Relearning the lessons of the 1970s
At times, our pundits seem like a bunch of 8th graders that over summer vacation forgot what they had learned in the 7th grade. How many times over the past decade have you heard pundits declare that the Fed was pumping up asset prices with expansionary monetary policy?
There are two problems with this view. First, our monetary policy has been slightly contractionary until roughly a year ago, with inflation consistently running below the Fed’s 2% target. Second, when the Fed did finally run a highly expansionary policy in late 2021 and early 2022, asset prices plunged.
To anyone who recalls the Great Inflation of 1966-81, none of this is surprising. The asset markets (both stocks and bonds) performed abysmally during that sustained period of extremely expansionary monetary policy.
Over the next few years, we’ll relearn many other forgotten lessons. Easy money is not a sustainable way of creating jobs. Interest rates don’t measure the stance of monetary policy. Monetary policy determines the path of inflation, not fiscal policy.
Remember this guy?
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13. June 2022 at 11:18
We really could probably have a computer do our monetary policy decisions, and then just have the Fed occasionally change those decisions by majority committee vote only if they feel the urgency for it.
13. June 2022 at 12:06
I’m sorry to say this, but in January you echoed the Fed’s view and told us inflation would be “transitory”, so this is a monday morning quarterback post which contradicts your previous post.
But yes, of course inflation will rage. The Austrians told you this back in 2020, while you were advocating trillions in stimulus. Did you listen? Of course, not.
The truth is you panicked. You panicked over a virus with a fatality rate slightly higher than the common flu.
Indeed, you wrote post after post, for months on end, begging politicians to “follow the CCP”, “follow Taiwan”, or any dystopia that monitored the health of their citizens 24/7.
The panic, the hysteria, it was truly mind boggling. Some might say it was “deranged”.
Btw, I have not received the vaccine. I haven’t been sick since the winter of 2019, so your prediction of imminent demise didn’t age well.
It’s also very difficult to take posts calling for “computers” to “make decisions” seriously. Quant traders spent the last decade telling us on Wall Street that they were going to make a major breakthrough, that everyones investment would “go to the moon”, and then like we all expected these morons lost billions.
The problem is that you cannot account for every action and every variable. Human action, human emotion, cannot be successfully modeled. It just way too complex. There are certain fundamental axioms, which Menger, Smith and others sought to lay down through observation. That is what should be taught in the classroom, not the pseudoscience you teach now.
13. June 2022 at 12:46
Titian’s painting always reminds me of Camus:
Sisyphus teaches the higher fidelity that negates the gods and raises rocks. He concludes that all is well. His destiny is his own. His rock is his own. That is why he says yes to his futile activity. Yes to his “toil without end”, which always begins anew and only comes to an end with death. It makes fate a human affair that must be settled among men. Convinced of the purely human origin of everything human. The struggle itself toward the heights is enough to fill a man’s heart. “Il faut imaginer Sisyphe heureux.” One has to imagine Sisyphus (as) happy.
I just read that in English one says TISH-ən instead of titˈtsjaːno. Are you kidding me? A name is a name. It’ s kind of absurd to pronounce it in such a different way. And Camus is kəˈmuː/ kə-MOO.
😇 🙂 🙃 😉 😌
13. June 2022 at 13:03
Not sure what blog Ricardo has been reading. I looked up Scott’s blog posts for 30 seconds and found this one from January: https://www.themoneyillusion.com/a-disappointing-powell-press-conference/
Scott says: “Powell was asked whether, in retrospect, the recent monetary and fiscal policy stance had been too expansionary. *It seems clear that the answer is yes*, but Powell indicated that we would have to wait 25 years for future historians to answer that question. This is nothing new; the Fed never blames itself for policy mistakes in real time.”
13. June 2022 at 13:13
Ricardo, You said:
“I’m sorry to say this, but in January you echoed the Fed’s view and told us inflation would be “transitory”, so this is a monday morning quarterback post which contradicts your previous post.”
Are you referring to this January post? If so, read it again.
https://www.themoneyillusion.com/the-fed-is-behind-the-curve-as-usual/
If not, which post are you referring to?
Christian, Wait until you discover how the English pronounce Deutschland!
13. June 2022 at 15:42
economist manque and dilettante art critic sumner chooses sisyphus as a symbol of the failures of the fed, illuminating his weak understanding of greek mythology. those in the know would choose prometheus as the symbol for the fed: it’s heart is in the wrong place but its head is smashing against the irreducibility of money vs credit.
13. June 2022 at 16:01
Agrippa, LOL, I wasn’t even trying to apply the Sisyphus symbol to the Fed.
Nice try, but trolling is not your forte.
13. June 2022 at 16:39
Scott,
Stock prices didn’t start to plunge recently until the Fed’s tightening cycle began on January 3rd. You weren’t convinced it was tightening, but the rest of the world has seen it as tightening the whole time. Doubting that narrative means having to explain why stock prices rose throughout Q4 2021. I would say the same applies to Q3 2021 also.
First, it’s important not to forget the logic behind inflation increasing stock prices. Are stock investors too stupid to demand that dividends and share prices reflect inflation?
Second, it’s important to consider international data when talking about the effects of loose monetary policy on stock prices. If you look at Argentina, for example, which routinely has much, much higher inflation than even the worst years of the Great Inflation, it’s stock prices have gone through the roof.
https://tradingeconomics.com/argentina/stock-market
In real terms though, things aren’t so great. For example:
https://tradingeconomics.com/argentina/gdp-per-capita-ppp
The 1970s US example is not typical, and largely reflects federal income tax bracket creep. That pattern went away when bracket creep went away in the 80s. (There’s still a little bracket creep in some state income taxes, but it’s a minor issue.)
If you accept these facts about stock prices, then you should probably also accept the fact that monetary policy was too tight in 2019 and late 2006. You’ve resisted these views, but there’s good evidence that under the Fed’s 2% core PCE inflation targeting regime at the time, monetary policy was too tight.
For example, look at the 5 year breakeven rates for those years:
https://fred.stlouisfed.org/graph/?g=Qx19
Inflation was a good bit below 2%, especially in core PCE terms in 2019, and fell below that level in latter 2006.
13. June 2022 at 16:41
In that last sentence above, I should have referred to inflation expectations, not “inflation”.
13. June 2022 at 16:58
“the Fed’s tightening cycle began on January 3rd”
Michael, inflation has accelerated since January.
13. June 2022 at 17:39
often wrong but never in doubt sumner posts a sisypus photo with his about fed policy but denies it has any reference to the fed. oh, wherefore art tho afraid manque?
13. June 2022 at 17:42
There’s all kinds of amazing things going on these days. There’s still people saying that inflation cannot come down until interest rates go over inflation! The boldest Powell wouldn’t get to 8% rates in years. If they just came here, they’d know that a few believable sentences would get us there without changing rates much.
Also amazingly, despite the high inflation we have here, most of the world is doing worse than the US: Look at inflation in South America, for instance. Also, the dollar that is rapidly losing buying power can be bought with …1.04 euros, the most pro-dollar exchange in 20 years. The ECB is only starting to think about action now, making the Fed look like they are being aggressive.
13. June 2022 at 18:06
Garrett,
First, inflation is not a good indicator of the stance of monetary policy, as Scott has been preaching since he began this blog. You have to look at NGDP growth. Inflation can be entirely supply-side.
Second, core PCE inflation has been falling since March:
https://fred.stlouisfed.org/graph/fredgraph.png?g=Qx9S
Third, inflation expectations, which is what really counts as inflation relates to monetary policy, fell beginning on January 3rd, until February 24th, when Russia invaded Ukraine. They then rose significantly until March 25th, and have fallen since.
https://fred.stlouisfed.org/graph/fredgraph.png?g=Qx9B
Fourth, the expected mean NGDP growth path, which I argue can be imputed from changes in the S&P 500 index, for example, has fallen from just over 5% on January 3rd, down close to 4% at market close today.
Monetary policy has tightened since January 3rd, as almost everyone who pays attention to such issues acknowledges.
13. June 2022 at 18:42
Michael, looking at core PCE year-over-year is misleading since the acceleration started in March 2021. See here for the data: https://fred.stlouisfed.org/series/PCEPILFE
Core PCE has actually accelerated since February (+0.3%, +0.33%, +0.34%). We don’t have May yet but core CPI accelerated in May.
13. June 2022 at 18:46
Garrett,
NGDP growth is what counts, as I pointed out above, which I learned from market monetarists like Scott in the first place. Again, inflation is not a good indicator of monetary policy.
Even when judging a central bank’s policy that uses inflation targeting, inflation expecations are what matter, not current inflation, as current inflation can be due to supply-side factors.
Why don’t you address the bulk of my reply?
13. June 2022 at 19:18
Bob, Monetary policy in Europe is not too easy—their problem is all supply side.
Michael, I told you a year ago that inflationary monetary policies are bad for the stock market, and you didn’t believe me.
And now here we are.
As for Argentina, I am focused on real stock prices. I’d guess that real stock prices in Argentina are higher during low inflation periods. Obviously, nominal prices rise during hyperinflation.
There’s a U-shaped relationship between real stock prices and monetary policy, with stocks doing poorly during inappropriately tight money and inappropriately easy money, and doing best with stable monetary policy.
Taxes on investment income in America are not indexed for inflation.
I don’t care what “the world” thinks is tight money. I’d guess 99% of people think high interest rates are tight money.
13. June 2022 at 19:34
Scott,
You replied:
“Michael, I told you a year ago that inflationary monetary policies are bad for the stock market, and you didn’t believe me.”
Which stock market are you referring to? The US stock market of the 70s, or the Argentine and US stock markets of today?
Was the Fed’s policy only inflationary beginning on January 3rd, when they actually began trying to talk down inflation expectations?
I give you credit for being right most of the time when you disagree with most other economists, but this is not one of those times.
13. June 2022 at 19:41
Here’s the S&P 500 data for the past 5 years:
https://fred.stlouisfed.org/graph/?g=QxjV
If you want to argue that a central bank letting monetary policy getting looser than it would like and then having to tighten is bad for the stock market, then I agree, at least in terms of unnecessary volatility. But, if I understand you correctly, I read an implication that there’s some factor you haven’t cited that hurts even nominal stock prices.
Again, in the 70s, when marginal income tax rates weren’t inflation-indexed, it did make stocks less attractive. That problem has mostly been solved.
How do you explain Argentina’s stock market performance if inflation is necessarily corrosive to stock prices? They typically often have 40%+ annual inflation rates.
14. June 2022 at 00:12
>a few believable sentences would get us there without changing rates much
A “believable” statement is a heavy lift for an organization that can’t even seem to make a “comprehensible” statement. Witness the widespread confusion surrounding the words “transitory” and “average.”
14. June 2022 at 05:40
I asked a friend at the NY Fed essentially, so in 2020 when the economy was in tatters due to external effects, despite the fact that these effects were external, there was a commitment to do “whatever it took” to bring unemployment in line. There appears to be a lack of commitment now, what gives?
And the answer is something something recession, people might get hurt, etc … which I sort of understand? But the problem is, there is a clear asymmetry there, that kills credibility. and then this issue doesn’t get resolved.
If you know you aren’t willing to impose effective austerity during a hot market, you cant be willing to i
expand as much during a contraction. Its fine regardless, but you need to be consistent.
14. June 2022 at 06:18
Bernanke doesn’t seem to think we will see a repeat of the 70’s, I hope he is right.
https://www.nytimes.com/2022/06/14/opinion/inflation-stagflation-economy.html
I think he might be too optimistic about the Fed’s independence from political pressure and its credibility.
While I’m handing out links, here is a great article by Warren Buffet from 1977 about why inflation is bad for stocks:
http://csinvesting.org/wp-content/uploads/2017/04/Inflation-Swindles-the-Equity-Investor.pdf
My favorite quote from the article: “Most of those in political office, quite understandably, are firmly against inflation and firmly in favor of policies
producing it.”
14. June 2022 at 06:46
How can Bernanke claim there was hesitation to raise rates in the 1970s unlike today?! A simple chart of inflation vs Fed Funds rate will show they basically moved in unison in the 1970s; whereas today there has been a massive lag in the response to inflation.
Do we need to add Ben to the (large) list of economists that are becoming delusional?
14. June 2022 at 08:46
Scott,
Sorry, but I missed the second and third parts of your original reply to me.
You also replied:
“As for Argentina, I am focused on real stock prices. I’d guess that real stock prices in Argentina are higher during low inflation periods. Obviously, nominal prices rise during hyperinflation.
There’s a U-shaped relationship between real stock prices and monetary policy, with stocks doing poorly during inappropriately tight money and inappropriately easy money, and doing best with stable monetary policy.
Taxes on investment income in America are not indexed for inflation.”
On the first part of above, okay, you’re only focusing on real stock prices. Good.
There’s some truth to the second statement also.
But, my impression is that the third statement about taxes on US investment income is wrong. Here’s the Tax Foundation, for example:
https://taxfoundation.org/personal-income-tax-inflation/
“The most basic provisions, namely, personal income tax brackets and the standard deduction, are adjusted for inflation. Additionally, the minimum income threshold for the alternative minimum tax, capital gains tax brackets, the maximum values of the Earned Income Tax Credit (EITC), limits on the 20 percent pass-through business income deduction, and the annual exclusion for gifts received all get adjusted for inflation.”
But, that issue aside, inflation expectations haven’t been high enough to make much of a difference recently, so the your argument doesn’t apply anyway.
US stock prices have been falling since January 3rd of this year after the Fed released guidance intended to slow inflation. Inflation expectations began falling, until the Ukraine invasion.
14. June 2022 at 09:03
By the way, the S&P 500 was rising until January 3rd in real terms too.
https://www.macrotrends.net/2324/sp-500-historical-chart-data
14. June 2022 at 09:42
Michael, Our tax system taxes the nominal return on capital, that’s why inflation punishes holders of financial assets.
I’m not saying that’s the only problem—inflation also tends to create more cyclical instability.
14. June 2022 at 10:22
Lenin was right. Professional economists can’t define money nor determine its impact. So, Powell threw away the rest of the tools by which we can dissect AD.
A contractionary money policy can not only lower interest rates in the longer term, but it can also lower the velocity of circulation as well
Economists now have us on the path of destruction. The Wilshire 5000 will never get back to their 48952.51 high on Nov 8, 2021.
Fullwiler was wrong: “Paying Interest on Reserve Balances: It’s More Significant than You Think”. It stokes asset prices and exacerbates income inequality. When you raise the remuneration rate, it induces nonbank disintermediation (destroying velocity).
Banks aren’t intermediaries. Contrary to George Selgin (who testified before Congress), July 20, 2017: “This is nonsense, Spencer. It amounts to saying that there is no such things as ‘financial intermediation,’ for what you claim never happens is precisely what that expression refers to.”
Never are the commercial banks intermediaries in the savings-investment process. From the standpoint of the entire payment’s system, commercial banks never loan out, and can’t loan out, existing funds in any deposit classification (saved or otherwise), or the owner’s equity, or any liability item. Every time a DFI makes a loan to, or buys securities from, the non-bank public, it creates new money – demand deposits, somewhere in the system. I.e., all deposits are the result of lending and not the other way around.
All monetary savings originate within the payment’s system. The source of interest-bearing deposits is non-interest-bearing deposits, directly or indirectly via the currency route (never more than a short-term seasonal situation), or through the bank’s undivided profits accounts. This is the cause of secular stagnation, the deceleration in velocity.
14. June 2022 at 10:38
The 1970’s spawned the DOW PE ratio theory, lower highs and lower lows.
The Great Inflation of 1966-81 was due to a policy blunder. William McChesney Martin reintroduced interest rate pegs during the monetization of time deposits (the ungating of time deposits in conjunction with the transition from clerical to electronic processing). I.e., the time frame of the FED’s horizon was 24 hours rather than 24 months.
14. June 2022 at 11:16
Scott,
I have sometimes heard this from (educated) Americans and it was fairly okay. It’s a rather difficult word with sounds like “eu” and “sch” that are not known in English. From that point of view, I was really satisfied. It was surprisingly good.
Especially since at least 95% of Germans can’t explain what “deutsch” actually means. I would have to google it as well. It’s not common knowledge, the meaning is completely lost. It’s way more lost than the meaning of, let’s say, “America” or “Colombia”, which is fairly easy.
“Deutschland” doesn’t make much sense — as I said, the common man couldn’t explain it. Terms like “Germany” or “Germania” would make more sense — everyone would know where it comes from. Well not everyone but you know what I mean.
What I don’t understand is how many Italian words are butchered. It took me years to understand that Americans mean “Bologna” when they produce a word that sounds like “Baloney” (???) or even weirder. I’m really sorry America, but there is no “baloney” in Bologna and no “Titian” in Tiziano.
14. June 2022 at 11:39
Christian, You missed my point. Just as we pronounce Tiziano as “Titian”, we pronounce Deutschland as “Germany.” Which is even worse!
Call them by their actual name. Or don’t. But society needs to make up its mind.
14. June 2022 at 12:16
Scott,
Yes, of course nominal gains are taxed. I said that tax brackets have been inflation adjusted since the 80s, which is true
3.5% inflation versus 2% inflation is not a big enough difference to matter much for capital gaina taxes.
My point remains that all of the evidence shows that monetary policy tightened beginning January 8th.
You have a forex metric that you’ve claim3aed in formal papers indicates the stance of monetary policy at policy inflection points. What does that metric tell you?
14. June 2022 at 13:50
Scott,
I also had a phase in my life when I thought that way. Now I think it has its justification with certain area names. I think it’s actually great. There’s a lot of history in that.
I think, I noticed this when I went through the many names for “Deutschland” abroad. Almost nobody says “Deutschland”. Why is that?
Well, there are good reasons for this, because, as we all know, the area where Germany is located has been settled for thousands of years before “Deutschland” even existed. So these names are actually much older than “Deutschland” — and for this reason, I think, they have their well-founded justification.
With names of persons (and cities) it is different. The person never had a different name ever. There’s no history in naming Bologna “baloney”. So either I’m missing something here (which is possible) – or it’s just ignorant to pronounce it “baloney”.
I think a lot of Americans also do this with the pasta sauce from Bologna. I had to ask three times what kind of pasta they mean — and then the thing comes — and it has nothing to do with ragu bolognese. Oh, so that’s why it’s called differently, now I get it. It’s a big fat warning sign.
19. June 2022 at 14:31
Scott,
Everyone I’ve worked with in finance, to the man or woman, is convinced liquidity flows (largely from the Fed) are the main driver of asset prices. In 2020-21 you had a perfect storm of new, naïve, investors entering the market and a huge influx of liquidity (tons of QE, and M2 increasing rapidly). The result was a massive bubble in speculative stocks (see ARKK).
Could you link me to the best argument against this that you know of? Thank you.
I don’t think the CPI prints during that time are much indication of the quantity of brrr, since they’re influenced by big shifts in behavior during covid. Housing inflation prints also lag a lot, due to the CPI using rent and OER instead of home prices.
Relatedly, I don’t see how the Fed’s general approach to controlling inflation makes much sense. They seem to treat inflation from tight supply chains the same as from monetary excess. This looks like reasoning from a price change?