The Fed’s targeting the wrong forecast

David Beckworth has a nice interview with Ryan Avent, which touches on a number of monetary issues. In the final part of the interview they both suggest that the Fed may be treating their 2% (PCE) inflation target as a sort of ceiling, rather than the symmetrical target the Fed claims to be aiming at.

I share their frustration, but I suspect the problem lies elsewhere. I believe the Fed would actually prefer that PCE inflation average 2%. Instead, I suspect the Fed is consistently missing its target in recent years because they are relying on a flawed (Keynesian) model, which bases its inflation forecasts on concepts such as the Phillips Curve. They would have been much more successful if they had instead relied on market forecasts. (Of course NGDP level targeting is far superior to inflation targeting.)

Lars Svensson has argued that the Fed should target its own internal forecast of inflation. Two facts lead me to believe that this is exactly what they are doing. First, the Fed sees the world in a very “conventional” way. It’s a big institution full of mainstream economists. Second, mainstream economists have been forecasting roughly 2% PCE inflation over the past 11 years, since the US entered the Great Recession. Here are the 11 most recent forecasts of PCE inflation over the next two years, in each case representing the 4th quarter forecast from the Philadelphia survey of private sector economists:

(The data shows the date of the forecast, then the next year inflation rate, then the two-year forward inflation rate.)

2018:Q4 2.1% 2.1%

2017:Q4 1.8% 2.0%

2016:Q4 1.9% 2.0%

2015:Q4 1.8% 1.9%

2014:Q4 1.8% 1.9%

2013:Q4 1.9% 1.9%

2012:Q4 2.0% 2.2%

2011:Q4 1.7% 2.0%

2010:Q4 1.4% 1.8%

2009:Q4 1.3% 1.8%

2008Q4: 1.8% 2.2%

The Fed believes that its policy affects inflation with a long lag. So it seems reasonable to assume they set policy with the goal of getting inflation on target in the second year. In that case, they’ve almost perfectly targeted the Philly Fed consensus, where expected 2-year forward inflation averages 1.983% over the 11-year period. That’s not 2.0%, but it’s extremely close.

Actual PCE inflation has been much lower (averaging 1.5% from 2008:Q4 to 2018:Q4), but that’s not because the Fed was secretly targeting lower inflation; it’s because they used bad forecasts.

If the Fed had instead targeted something like TIPS spreads, minus 0.25% to account for the fact that CPI inflation runs about 0.25% above PCE inflation, then they would have done a far better job of hitting their inflation target. The TIPS spread is not perfect, with sudden oil price changes biasing it slightly, and a small risk spread, but it’s better than relying on professional forecasters.


PS. Pat Horan and I have a new piece on MMT.

Why modern leftism and modern conservatism are both evil

During the 1990s, neither leftism nor conservatism were evil. Now they both are. How did this happen? Let’s start with leftism:

During the 1980s and the 1990s, neoliberal policy reforms led to the greatest improvement in human welfare in global history. Indeed nothing else even comes close. Billions of people moved out of extreme poverty. And no, don’t tell me that “correlation doesn’t prove causation”. The neoliberal policy reforms actually caused the sharp reduction in extreme poverty, and places that didn’t reform (like North Korea) remained mired in misery while reformers like India and China and Bangladesh saw huge reductions in poverty.

To modern leftists, ‘neoliberalism’ is a dirty word. A very bad thing. Perhaps the greatest evil of the modern world. Any ideology that views the most wonderful thing that ever happened in the past 4.6 billion years as being a great curse is a truly evil ideology.

Of course left-wingers won’t go down without a fight, and they try to concoct arguments in defense of their peculiar views. “Of course we all agree that markets must play a role, it’s just about market fundamentalism”. Oh really? Just where are the market fundamentalists screwing things up?

The most neoliberal regime in Europe is Switzerland. Did they go too far? Would they be better off like the least neoliberal regime (Greece)?

The most neoliberal regimes in Asia are Hong Kong and Singapore. Would they be better off with a mixed economy like Vietnam or China?

The most neoliberal regime in Latin America is Chile. Would they be better off with the sort of Latin American regimes frequently praised by Sanders and Corbyn?

The most neoliberal regime in North America is Canada. Would they be better off with the Mexican regime? Here you might argue that the US (lower in the Heritage rankings and higher in the Fraser rankings) is more neoliberal than Canada. On health care yes, but not on many other issues. In any case, if the US is such a neoliberal hellhole, why do so many people want to move here?

The most neoliberal regimes in Africa are Rwanda and Botswana (and Mauritius, if that’s considered Africa). Would they be better off with Zimbabwe’s socialistic “land reform”?

The most neoliberal regimes in Oceania are Australia and New Zealand. How many better places to live are there in the entire world?

So where are all these regimes that “went too far”. Maybe the US on healthcare, but even our health care system is pretty socialist, with government spending on healthcare at higher levels than in Europe as a share of GDP. It’s just extraordinarily inefficient socialism.

As I look around the world, I see countries like Ethiopia moving toward freer markets, and that’s a good thing. I really don’t see any countries “going too far” toward free markets. If you find one, please let me know where it is. As far as welfare, even the more extreme neoliberals (Friedman, Hayek, etc.) never rejected a safety net, and more moderate neoliberals like Brad DeLong were even more supportive.

As bad as modern leftism is (and I haven’t even mentioned the fanatical “Chinese Cultural Revolution” aspect of modern PCism), it is still the lesser of evils when compared to modern conservatism.

During 2016, most thoughtful conservatives were appalled by Trump. Recall the “Against Trump” issue of the National Review, which laid out all their objections. Now conservatives (with a few lonely exception) have swallowed the kool-aid.

Conservatives often quibble that this isn’t really fascism, because no one is talking about eliminating elections and tearing up the Bill of Rights. True, and that’s certainly very important. But that merely means that we aren’t in the mid-20th century anymore. Today’s leftist aren’t going to kill millions of people and send even more to work in the countryside. They aren’t even going to nationalize big corporations and install Nixon-style wage/price controls on the entire economy. This isn’t the mid-20th century–I get that.

But in most other respects this is fascism, at least as I learned about it in high school. It’s authoritarian, exalting the power of the “great man” who is cruel (Putin, Kim, etc.) It blames our problems on unpopular minorities and foreigners. It’s deeply sexist, with more sympathy for men who are proven sexual predators than women who are victims. It engages in the big lie, day after day. It demonizes the media. It’s xenophobic, hostile to multinational institutions like NATO, the EU, the UN, the WTO, etc. It rejects modern science, and indeed any form of expertise, substituting a faith-based reality. It dismisses examples of police brutality against the poor, while whining when their own members are investigated for corruption.

Conservatives knew all this in 2016, when most preferred a more principled (or at least less unprincipled) conservative. Someone who believed that Congress should make decisions on federal spending, not the President. Now they’ve made a pact with the devil.

So I completely reject modern leftism and modern conservatism. I want nothing to do with either ideology. That doesn’t mean I reject the people–some of my best friends are conservatives and leftists. That’s fine, they are merely misguided. But their ideology is truly evil.

PS. Feel free to leave comments telling me that my ideology is also evil. I’m not a leftist or a fascist, so I won’t delete them.

The issue is the issue

The NYT has an interesting article showing how Brexit has split British society right down the middle, as people lose their best friends and stop speaking to family members:

“It’s definitely visceral, it’s definitely nasty, and there are certainly people who won’t accept the core of the other person’s position,” added Mr. Fraser, who thinks that his support for Brexit in London, which generally voted the other way, cost him friends.

At one level this is kind of surprising, as Brexit is not a very important issue in substantive terms. I believe it will lower Britain’s RGDP a couple percent and Brexit supporters think it will raise GDP by a few percent. But lots of other issues also impact the economy without stirring this sort of passion. Yes, Brexit might affect immigration, but I doubt it. The UK already has the ability to control immigration from non-EU countries and nonetheless decided on a high immigration policy. The next government will likely be Labour, and they certainly won’t sharply restrict immigration.

As far as cultural change, the only immigrants affected are from other EU countries, whereas it is immigrants from South Asia and the Caribbean that have the bigger impact on British culture.

While I opposed Brexit, it’s just not that important. For God’s sake, even Norway and Switzerland are not EU members!

Just as it’s a mistake to look for American explanations for Trumpism, it’s a mistake to look for British explanations of the Brexit civil war. The NYT story would apply just as well to the governorship of Scott Walker in Wisconsin, which split apart the good people of that formerly “nice” state. A few months ago I did a post on Poland, which noted a similar phenomenon. There are dozens of other examples.

Earlier in American history, the issues were far more important but people did not take them so personally. You might object that Vietnam and civil rights tore the country apart during the 1960s. Not really. At a certain level, the political right knew that the left were the good guys (albeit a bit too idealistic). The right might not have wanted blacks moving into their neighborhood and they might not have wanted a defeat in Vietnam, but they understood that protestors had a point. Everyone knew that blacks had been treated shamefully and the Vietnam War was a misguided adventure. Lots of Republicans participated in forcing Nixon from office. Things were nowhere near as polarized as today. (The old TV show “All in the Family” accurately captured the mood.)

Unlike in the 1960s, the right is no longer ashamed of its views, and is willing to state them publicly. They are in a mood to fight back against the smug condescension of elite liberal opinion. After the Vietnam War, things quickly got back to normal in America. Today’s splits (which are occurring in countries all over the world) will take much longer to heal. Social media has helped to create two tribes.

When I used to be a professor, there was a joke about faculty senate debates being so vicious because they involved such trivial issues. In the modern world, the political debates aren’t about consequential issues like workers’ rights, civil rights, war and peace, etc. No one seriously expects Trump to do anything about illegal immigration, trade deficits, etc. Today’s debates are about symbolic issues. It’s as if half the population decided to pick a fight with the other half, just as an aggrieved spouse that had built up years of resentment suddenly lashed out at their partner over some trivial issue—forgetting to do the dishes.

While Brexit itself has only a trivial effect on the UK in utilitarian terms, the Brexit debate might be the biggest blow to the UK’s aggregate utility since WWII. It is reducing happiness on both sides.

The real issue is the issue itself, not what the issue is about.

PS. Here’s something else that’s lurking the background. For the first time in human history, most voters are older (above 50 in the case of Brexit). And they are increasingly getting their way, all over the world, to the dismay of the young.

Never reason from a quantity change

The jobs number for February (20,000 jobs) was quite weak. It might just be a one-month blip—the moving average of job creation is still pretty good—but let’s suppose it’s real. What does that mean?

It might mean there is not much demand for workers. Or it might mean there is not much supply of workers. How can we tell? One place to start is with wage numbers. Less demand for workers results in lower wages, while less supply of workers results in higher wages. (Supply and demand. You won’t get this sort of PhD-level sophistication in MMT blogs!)

Here’s the FT:

Wage growth is up to 3.4%, the highest since 2009. As wage growth continues to accelerate, I’m becoming less concerned about the “lowflation” issue.

Just to be clear, I’m not saying that wage growth is driven by a reduced supply of workers—it’s very possible that February’s jobs number was just a blip and strong jobs growth will continue in 2019. What I am saying is that if we are in a new era of slower jobs growth then lower supply is the most likely culprit.

Don’t reason from a price change and don’t reason from a quantity change.

Reason from a P&Q change.

PS. FWIW, the FT suggests that February may not be a blip:

Data out over the past month have added to the view US economic growth may be cooling. Both industrial production and retail sales surprised on the downside in January and in December respectively. The housing sector meanwhile had a lacklustre end to 2018, with housing starts falling to their lowest level in more than two years in December while home price growth decelerated. . . .

In a sign of the economic uncertainty, Goldman Sachs said this week its rolling forecast for first-quarter US economic gross domestic product was pointing to growth at an annualised rate of just 0.9 per cent. A separate ‘tracking estimate’ from the Atlanta Fed forecasts growth at a rate of 0.3 per cent.

Soft landings have never been easy. This would be America’s first ever.

But if the Aussies and Brits can do it . . .

Is Trump winning? (yes and no)

Here’s Tyler Cowen in Bloomberg:

What about trade and immigration, two issues dear to the heart of President Donald Trump? In those areas I expect to see surprisingly few changes. Fears about China are bipartisan, and with his quest for a market-boosting trade agreement with China, Trump is turning out to be a trade dove, relatively speaking. Meanwhile, on NAFTA, the Democratic-controlled House of Representatives is holding up the renegotiated agreement.

Most important, I don’t see the major Democratic presidential candidates making a big public push for Trans-Pacific Partnership, the World Trade Organization or any other trade agreements. The era of greater skepticism about trade and globalization is probably here to stay, and it counts as one of Trump’s ideological triumphs.

And immigration? Well, I don’t expect our next president to separate arriving children from their parents. But neither do I expect a big breakthrough on immigration policy. Are any of the leading Democratic candidates putting forward a grand immigration plan for public debate? No, even though in other areas they are quite willing to think big. They realize that in terms of intensity, America is moving to the right on immigration — as it did a century ago, leading up to the 1920s restrictions. Count that as at least a half-triumph for Trump.

I don’t think this is right; I don’t believe Trump’s had any ideological triumph’s—just losses. Although I don’t intend to contest the view that Trump personally has been successful with these topics as issues. He won in 2016 and might win in 2020. But in two other areas, one obvious and one less obvious, I think he’s failed. Start with the obvious; this is from today’s news:

“But illegal immigration is simply spiraling out of control and threatening public safety and national security.”

Someone suffering TDS? No, the official in charge of Trump’s immigration enforcement program. Trump’s more than half way through his term, and he’s completely failed to do anything about the single most important issue in his campaign.

I also disagree with Tyler’s comparison of the mood in America today with the 1920s, where there was fairly broad support for restricting immigration. I get that Tyler notes the “intensity” of the anti-immigration crowd. Indeed he has to, as the polls clearly show increasing support for immigration. (I doubt that was the case in the 1920s.) But I think it’s more complicated than that, with three groups involved, not just two.

You have 3% to 5% of the US population directly impacted by immigration crackdowns, and they intensely oppose Trump. Another 30% are fairly strongly opposed to immigration, for nationalistic or economic reasons. And then there are about 65% of people who don’t pay a lot of attention to the issue, but are becoming increasingly sympathetic to immigrants. Importantly for the future, the young are especially strongly moving in favor of immigration.

Does this sound familiar? How about 3% to 5% of Americans are gays who intensely support gay marriage, 30% strongly oppose it for religious/cultural reasons, and 65% who don’t give it much thought, but are increasingly in favor? How’d that issue play out over time? Gays benefited from a media that increasingly portrayed them sympathetically as real people, not caricatures. Isn’t the same beginning to occur with illegal immigrants?

Where Trump may win is the politics of immigration, even while losing on policy. While he ran in 2016 as a dealmaker who could get things done, a man who would force Congress to do his bidding, we’ve discovered he’s actually an appallingly incompetent dealmaker. Now he portrays himself as a victim of faceless “elites”. His supporters lap this up, so it may not matter if Trump fails to enact Trumpism; he’s not really the President, just the “Troll in Chief”. He might be re-elected on that basis, with the help of the hapless Dems. (I think it’s a toss-up.)

Trump is also losing badly on the single most important trade issue in his campaign–the deficit. Here’s a set of Bloomberg stories that appeared side by side, and caught my eye:

Hmmm, I wonder if there is any relationship? The trade deficit article had this observation:

The strong dollar matters because it has led to near-record deficits in manufactured goods and non-oil goods that are being masked by increases in exports of oil and services, [Robert] Scott said. To his mind that means the U.S.’s trade balance is worse than even the official data reflects. “There’s a lot going on below the surface here,’’ he said.

It is rather striking that the trade deficit is getting larger just as the fracking boom is dramatically improving our net export position in oil.

Tyler argues that the establishment has adopted Trump’s trade skepticism, while simultaneously arguing that Trump is actually somewhat of a trade dove. I suspect this is an example of Tyler using a bit of hyperbole to be provocative and contrarian. OK, I’ll take the bait.

The establishment has always held a “pragmatic” view of trade, where free trade was good as long as other countries played fair. (In contrast, economists believe free trade is the best policy even when other countries don’t play fair.) So I don’t think the establishment has moved in Trump’s direction, it’s always been right where it is now. It’s been hard to sell the Dems on free trade ever since the 1960s.

On the other hand, Democratic voters are moving very strongly in the free trade direction. You might argue that a steelworker in Ohio who votes for Sherrod Brown has more “intense” views on trade than a barista in San Francisco who likes imported coffee. But there’s one big problem with that. Steelworkers in Ohio are no longer Democrats, and the future of the Democratic Party is obviously not people like Sherrod Brown. Heck, I remember lots of Dems like him when I was a teenager. He’s a dinosaur. The barista in San Francisco is the future of the Democrats, which will eventually become the pro-immigration, pro-trade party.

[In the UK, the older Labour leaders (Corbyn) are skeptical of free trade, but the younger voters are super supportive of the EU. BTW, watch the Brexit end-game closely; just as Thatcher predicted Reagan, Brexit predicted Trump.]

I’m not at all optimistic about the politics of America. The 2020 election is likely to feature an awful Democrat and an even worse Republican. The budget situation is bad and will get worse. But I am pretty optimistic about trade and immigration, as I think Trump’s clearly lost on both issues and things will soon swing our way. I expect the Trump people to eventually admit that the trade deficit doesn’t matter, and indeed is often a sign of a prosperous economy. Trump cares about “winning ” more than he cares about ideology. That’s why he’s tough on Iran and soft on N. Korea; he wants to undo whatever Obama did. If Obama had done the deal with Korea, not Iran, Trump’s positions would be reversed.

I recently happened to overhear some of the most moronic talk radio I’ve ever encountered. I used to occasionally listen to Rush in the early 1990s, and he often sounded fairly intelligent, at least compared to the current right wing nuts on the radio. One tirade that caught my attention was a guy saying something like “how dare they impeach Trump, he’s been so successful”, and then cited his trade deals. No, I’m not making that up—his trade deals were cited as a policy success. (It may have been Sean Hannity, I’m not sure.) So while in substantive terms Trump has failed on trade, his supporters seem happy to accept hollow trade deals that entrench the neoliberal leviathan ever more deeply into the global economy.

And that’s really good news. Imagine if his supporters actually cared about seeing the alt-right agenda put into place. Steve Bannon must be feeling pretty lonely right now.