Central bankers and the Great White Whale

Here’s the Financial Times:

Global economy: Why central bankers blinked

It’s been 18 years since I read Moby Dick, but I vaguely recall that Captain Ahab made the mistake of anthropomorphizing the white whale.  Ahab had a sort of steely-eyed gaze—and didn’t blink when seeking revenge.

Central bankers need to work hard to avoid anthropomorphizing the market.  Better to view market forecasts as a sort of natural force, like wind and waves.  If market forecasts change (as they did late last year), then by all means “blink”.  

It’s nothing personal.

What I’ve been reading

The Mercatus Center has a new paper by Stephen Matteo Miller and
Thandinkosi Ndhlela
, which examines the Zimbabwe hyperinflation. Here is the abstract:

Unlike most hyperinflations, during Zimbabwe’s recent hyperinflation, as in Revolutionary France, the currency ended before the regime. The empirical results here suggest that the Reserve Bank of Zimbabwe operated on the correct side of the inflation tax Laffer curve before abandoning the currency. Estimates of the seignorage maximizing rate derive from a short-run structural vector autoregression framework using monthly parallel market exchange rate data computed from the ratio of prices from 1999 to 2008 for Old Mutual insurance company’s shares, which trade in London and Harare. Dynamic semi-elasticities generated from orthogonalized impulse response functions indicate that the monthly seignorage-maximizing rate equaled 108 to 118 percent, generally exceeding monthly inflation.

One often thinks of hyperinflation as showing the weakness of fiat money. But in a strange way it also shows the enormous value of fiat currency. The fact that the revenue maximizing rate of inflation is so high is an indication that people really value their traditional fiat currency, and will only abandon it under the most costly forms of hyperinflation.

2. It seems like ideas take about 10 years to go from whacky MoneyIllusion posts to conventional wisdom. In early 2009, I said the Fed should consider negative interest on reserves, an idea that was widely dismissed at the time. A new study Vasco Cúrdia of the San Francisco Fed suggests that the actual lower bound was more like minus 0.75% (100 basis points below the Fed target), and that having negative interest rates on reserves would have allowed the Fed to achieve a higher inflation rate and a faster economic recovery.

Some people will complain that they hate the idea of ultra-low interest rates, which punish savers. They overlook another argument I frequently make, which is also widely ignored. A more expansionary policy means higher interest rates over any extended period of time. Take a look at this graph in the Cúrdia paper:

If you want higher interest rates in the future, pray for easier money today.

3. In a previous post I discussed a David Beckworth interview with Adam Ozimek, discussing the “hidden recession” of 2016. Now Ozimek and Michael Ferlez have an online paper with a more in depth explanation of what happened. The basic idea is that the Fed raised rates prematurely in late 2015, and this sharply slowed the recovery in 2016.

It is clear from comparing past projections to the current one that the Fed made a numerically significant error in underestimating the amount of labor market slack over the past few years. How consequential this error was depends upon on how the error maps to monetary policy decisions. We utilize two approaches to demonstrate how the Fed might have differed the path of federal funds rates if it had not underestimated labor market slack: a revealed preference approach and a rules-based approach.

This paper provides an excellent case study of why we need the sort of “look back” accountability process that I’ve recently been advocating.

Note: I’m am not saying that 2016 was an actual recession—it wasn’t. Rather it was an unwarranted slowdown in NGDP growth (which may have cost Hillary the election):

HT: David Beckworth

Update: I also recommend this Greg Mankiw review of Trump’s economic policies. I’ve seen Mankiw’s essay mischaracterized as claiming no long run growth effect from the recent tax cuts. That’s not quite accurate, especially under the plausible assumption that the cut in corporate tax rates will be extended beyond 10 years. Mankiw is a moderate supply-sider, as am I.

A decade later

I began this blog 10 years ago today, although my crusade to change monetary policy first began in the fall of 2008. In my first blog post I laid out my goals:

A blog is not the place for a lengthy dissertation, and so here I’ll merely list three views that underlie my unusual take on the current recession:

Premise 1: The only coherent way of characterizing monetary policy as being either too”easy” or “tight” is relative to the policy stance expected to achieve the central bank’s goals.

Premise 2: “Monetary policy can be highly effective in reviving a weak economy even if short-term interest rates are already near zero.”

Premise 3: After mid-2008, and especially in early October, the expected growth in the price level and nominal GDP fell increasingly far below the Fed’s implicit target.

In plain English, the first premise means the Fed should adopt the policy stance most likely to achieve its goals.  It is a point forcefully advocated by Lars Svensson, who Paul Krugman recently cited as an expert on the role of expectations in monetary policy.  The second is a quotation from Mishkin’s best selling monetary economics text (p. 607), i.e. it’s what we have been teaching our students.  And I have encountered few if any economists who disagree with my third assumption.  Indeed, if this were not so, why would Bernanke be calling for fiscal expansion?

The logical implication of these three premises is that the Fed has the ability to boost nominal growth expectations, and if they let those expectations fall far below target (as they did last fall) the subsequent recession (depression?) is their fault.  Why does almost no one else see things that way?  That’s what I’d like to explore.

So where do we stand today? To me, it looks like one of those glass half full/half empty situations. I see lots of good things and lots of room for further progress. Let’s start with the good—changes that are in line with what I was discussing in early 2009:

1. After a steep recession in 2008 and early 2009, the growth rate of nominal GDP has been reasonably steady over the past 9.5 years. I expect this to continue.

2. There is greatly increased interest in NGDP targeting, as well as level targeting.

3. There is a greater awareness of the fact that the Fed is not out of “ammunition” once rates hit zero.

4. There is greater awareness of how asset prices provide useful information on the stance of monetary policy.

5. There is greater awareness of the importance of not reasoning from a price change.

6. There is greater awareness that monetary offset must be considered when thinking about economic shocks.

7. There is greater awareness that money was too tight in 2008.

8. There is greater awareness that the Fed should not have begun paying positive IOR in October 2008.

9. There is greater awareness that central banks can pay negative interest on bank reserves.

10. There is greater awareness of the importance of forward guidance.

Now let’s think about where we’ve fallen short:

1. NGDP growth was far too low during the years after 2009.

2. The Fed has not formally adopted NGDP targeting and/or level targeting.

3. We still don’t have a highly liquid NGDP futures markets (such as my “guardrails” proposal.

4. The profession still has not embraced the belief that tight money caused the big drop in NGDP during 2008-09.

5. There is still too much of a tendency to equate low rates and/or QE with easy money.

6. There is still too much faith in fiscal policy, too little awareness of monetary offset.

7. The forward guidance we do have is not as “data dependent” as it should be.

This is my 3882nd post and I’ve read almost all of the 160,270 comments. I don’t know how many total hits (WordPress is now so complicated I can’t really use it effectively.) But I’d guess close to 10 million hits, as I’ve averaged several thousand per day (trending lower over time.) The biggest day I recall was about 39,000 hits. Probably 10,000 unneeded commas.

All good times must end and the golden age of economics blogging is certainly over. But I’ll keep going. The next three years will be more interesting than the past three years because something unusual will definitely happen to the macro economy. Either our first successful soft landing (my guess), high inflation, or recession.

Thanks for your support.

A perfect choice

Trump is rumored to be considering Herman Cain for a position on the Federal Reserve Board. For a number of reasons, this would be Trump’s single most perfect nomination.

Cain has an ultra-hawkish position on monetary policy:

In Kansas City, Cain was known as an inflation hawk who was constantly lobbying for higher interest rates. Even during his presidential run in 2011 — when the unemployment rate sat near 9 percent, and inflation was virtually nonexistent — Cain argued that the central bank must raise interest rates to protect the value of the currency, and leave job creation to the job creators.

Trump is an ultra-dovish person, at least while he is President. That makes Cain perfect, as Trump often nominates people with diametrically opposed views on the key policy questions.

You might argue that Cain is corrupt and will do Trump’s bidding. But that would also make him perfect for the job.

Cain has other qualifications as well. Like Trump, Cain is “not a reader”. Reading can interfere with one’s understanding of monetary policy, better to leave reading to the staff.

Cain was also responsible for my all-time favorite campaign commercial, involving a cigarette.

Unfortunately, his nomination may be tripped up by some minor sexual scandals:

He was then asked, “Have you ever been accused, sir, in your life of harassment by a woman?”

He breathed audibly, glared at the reporter and stayed silent for several seconds. After the question was repeated three times, he responded by asking the reporter, “Have you ever been accused of sexual harassment?”

PS. I wonder how long it takes for someone who doesn’t realize this post is a spoof to rake me over the coals for not being politically correct. There are times I wish I lived in France, where a top official who doesn’t read is considered a bigger scandal than smoking in a campaign commercial.

PPS. Off topic, I wonder if this would allow me to monetize my blog.

PPPS. The new wage growth numbers (up 3.2%, yoy) continue to impress—still no sign of a slowdown in the economy.

Like an ox

Six years ago, I wrote a post that reflected my view of the proper relationship between the Fed and the markets:

That’s not Bullard’s job.  He hasn’t been hired to outguess the markets.  If he wants to do that he should go run a hedge fund.  His job is to be led around by the markets like a stupid ox with a steel nose ring being dragged along by a farmer.

Here’s a Bloomberg headline, reacting to today’s Fed decision:

Congratulations, Market. The Fed Is Officially at Your Mercy.

So am I ready to declare victory for market monetarism?  Not quite.  We still need a NGDP market.  TIPS spreads and stock market indices are better than nothing, but there’s no substitute for a NGDP futures market.

But we are making real progress.  The Fed is not using macro “models” to set interest rates.