Archive for the Category Scandinavia


Williamson on NeoFisherism (define “loosening”)

Stephen Williamson has a new post that interprets recent monetary history from a NeoFisherian perspective.  It concludes as follows:

What are we to conclude? Central banks are not forced to adopt ZIRP, or NIRP (negative interest rate policy). ZIRP and NIRP are choices. And, after 20 years of Japanese experience with ZIRP, and/or familiarity with standard monetary models, we should not be surprised when ZIRP produces low inflation. We should also not be surprised that NIRP produces even lower inflation. Further, experience with QE should make us question whether large scale asset purchases, given ZIRP or NIRP, will produce higher inflation. The world’s central bankers may eventually try all other possible options and be left with only two: (i) Embrace ZIRP, but recognize that this means a decrease in the inflation target – zero might be about right; (ii) Come to terms with the possibility that the Phillips curve will never re-assert itself, and there is no way to achieve a 2% inflation target other than having a nominal interest rate target well above zero, on average. To get there from here may require “tightening” in the face of low inflation.

I partly agree, but disagree on some pretty important specifics.  I thought it might be instructive to start out by rewriting this paragraph to express my own view, with as few changes as possible (in bold):

What are we to conclude? Central banks are not forced to adopt ZIRP, or NIRP (negative interest rate policy). ZIRP and NIRP are choices. And, after 20 years of Japanese experience with ZIRP, and/or familiarity with standard monetary models, we should not be surprised when ZIRP results from low inflation. We should also not be surprised that NIRP results from even lower inflation. Further, experience with QE and inflation forecasts embedded in TIPS should not make us question whether large scale asset purchases, given ZIRP or NIRP, will produce higher inflation. The world’s central bankers may eventually try all other possible options and be left with only two: (i) Embrace ZIRP, but recognize that this means a decrease in the inflation target – zero might be about right; (ii) Come to terms with the possibility that the Phillips curve will never re-assert itself, and there is no way to achieve a 2% inflation target other than eventually having a nominal interest rate target well above zero, on average. To get there from here may require “loosening” in the face of low inflation.

Why do we reach such differing conclusions?  I think it’s because I have a different understanding of recent empirical data.  For instance, Williamson’s skepticism about monetary stimulus in Japan is partly based on his assumption that the recent sales tax increase raised the Japanese price level by 3%. But there’s never a one for one pass through, as it doesn’t cover major parts of the cost of living, such as rents.  So the Japanese price level (net of taxes) has risen by considerably more than Williamson assumes (albeit still less than 2%/year).  Even more importantly, Japan had persistent deflation prior to Abenomics.  And if Williamson is going to point to special factors such as the sales tax rise, it’s also worth mentioning that his recent data for Japan (and the other countries he considers) is distorted by a large one-time fall in oil prices.  Almost all economic forecasters (and the TIPS markets) expect inflation to soon rise from the near zero levels over the past 12 months.  Abenomics drove the yen from 80 to 120 to the dollar—-is that not inflationary?

In the Swiss case Williamson mentions low rates and asset purchases, but completely misses the elephant in the room, the huge upward revaluation of the franc earlier this year, which was widely condemned by economists (and even by many Swiss).  This policy was unexpected, unneeded and undesirable.  It immediately led forecasters to downgrade their forecasts for Swiss inflation, and those bearish forecasts have turned out to be correct.  I hope that’s not the sort of “tightening” of monetary policy that Williamson believes will lead us to higher inflation rates.

Seriously, I’m confident that Williamson would agree with the conventional view that currency appreciation is deflationary. That should send out warning signals that terms like “loosening” are very tricky.  Before we use those terms, we need to be very clear what we mean.  You can achieve higher interest rates through either loosening (a crawling peg devaluation forex regime) or tightening (open market sale of bonds), it all depends how you do it.  More specifically, it depends on the broader policy context, including changes in expectations of the future path of policy.

I think he also gets the Swedish case backwards.  The Swedish Riksbank tried to raise interest rates in 2011.  Instead of producing the expected NeoFisherian result, it led to what conventional Keynesians and New Keynesians and Market Monetarists would have expected—falling inflation. It led to exactly the type of bad outcome that Lars Svensson predicted. So Svensson was right.  And contrary to Williamson, the Riksbank did not turn around and adopt Svensson’s preferred policy, which is actually the “target the forecast” approach; rather they continued to reject that approach.  They continued to set rates at a high enough level so that their own internal forecasts were of failure. Once a tight money policy drives NGDP growth lower, the Wicksellian equilibrium rate falls and policy actually tightens unless the policy rate falls as fast or faster.  That did not occur in Sweden.

Let me try to end on a positive note.  I have a new post at Econlog that took a position roughly half way between the NeoFisherians and the Keynesians.  Brad DeLong had noted that Friedman often claimed that low rates are a sign that money has been tight. I’d emphasize, “has been.”  Krugman said this was wrong, at least over the time frame contemplated by Friedman.  I disagreed, defending Friedman.  I believe that Keynesians overestimate the importance and durability of the so-called “liquidity effect” and underestimate how quickly the income and Fisher effects kick in.  At the same time, as far as I can see the NeoFisherians either ignore the liquidity effect, or misinterpret what it means.  (My confusion here depends on how literally we are to take the “tightening” claim in the quote above.)

Question for the NeoFisherians:

I often discuss the Fed announcements of January 2001, September 2007 and December 2007.  That’s because all three were big shocks to the market.  In all three cases long-term interest rates immediately reacted exactly as Irving Fisher or Milton Friedman might have expected.  In the first two cases, easier than expected policy made long-term rates (and TIPS spreads) rise.  And in the last case tighter than expected policy made long-term rates (and TIPS spreads) fall.  Please explain.

To me, that’s the Fisher effect.  But here’s the problem, the Fed produced those three results using the conventional manipulation of short-term rates.  Thus in the first two cases the Fed funds rate was cut more than expected, and vice versa in the third case. From a Keynesian perspective this is really confusing—why did long-term rates move in the “wrong way”? From the NeoFisherian perspective this is also really confusing—why did moving short-term rates one way, cause TIPS spreads (and long term rates) to move the other direction?  From a market monetarist perspective this all makes perfect sense.  (It doesn’t always play out this way, but if you look at the really big monetary shocks the liquidity effect is often swamped by the long-term effects.)

HT:  Marcus Nunes

Evidence that central bankers cannot be trusted

There’s a great new Wall Street Journal article that begins as follows:

In the seven years since the world’s central banks responded to the financial crisis by slashing interest rates, more than a dozen banks in the advanced world have tried to raise them again. All have been forced to retreat.

But it’s never their fault:

Riksbank Deputy Governor Per Jansson, in a 2014 speech, responded to critics saying, “with hindsight, it is clear that monetary policy could have been somewhat more expansionary if we had known that inflation would be as low as it is now.” But, he said, “This is a natural and unavoidable consequence of the fact that monetary policy has to be based on forecasts, which are uncertain.”

Former ECB President Jean-Claude Trichet, who pushed eurozone rates up in 2011, said he needed to react to rising inflation driven by commodity prices and a threat that households and businesses might expect higher inflation rates in the future. The ECB’s mandate was for inflation near 2%, and the ECB delivered “exactly what we promised” during his term, he said in an interview. Subsequent rate reductions happened after he left and the inflation backdrop shifted, he said. Mr. Trichet said he used other measures to combat financial turmoil, including bond purchases and emergency loans to banks.

Per Jansson doesn’t tell the WSJ readers that the Riksbank’s own internal inflation forecast predicted failure, as inflation was expected to remain below target even without a rate increase.  Lars Svensson was so exasperated he resigned in protest. The Riksbank was clearly violating its legal mandate to target inflation.

Regarding Trichet, I don’t know whether to laugh or cry.  Imagine someone named Trichet racing to the edge of the Grand Canyon at 100 mph. Besides him sits Mr. Draghi.  Just before he reaches the edge of the canyon, Trichet rips off the steering wheel and hands it to Draghi.  Here, you drive.  And then he jumps out the window.

Heh, we hit the inflation target under my watch, it was my replacement who fell short.  Don’t blame me.

For years, the Paul Krugmans of the world have been telling us the Eurozone Depression is so deep that monetary policy isn’t enough, we also need fiscal stimulus. At the same time the Trichets of the world are raising rates to prevent eurozone overheating.  You can’t make this stuff up, it’s just too bizarre.

Who am I to question the wisdom of the central bankers of the world?  They are often much more distinguished than I am.  In fact, I don’t trust my own judgment; I presume that Yellen and Fischer are much better monetary economists than I am. But it seems the markets also think the Fed is wrong:

Fed officials now say they plan to move gradually. But their expectations for rates could still be too high. Officials in June estimated the Fed would raise the short-term federal-funds rate from near zero now to 1.625% by the end of 2016 and to 2.875% by the end of 2017.

Investors have a different view. Fed-funds futures markets, where traders place bets on the outlook for the central bank’s benchmark interest rate, put the Fed target at under 1% at the end of 2016 and under 1.5% at the end of 2017. In anticipation of the Fed’s next policy meeting, some officials have said they expect to reduce their projections for rates in the future. Their projections for where rates will end up in the long run have drifted down by a half percentage point in the past three years.

Yup, they’ve “drifted down” and they’ll keep drifting down, as long as central bankers think they are smarter than the markets.

As you read the following, think about how the real risk free interest rate is determined in global markets.  Then ask yourself how much success the Fed is likely to have against this backdrop:

Mario Draghi’s promise that the European Central Bank is willing to step up its stimulus if needed is resonating with economists, who see the euro-area recovery as too shallow to be sustained.

More than two-thirds of respondents in a Bloomberg survey predict the ECB’s president will expand or extend the 1.14 trillion-euro ($1.3 trillion) quantitative-easing program, and almost all of those say he’ll do so within nine months. While an increasing number of respondents see the economy improving for now, they’re also fretting that the upturn won’t last long.

The ECB’s Governing Council has already shown concern that a slowdown in global trade will erode exports, a pillar of the regional recovery, before domestic demand is strong enough to compensate. The central bank this month cut its growth and inflation forecasts and Draghi told reporters that QE is flexible in size, duration and composition. In contrast, the Federal Reserve may raise its interest rates as soon as this week.

“QE risks becoming a semi-permanent feature,” said Gianluca Sanna, a portfolio manager at Banca Monte dei Paschi di Siena SpA in Milan. “While it’s certainly true that the euro zone is indeed going through a phase of decent, maybe even above-potential, output growth, chances are that there is nothing self-sustaining in what we are seeing right now and the euro zone ends up again in a low-growth environment with inflation dangerously close to zero.”

I very much hope I’m wrong, just as I hope I’m wrong in my prediction that Chinese growth will come in well below the consensus.

HT:  Foosion

Nationalist–Socialist America

The German tight money policy of the early 1930s led to a surge in vote support for two groups, the nationalists and the socialists.  Today in America the nationalists and the socialists have all the momentum.  Consider:

1.  Dick Cheney might have been the worst Vice President in American history (at least Agnew didn’t do anything.)  Now add to the list his choice to be one heartbeat away from the presidency—Sarah Palin.  Palin is now gushing praise over Donald Trump, who campaigns on the same mix of statism and xenophobia that you see among the neo-fascist parties in Europe, with militarism thrown in.  For years I could take pride in the fact that America largely avoided that particular policy mix.  I don’t think even Pat Buchanan was a militarist.

Update:  Well that must be one of the most epic brain freezes in my 6 1/2 years of blogging, it was obviously McCain who chose Palin.  Cheney didn’t chose anyone, unless perhaps himself, when he headed Bush’s VP search committee.

2.  The heart of the Democratic Party is now with Bernie Sanders, whatever the polls show.  And let’s not have anyone accuse me of McCarthyism, he calls himself a “socialist.”  When asked, the head of the Democratic Party couldn’t think of a single difference between socialists and Democrats. And please don’t insult my intelligence by talking about Sweden.  Sweden is not a socialist country.  Venezuela is socialist.  When Sanders starts advocating free trade and investment, liberal immigration rules, privatization, zero inheritance tax, 100% nationwide school vouchers, a $0/hour minimum wage rate, then come back to me with your Sweden talk.  For now, he just wants the bad parts of Sweden.

The official Democratic platform now advocates a nationwide $15 minimum wage. Whatever you think of extreme Reagan era supply-side economics, the GOP never went that far off the rails on economic policy.  The GOP platform said consider the gold standard, not adopt the gold standard.  I suppose the Seattle case is debatable, but a nationwide $15 minimum wage law would literally destroy the economy in many low wage/low productivity parts of the country, such as Puerto Rico.  It would also create even more crime, a massive underground economy.

PS.  I hope it goes without saying that neither of these guys will win, but remember what happened to the policy platform of Eugene Debs

Next stop, Stockholm?

Back in August just about everyone was pessimistic about the economy, including me.  I’m still pessimistic, but markedly less so than a few months ago.  Recent numbers from both the asset markets and the real economy point to slightly faster than expected growth going forward.  For instance, weekly unemployment claims have recently fallen quite sharply, which suggests that the recent drop in the unemployment rate may not be a fluke.  Of course we need to keep in mind that this “recovery” has already gone through several phases that proved quite misleading.  But let’s say it’s true that growth is picking up; what could account for this?

My hunch is that I misjudged the Fed move back in August, when they promised low interest rates for the next two years.  That seemed pointless without making the promise condition on some sort of nominal growth target (GDP or inflation.)

Now there are indications that the Fed may do just that at the January meeting.  At that meeting the FOMC is likely to be considerably more “dovish” than the current FOMC (where three of the four floating seats are filled by hawks.)  Bernanke probably thinks it’s a good time to go on record with future policy intentions, and will be able to reassure markets that the Fed won’t make the same mistake as the BOJ and ECB made.  Recall that those two institutions twice tightened prematurely, and then soon after had to do humiliating about faces and cut rates again.  Central banks don’t like doing that, which shows just how bad the tightening errors were.  (The BOJ did this in 2000 and 2006, the ECB in 2008 and 2011.)

If the press chatter is correct, Bernanke will promise to avoid the mistakes of the BOJ and ECB, he’ll promise to keep rates low as long as it takes to get a decent recovery (by his criterion, not mine.)  This will be done by combining interest rate and economic forecasts, which will allow readers to discern implied policy feedback rules.  At least that’s what I think is going on.

If I’m right, and if it works, then Michael Woodford and Lars Svensson might come out of this as heroes, not we market monetarists.

But this policy will still be too little too late.  I still say they should promise to buy securities until they expect NGDP growth of 6% to 7% over the next few years, and something like 4.5% thereafter.  That won’t happen.  But if I’m not mistaken, even this policy will help somewhat.  More than I thought back in August, when the promise seemed too vague to have any impact. I misjudged the fact that there probably always was an implied conditionality in the interest rate promise.

Of course if the eurozone blows up . . .

[BTW, the title of this post refers to the Swedish Riksbank, which has been doing this sort of signaling for years.]

It’s interesting that it took me so many months to have second thoughts about my negative verdict on the policy last August.  Equity investors seemed to need only about 30 minutes to figure this out (after the 2:15 announcement.)

BTW, if they make the path of the fed funds rate conditional on demand, then there will no longer be any doubt about whether monetary policy is at least partly offsetting fiscal policy.

PS.  And kudos to Karl Smith, one of the few people that didn’t seem pessimistic a few months ago.  BTW, here’s a good Karl Smith post on this general topic.

Riksbank Governor hires PR firm to defend against Svensson, et al.

Yesterday I did a post expressing amusement at the way Lars Svensson demolished the reasoning of the hawks at the Riksbank.  Now Riksbank Governor Ingves has hired a PR firm for 140,000 sk (a bit over $20,000 US$) to defend their action.

Ingves hire help to explain the rise in interest rates

Riksbank Governor Stefan Ingves interest rate increases has been questioned by everyone from finance minister to bank forecasters.

Express can today reveal that he hired a star consultant to defend the interest rate increases.

Cost: 140 000.

Riksbank Governor Stefan Ingves has been under fire recently.  Internally, the Bank, he has met with resistance by the so-called doves – Lars EO Svensson and Karolina Ekholm – who time and again expressed its reservations about interest rate hikes and sharp interest rate forecasts.

Harbinger of more hikes
Ingves and his interest rate hawks, however, been able to raise rates and to announce a continued sharp increases in interest rates since the position of the Executive Board are 4-2 in hökarnas favor.

The Riksbank’s monetary policy has also been questioned externally.

In conjunction with the budget presentation, it was clear that the Finance Minister Anders Borg did not believe in Ingves interest rate forecast. Borg expects significantly lower rate in the future – just as the so-called räntemarknden.

When Ingves later told of the latest interest rate decision and the fact that the Riksbank has now lowered the interest rate forecast noted Expressen that he was accompanied by a PR consultant Willy Silberstein.

I’m afraid $20,000 is way too little to get a consultant capable of rebutting Svensson’s devastating logic.

HT:  Stefan Elfwing