOR in Europe and Japan.  I don’t have my head in the sand, it’s the business press that does.

In this year of Trump, it has become fashionable to sneer at things you don’t understand.  Like the EMH.  TravisV sent me an example from the normally sensible Joe Weisenthal and Matthew Klein.  It’s also a good example of why I don’t use Twitter.  Lots of snarky comments that make a person look smart, but on closer examination merely show that the writer is witty.

JP Koning pointed out that I viewed yesterday’s market reaction as supporting the claim that the ECB actions helped European banks.  Stocks rose on the announcement, and bank stocks rose especially sharply.  I stand by that claim. Then Joe Weisenthal responded:

Almost all of the gains to which Sumner is referring to in this post were erased by the end of trading.

That’s true, but completely irrelevant.  The problem here is that people don’t understand markets.  Equity prices are always moving around.  When you do an event study, what matters is the market response immediately after the announcement, not later in the day.  You may “feel bad” that the stock rally didn’t last, but markets aren’t about feelings, they are about cold hard facts.  In fact, if markets never reversed gains made early in the trading day, then the EMH would be entirely false.  A few weeks back I was sent an email by a guy showing that previous BOJ surprises were followed by additional gains in the days and weeks ahead.  Free money?  Nope, right after making that observation, the Japanese markets reversed, and lost more than the initial gain from the BOJ’s recent decision to go negative. It’s just one coin flip after another.

Matthew Klein responds:

LOL

Joe Weisenthal responds:

Sumner’s insistence on using snap market reactions to judge policy a success or failure is head-scratching.

I’m honored that Joe thinks I invented “event studies”—that this is all my peculiar idea, but there are actually thousands of academic event studies.  I’ve seen Paul Krugman favorably discuss the outcome of event studies.  Then this was added to the Twitter thread, by someone else:

Sumner’s view is unfalsifiable. He will now say that ECB did not do enough.

Actually, event studies are among the most “falsifiable” of all academic studies. But notice how misleading this is.  I actually did say the ECB needs to do more, but the commenter is giving readers the impression that I use that as an excuse for the decline in stocks later in the day.  That is completely false, as it would not be consistent with the EMH.  Yes, they need to do more, but my explanation for the decline in stocks later in the day was exactly the same explanation as the financial press provided. That’s right, publications like the Financial Times are apparently just as clueless as I am.  I wonder why Weisenthal doesn’t say, “The mainstream financial press’s claim that asset prices reversed later in the day on Draghi’s comment that no further rate cuts were likely was head-scratching”?  Perhaps he doesn’t know that this is what happened.

Asset markets are ruthlessly efficient.  If they were not it would be easy to get rich. Just sell European bank stocks short after the “irrational” stock price run-up following an ECB announcement. Indeed I’d guess that even EMH skeptics like Robert Shiller mostly buy into the idea that markets respond immediately to new information.  What reporters don’t understand is that the real world is messy. Asset prices change all the time.  The standard deviation of daily changes in stock price indices is about 0.8%, which it pretty big (or at least it was last time I looked–for the 20th century).  But the average change in any 10-minute interval is far smaller, so when you have a dramatic policy announcement, it’s often possible to see the market response–it really jumps out when you look at the data.  And when you have many such announcements and the markets almost always respond as monetary theory would predict, then you can be especially confident.

Here is what apparently happened over the last couple of days:

1.  Stocks rallied and the euro fell on the more stimulative than expected ECB announcement.  Totally consistent with what we know about monetary policy.

2.  Stocks fell sharply and the euro rallied on Draghi’s (perhaps misunderstood) statement at a press conference.  Again, totally consistent with what we know about monetary policy

3.  I don’t know why the markets reversed course again today, but James Alexander watches these things more closely than I do, and here’s what he reports:

There seems to have been a lot of public and private follow upon Friday from the ECB to reinforce their original, positively-taken, message.

“The European Central Bank embarked on a rearguard action to win over skeptical investors on Friday, a day after chief Mario Draghi unveiled a new stimulus package but blunted its impact by suggesting the ECB would not cut interest rates again.

A number of top ECB officials, both publicly and behind the scenes, spoke out in support of the measures Draghi announced on Thursday although some recognized the ECB had muddled its message to financial markets.”
http://reut.rs/1U6EeID

I have absolutely no idea whether that Reuters story is right or wrong, but it’s the sort of information that moves markets all the time.  And markets should react to that sort of information, if it sends signals about future policy intentions. I’m sorry it’s so complicated, but that’s the world we live in.

Unfortunately, not all policy experiments are perfectly clean.  In the old days you could look at fed funds futures prices, and then see if the Fed cut rates more or less than expected.  The event studies were highly reliable.  I admit that announcements are now somewhat more complex, but let’s not throw the baby out with the bathwater; they are still far better than any other method.  What’s the alternative, wait 6 months and see what happens to the macroeconomy?  Really? Like we know what the macroeconomy would have looked like if the decision had been a few basis points loser or tighter?  That’s ridiculous.

This skepticism about market efficiency was one cause of the Great Recession (Joe’s probably thinking “Good Lord, Sumner’s now blaming me for the Great Recession, he really needs to take his meds.”)  The Fed scoffed at market predictions of sharply lower inflation, right after Lehman failed.  The markets were right and the Fed blew it.

Markets may look crazy, but only in the sense that an extraterrestrial being that was 100 times as smart as you or I would seem crazy.  Asset prices move around all the time because the future is highly uncertain, and seemingly innocuous comments (like Draghi’s suggestion that no more rate cuts are expected) are actually very consequential.

If the ECB skeptics are correct, and market movements are just so much noise, then I must be hallucinating to claim I can connect any given market movement to a specific policy announcement.  OK, then take a look at the graph below, showing the value of the euro against the dollar, which is from Timothy Lee’s excellent Vox story on the day’s events.  Suppose you didn’t know what time of day the ECB made it’s initial announcement and also the time when Draghi said this was going to be the final rate cut.  Do you think you could guess, just from the graph?  Maybe I’m hallucinating, but I think I see a meaningful fall in the euro at about 12:45, and a big jump just before 2PM.  Gee, I wonder what those correspond to? It turns out the original ECB announcement was at 12:45.  And Draghi’s statement that it was the final rate cut was at 1:56:30—just before 2pm.   Huge market moves right after important new information.  What an astounding coincidence!!  After all, event studies are useless, right?  Asset prices are just random noise.

PS.  People are always telling me to get on Twitter.  This is a perfect example of why I prefer blogging.  You can have the sort of serious discussion in blogs that’s just not possible in 140 characters.

It wasn’t expected by everyone, but MMs have been predicting this for quite some time (although they are even lower than I expected):

World markets may have recovered their poise from a torrid start to the year, but their outlook for global growth and inflation is now so bleak they are betting on developed world interest rates remaining near zero for up to another decade.

Even though the U.S. Federal Reserve has already started what it expects will be a series of interest rate rises, markets appear to have bought into a “secular stagnation” thesis floated by former U.S. Treasury Secretary Larry Summers.

Of course Summers was a latecomer to this idea; I’ve been talking about slower trend growth and low interest rates as the new normal for many years.  Tyler Cowen’s book entitled “The Great Stagnation” also preceded Summers.

If you believe the press (and many economists), this period of low interest rates represents “easy money”,  That’s right, the implied claim is that the “liquidity effect” (normally very transitory) has now lasted for a decade. And there’s more to come:

Take overnight interest rate swaps. They imply European Central Bank policy rates won’t get back above 0.5 percent for around 13 years and aren’t even expected to be much above 1 percent for at least 60 years.

Japan‘s main interest rate won’t reach 0.5 percent for at least 30 years, they suggest, and even U.S. and UK rates are set to remain low for years. It will be six years before U.S. rates return to 1 percent, and a decade until UK rates reach that level.

“Although interest rates are low, they’re not accommodative,” said Harvinder Sian, global rates strategist at Citi in London. “The era of zero rates will be with us for years and years, it wouldn’t surprise me if we’re looking at another five to 10 years.”

Sixty more years!?!?!  At least there is one guy dissenting from the view that low rates mean easy money.  It will be interesting to see how long it takes the others to figure this out.  Let’s hope it’s not 60 years.

Update:  Commenter BC pointed out that the US interest rate data looks fishy, given that 5 year T-notes currently yield well over 1%.  So the article I cited may not be accurate.

And as predicted by MMs, the Swiss decision to revalue the franc has backfired. Now that markets understand that the Swiss are willing to let the SF appreciate over time, Swiss interest rates are forced below the already very low eurozone rates (due to the interest parity condition.)  In contrast, the Danes fought the speculators off, and are now reaping the (admittedly small) benefits, of having slightly higher bond yields than Germany:

The five countries or economic blocs currently with negative deposit rates have yields below zero on all their bonds from a minimum of five years’ maturity (Denmark) to a maximum of 20 years (Switzerland).

The pro-revaluation crowd thought that the SF would no longer be expected to appreciate, if speculators could be placated with a revaluation upwards.  But that was like feeding meat to sharks, it just increased their appetites.

PS.  Here’s what Tyler Cowen said 13 months ago, about the ability of the Danes to fight off speculators:

I would bet against them [the Danes], in any case this will be a neat test case for our judgments of Switzerland.

PPS.  Lars Christensen says the US may be about to enter a recession.  Possibly, but I’m less confident than he is.  BTW, here’s the track record of IMF economists in predicting downturns:

As The Economist noted, between 1999 and 2014, the International Monetary Fund, in its April forecasts, failed to predict every one of the 220 instances in which one of its members suffered negative annual growth in the next year.

Ouch!  I wonder if they ever predicted anyone will have negative growth?  Kudos to Lars for going out on a limb.

PPPS.  Tyler Watts sent me a music video on “Tall Paul” (Volcker), which might be fun to use in undergrad money/macro classes.

Update:  Timothy Lee has a great post on Draghi’s screw-up today.