Market monetarism is gaining ground

I recently did a post over at Econlog, discussing how Jerome Powell has adopted some ideas that sound vaguely market monetarist.  Marcus Nunes sent me another example, this time from St. Louis Fed President James Bullard:

In his talk, Bullard laid out a possible strategy for extending the U.S. economic expansion—one that relies on placing more weight on financial market signals, such as the slope of the yield curve and market-based inflation expectations, than has been customary in past U.S. monetary policy strategy. He explained that the empirical relationship between inflation and unemployment has largely broken down over the last two decades and that many current approaches to monetary policy strategy continue to overemphasize the now-defunct empirics of the Phillips curve.

“U.S. monetary policymakers should put more weight than usual on financial market signals in the current macroeconomic environment due to the breakdown of the empirical Phillips curve,” he said. “Handled properly, current financial market information can provide the basis for a better forward-looking monetary policy strategy.”

Market monetarists have long argued that financial market indicators are superior to the Phillips Curve as a forecasting tool for inflation.

On another topic, Karl Rhodes directed me to some Richmond Fed research on the zero bound.  Here’s the abstract of the paper, written by Thomas A. Lubik, Christian Matthes and David A. Price:

The likelihood of returning to near-zero interest rates is relevant to policymakers in considering the path of future interest rates. At the zero lower bound, the Fed can no longer lower rates and thus can respond to a contraction only through alternative policy measures, such as quantitative easing. Recent research at the Richmond Fed has used repeated simulations of the U.S. economy to estimate the probability of such an occurrence over the next ten years. The estimated probability of returning to the zero lower bound one or more times during this period is approximately one chance in four.

I certainly don’t have any reason to contest their finding, but I do have doubts about the method they used:

Lubik and Matthes began by estimating the TVP-VAR model over the full sample from 1961 to 2018 for quarterly data on real GDP, inflation (personal consumption expenditures inflation), and the federal funds rate. They then used the model’s estimated coefficients to produce forecasts over a ten-year horizon. The researchers generated multiple simulations of the shocks hitting the economy over the ten-year period and recorded their effects on macroeconomic variables for each quarter. The result of this process was a distribution of likely outcomes for each quarter.

In my view, the US is extremely likely to hit the zero bound in the next recession.  Thus for me, the chance of hitting the zero bound over the next 10 years is almost identical to the chance that there will be a recession during the next ten years.

If they agreed with my intuition, and used a VAR model to predict the chance of recession during the next 10 years, they might have come up with a figure higher than 25%. So does that mean that the risk of hitting the zero bound is greater than 25%?  I’m actually not sure, because I’m also skeptical of whether past performance is the best way to predict the timing of the next recession.  Yes this is true:

1. The US has never gone more than 10 years without a recession.

But these claims are also true:

2.  The US business cycle has recently been “stretching out”, getting longer.

3.  Other similar economies such as the UK and Australia have recently experienced extremely long expansions—about 15 years for the UK, and 27 years (so far) for Australia.

Is fact #1 more relevant for forecasting the risk of recession in the US over the next 10 years?  Or facts #2 and #3?

Forecasting is more an art than a science.



22 Responses to “Market monetarism is gaining ground”

  1. Gravatar of sean sean
    6. September 2018 at 12:44

    If the FED adopts NGDP targeting. I have a 0% probability factor of another recession since supply side factors largely do not matter to an economy such as the USA (large, highly diversified, not dependent on one industry, and recently energy independent).

    I think its possible something could happen to cause rates to hit 0% absent a recession. Something like 9/11…where if the FED moves aggressive we could potentially escape an actual recession.

    I agree with you that in a recession the US will likely hit 0% rates again. For whether a recession occurs again it largely depends on monetary policy.

  2. Gravatar of Student Student
    6. September 2018 at 13:29

    Out period forecasts from a VAR model might be somewhat relatable 8 quarters or so out… but 40! I am with you… this isn’t very convincing.

  3. Gravatar of Benjamin Cole Benjamin Cole
    6. September 2018 at 17:08

    If one wanted to catalyze ossification, one would create a self financing independent public agency.

    Of course I have just described the Federal Reserve.

    Suppose we did have 0% inflation and 0% real GDP growth for a couple years in a recession.

    Does anyone imagine this central bank would tolerate 4% or 5% inflation in a drive to regain NGDPLT?

  4. Gravatar of bill bill
    7. September 2018 at 08:59

    How are we to think of the ZLB? I recall somewhere that the Fed in 2008 thought raising the rate of IOR to 25 bps meant they wouldn’t be at the ZLB. That seems bizarre. The lowest rate of IOR that I’m aware of to date was minus 75 bps. I think that was Denmark. It seems that the ZLB is more a state of mind than a real thing? And what to make of the Japanese situation? Do the actual interest rates matter if the real economy is doing OK?

  5. Gravatar of ssumner ssumner
    7. September 2018 at 09:34

    Bill, Japan needs faster NGDP growth, even if the real economy is doing OK. It has debt problems.

  6. Gravatar of bill bill
    7. September 2018 at 13:04

    I wish I had left out the reference to Japan as I’m most interested in my first question. What does ZLB mean?

  7. Gravatar of Matthew Waters Matthew Waters
    7. September 2018 at 13:37

    On supply-side recessions in US, 1975 was nuts. 10% PCE inflation and 9% unemployment. Unemployment was only 3.3% 6 years earlier.

    The 70’s are discussed in inflation terms, but I’m curious about relatively high unemployment. Was it *real* wage stickiness, with unions or large company COLAs? More gov benefits discouraging work? If only nominal wage stickiness exists, 10% inflation and NGDP growth more than enough to offset the supply-side oil shock.

  8. Gravatar of Matthew Waters Matthew Waters
    7. September 2018 at 13:53


    The true lower bound is when the cost of holding literal cash versus electronic reserves. Banks or depositors may pay >200 basis points before converting to cash. It depends on highest denonimation as well. The CB could limit number of high denonimation notes printed.

  9. Gravatar of Scott H. Scott H.
    7. September 2018 at 16:00

    Seems to me that Trump is going to draw out the business cycle here. He makes it tough for most people to get really exuberant.

  10. Gravatar of bill bill
    8. September 2018 at 02:57

    MW, That definition seems logical to me. But in that case no one has ever hit the ZLB and the probability of hitting it is close to 0%. Also, how does IOR factor into things?

  11. Gravatar of Matthew Waters Matthew Waters
    8. September 2018 at 11:28


    By negative interest rates, I mean negative IOR. Having negative rates on bonds doesn’t make sense if reserves earn 0% or 0.25%.

  12. Gravatar of ssumner ssumner
    8. September 2018 at 16:37

    bill, It means whatever the Fed thinks it means.

    Matthew, The natural rate of unemployment was quite high at that time.

    Scott, I don’t think presidents have much impact on the business cycle

  13. Gravatar of Benjamin Cole Benjamin Cole
    8. September 2018 at 21:50

    OT but in the ballpark.

    Here are some mystifying paragraphs from the NYT article covering the recent jobs report.

    “Over the past year, for example, roughly 68,500 ZipRecruiter postings for administrative assistants attracted over 8.1 million applications, or 118 responses on average for every job. The 136,000 warehouse job listings drew over 9.2 million applications, or 68 per job.

    Geography is critical: Lower-wage workers rarely move for a job, so openings in distant places, of course, might not be useful to them. Still, on average, Ms. Pollak wrote in an email, “it is harder (in some sense, at least) to get a job as an administrative assistant, receptionist or warehouse worker than it is to get into Harvard, with its relatively generous 5.2 percent acceptance rate” in 2017.

    At the other end of the market, there are severe labor shortages for jobs demanding specialized skills, licensing requirements or tough working conditions. For the roughly 246,000 truck-driver listings on the ZipRecruiter site, there were 12 responses for each job, Ms. Pollak said. For the 237,000 skilled nursing jobs, there were just nine on average.”


    This is a “tight” job market? I ran a small furniture factory for 20 years. If I had a pool of 10 applicants for a job, I thought that was fine. I did not know I was struggling against “tight” labor markets.

    Checking around:

    Here is a job ad for Seattle:

    Customer Service Agent – Full Time – new
    Alaska Airlines 288 reviews
    Seattle, WA 98194 (Downtown area) +2 locations
    $12.65 an hour
    We’ve been honored with a variety of awards by readers of Travel + Leisure, Conde Nast Traveler, USA Today and others. ## ALASKA AIRLINES’ STORY….


    Here is rent in Seattle:

    Average Rent In Seattle, Seattle Rent Trends and Rental Comps
    As of August, 2018, average apartment rent within 10 miles of Seattle, WA is $2177.

    Gee, maybe they have a tight job market in Seattle. Why would that be?

    Back when I was in grad school, a greybeard Prof. Gronkowski, former postmaster general and a man who kicked around in life said to me, “Kid, you want to know what is going on in a city? Don’t read the headlines. Read the classifieds.”

    Hyperbole to make a point, but the words have rung true across the decades.

    Today the classifieds are online.

    I advise academics to read the classifieds.

  14. Gravatar of Willy2 Willy2
    9. September 2018 at 14:17

    – Based on the figures I have seen Australia and the US are already in a recession. This based on 4 persons who all have their own method to see what’s going on with the economy.
    – I don’t rely on the NBER to conclude that the US is in recession. The calculation of GDP is a joke. E.g. Housing is counted twice. Once when a home is build and after that is counted every year that house is occupied.
    These 4 persons also made an accurate prediction of when the previous recession began. And that was in the 1st half of 2005 (!!!) and NOT – like the NBER stated – november 2007. But that recession of 2005 & 2006 was actually (very) shallow to what happened after that.

  15. Gravatar of ssumner ssumner
    9. September 2018 at 15:38

    Willy, You’ve been saying Australia’s in recessions for years. Actually, it’s still growing at 3%.

  16. Gravatar of LK Beland LK Beland
    10. September 2018 at 10:13

    Ben Cole

    With today’s technology, it’s easier and cheaper for employers to post an opening, but it’s also easier and cheaper for employees to apply.

    In regards to vacancies and applicants per vacancy, comparisons with previous decades should be made with caution.

  17. Gravatar of Justin Justin
    10. September 2018 at 11:40

    The sad thing is we had to have millions of people un- and under-employed for a decade before they came around to this.

    “the now-defunct empirics of the Phillips curve.”

    I’ll tell you I never understood the obsession with the classical PC in the Bernanke-Yellen days. When I studied macro the New Keysian PC was center stage, and all the empirical and theoretical work undermining the classical PC used to boost the NKPC.

    I guess we should be grateful policy makers have caught up with the macro consensus circa 1998.

  18. Gravatar of Todd Kreider Todd Kreider
    10. September 2018 at 11:44

    Scott wrote: ” Other similar economies such as the UK and Australia have recently experienced extremely long expansions—about 15 years for the UK, and 27 years (so far) for Australia.”

    Australia had extremely mild negative growth per capita (OECD) in:

    2011 -0.04%
    2008 -0.01%

    The U.K had serious negative growth during the great recession:

    2009 -4.9%
    2008 -1.3%

  19. Gravatar of Todd Kreider Todd Kreider
    10. September 2018 at 11:45

    Scott wrote: “Bill, Japan needs faster NGDP growth, even if the real economy is doing OK. It has debt problems.”

    Japan doesn’t have serious debt problems – maybe a mild one but that isn’t clear.

  20. Gravatar of ssumner ssumner
    10. September 2018 at 22:22

    Todd, Neither of those comments about the UK and Australia in any way conflict with my claims. The UK expansion was 1992-2007.

    I disagree on the Japanese debt.

  21. Gravatar of Todd Kreider Todd Kreider
    11. September 2018 at 01:47

    Oh, I was thrown by your use of “recently” experiencing those expansions and misinterpreted that.

    Japan’s debt crisis has been predicted a few times. Back in 2002, Adam Posen was positive Japan would have a financial crisis in 2003 or 2004, which never happened. The head of MOF was sure there would be a debt crisis in 2015 and three years later that hasn’t occurred. Rogoff said in 2010 that Japan would have a financial crisis in 2020 – just 18 months away.

  22. Gravatar of Scott Sumner Scott Sumner
    11. September 2018 at 11:24

    Todd, Just to be clear, I’m not predicting a “debt crisis”, I’m predicting fiscal problems down the road if they don’t fix the problem. Fortunately, Abe is planning to raise taxes next year; if only our own government had this foresight.

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