What the press should ask Bernanke
Tim Duy has a new post showing the shocking deterioration in the Fed’s forecast for 2012 and 2013, and asks why this wasn’t enough for QE3. Evan Soltas points out that market inflation forecasts have fallen even faster. And Paul Krugman expresses the appropriate moral outrage:
The intimidated Fed: The minimal action “” extending Operation Twist “” wasn’t just inadequate, it was shameful. The Fed has a dual mandate, employment and price stability. Its own projections show high unemployment persisting for years and years, inflation running below its target “” and realistically its inflation projections are too high while its unemployment projections are too low. There is no rational argument I can see for not going all out with monetary stimulus.
But what we actually got was action that was pretty obviously calculated to be the absolute least the Fed could do without generating headlines saying “Fed ignores weak economy”.
I’m sorry, but this looks like pure concession to political intimidation “” a Fed refusing to do anything that would let Republicans accuse it of helping Obama. And for the sake of its own political comfort, the Fed is essentially betraying the unemployed.
All in all, the degree of elite failure in this crisis is just stunning.
I’m not sure it’s all attributable to corruption or cowardice; there also seems to be a lot of cluelessness going around. A reader sent me an email he received from a former Fed official:
Well, my view is that we don’t need more easing. I don’t think that is the problem at the moment. The role of the Fed (and any central bank) is to promote conditions that can lead to growth. They are there to be a lender of last resort, which they have done admirably. I think the easing talk is a disservice. I think it is important to calm the markets for sure. I mean…
[Then he provides some graphs showing near zero rates and a big monetary base—the sort of data that is consistent with ultra-tight monetary policy in 2008 driving NGDP sharply lower and thus leading to low nominal rates and a big demand for ERs.]
That quotation could have come almost word for word from a Fed official during the Great Depression, when lender of last resort really was their role. In that case we were still under gold standard, and the Fed had limited ability to steer the nominal economy. A fiat money regime doesn’t “take care of itself”. The Fed has to steer some sort of nominal aggregate all the time. Yes, the Fed can’t magically produce RGDP growth. We have to hope that other policymakers adopt a regime that’s closer to that of South Korea than North Korea. But as we saw in 1929-33, it can come close to destroying an otherwise relatively free market regime (and no, Hoover’s foolish interventionist policies don’t even come close to explaining the Great Depression, they were trivial compared to the intervention in a modern economy (such as the booming 1960s.)
Bernanke likes to say monetary policy is “not a panacea.” In one sense that’s true, but it most certainly is a panacea for inadequate NGDP growth, and all the associated problems that flow from inadequate NGDP, such as above natural rate unemployment and that part of financial/banking distress that flows from falling nominal incomes.
Bernanke has become skilled at evading the question of why the Fed doesn’t do more, when their projections clearly call for additional stimulus. So here’s what I’d ask him at the next press conference:
Mr. Bernanke: In 2003 you said that neither the money supply nor interest rates were reliable indicators of the stance of monetary policy, and that only nominal GDP and inflation were good indicators of whether policy is easy or tight. Given that both of these variables have grown at unusually low rates since 2008, would you say that monetary policy has actually been relatively contractionary over the past four years? If not, what indicators would tell you that it has been highly accommodative?
[Predicted answer: “Again, no one can deny the Fed has taken many extraordinary steps . . . ]
I’d also like to hear from researchers at the Fed (anonymously if you prefer) as to whether working there makes one gradually begin to see vague “costs and risks” of unconventional policy like QE as being more worrisome than the very real suffering of millions of unemployed.
PS. God knows when I’ll get to the comments.
Tags:
21. June 2012 at 18:45
Scott,
It’s time for you to abandon your view that the Fed is incompetent or simply following the consensus of mediocre economists. It’s clear the goal here is to get Romney elected.
21. June 2012 at 18:52
Scott,
Do you still think that “Obama controls the Fed”? You’ve been placing much less emphasis on his culpability for its actions due to his failure to stack it with loose-money political hacks earlier i his term, and talk much more as if this is an institution that actually has some policy agency of its own of late. My thoughts on all of this have been influenced over the last few months by your strong insistence earlier in the year that essentially Obama brought these policy failures that are likely to cost him re-election on himself (well, more importantly, on us) due to inaction and delay on appointments – indeed that responsibility for the failure of this independent institution lies with Obama, not the institution (i.e. that inflation hawks on the BoG are like scorpions who can’t be held responsible for their ‘nature,’ and that Obama is primarily at fault for failing to send Ben the reinforcements needed to help deal with these unthinking creatures, the Hawks). Not many other commentators have talked like that, but I’ve kept your view in mind while reading their exasperated criticism of the Fed and Bernanke. I haven’t read your blog as much in the interim, but I now I return to find you talking much more like the other critics than like you used to. Have you changed your view of who is responsible for the Fed’s actions?
21. June 2012 at 18:58
I thought Obama’s two new members of the FOMC were doves, but so far they seem to have had no effect. What happened to them?
21. June 2012 at 19:13
It’s time for you to abandon your view that the Fed is incompetent or simply following the consensus of mediocre economists. It’s clear the goal here is to get Romney elected.
But why do all of Obama’s appointees want to do that?
For that matter: Larry Summers … Repub secret agent?
21. June 2012 at 19:14
If there was ever evidence that unaccountable humans are the worst choice for deciding monetary policy this is it. Even the best can’t be trusted to make predictable good decisions, ala Bernanke. Like Einstein said of relativity, the old will have to die before the profession will accept the proof.
21. June 2012 at 19:22
There are days I wish I had never stumbled upon Sumner and Market Monetarism. There is bliss in ignorance.
If ever (on the merits) the Fed had a green light for QE and expansionism, it is now.
But the Fed is mincing around, fiddling and diddling with feeble fumbling.
Another great Sumner blog.
21. June 2012 at 19:30
a certain well respected economist quipped recently in response to whether QE works (paraphrasing): well im not sure but if Bernanke says so i believe him.
same with costs and risks. the difference between Bernanke saying something and me, or you, saying something, is that people believe it, and *therefore* it becomes true, because Bernanke sets expectations. Bernanke is Chuck Norris.
Bernanke ticked off a couple risks with QE, well im not sure, but i have to say, hes the guy controlling the Fed balance sheet, so i believe him.
21. June 2012 at 19:53
I’ll say 80% they are stupid; 20% corruption or political intimidation
21. June 2012 at 20:04
Philo,
You wrote:
“I thought Obama’s two new members of the FOMC were doves, but so far they seem to have had no effect. What happened to them?”
They’re nonentities. One is a Democratic finance professor and the other is a Republican lawyer. Neither has any record on monetary policy because neither knows anything about it.
Of Obama’s six BOG nominees or renominees only Bernanke and Yellen really know anything about monetary policy. And based on some of the things Yellen has said I’m not too sure about her.
In fact, the BOG, the governing body in charge of the nation’s economy only has three economists on it. There is an MBA and three lawyers (you can never have enough lawyers, right?)
Someday I suppose this will all be reciprocated when monetary economists get nominated to sit on the Supreme Court. Until then let the depression continue.
21. June 2012 at 20:10
And lest you think that only applies to Obama’s BOG picks let’s look at who Obama’s chief economic advisers are.
1)Treasury Secretary Timothy F. Geithner as the sole remaining top member of the original team. But Geithner is a financial markets expert, not an economist.
2)Summers, whose reputation added weight to White House policies, has been replaced as head of the National Economic Council by Gene B. Sperling, a respected veteran of the Clinton administration but not an economist by training.
3)Romer was succeeded by Goolsbee as head of the Council of Economic Advisors, and both often were the economic voice of the administration on television news shows. The current Chairman of the CEA is Alan Krueger, a labor economist who earned his PhD at Harvard and was previously a professor at Princeton.
4)Volcker is no longer head of the President’s Economic Recovery Advisory Board, a panel that changed its name to the President’s Council on Jobs and Competitiveness to focus on job creation and innovation. It is now headed by General Electric Co. Chief Executive Jeffrey R. Immelt, who is not an economist.
5)And lastly, Office of Management and Budget Director Orszag has been replaced by Jeffrey Zients, who is (you guessed it) also not an economist.
It seems to me the main problem with Obama’s economics team is the fact that, with one exception, none are economists.
21. June 2012 at 20:10
dtoh:
I have no way of knowing why the Fed does what it does and I don’t care much for Romney, Bernanke or Obama, but I wouldn’t be so quick with making that kind of assumption. The last meeting was the first since all of the BoG seats have been filled, all of them Obama appointees except for Bernanke, and the floodgates of QE didn’t open up. Nothing has changed. One could speculate that perhaps Obama was in no rush to fill those seats because the Fed was doing what he wanted, and filling them didn’t change anything because they are still doing what he wants.
The Full Employment and Balanced Growth Act of 1977 (where the full employment mandate came from) put the President’s economic plans at the center of governmental economic coordination efforts, and therefore Fed independence is limited in that respect. Why Obama wouldn’t want the Fed to do what it can doesn’t make that much sense except I have noticed reservations about monetary stimulus on his side of the political spectrum because it gives the new money to bankers or other asset holders as a matter of getting out into the economy. Perhaps he would prefer to use government spending as a way of distributing the money but that avenue is no longer politically feasible. And so we are stuck in economic no man’s land with politicians pointing fingers at each other while the suffering continues.
21. June 2012 at 20:30
Even if Obama is to blame (and I think he is), it’s too late for him to un**** up anything via directly manipulating who sits on the FOMC now, given that the appointments have been made. All we can do is hope and pray the existing members come to their senses.
However, there’s no excuse for Obama and the rest of the policy/political establishment not calling for easy money. It’s obvious to anyone with half a brain that given the economic crisis in Europe and the incredible amount of uncertainty in the present economic climate, demand for money has gone up. It is insanity to intentionally strangle the economy by not providing more liquidity commensurate with this increased demand.
The entire political and policy establishment is to blame for the idiotic monetary policy we have in place. Obama doesn’t deserve re-election, simply because he has totally ****ed up the only meaningful lever any politician in the US has on the macroeconomy to address a demand crisis. And a pox upon both houses (and parties) in Congress, for they have both totally abdicated their responsibilities as well.
It’s a total cluster****, and the frustration only gets worse every day. How long must we wait for sensible monetary policy, instead of this nonsense that accommodating increased demand for money will somehow worsen the problem of economic uncertainty, instead of ameliorating it?
P.S. Scott if you’re reading this, don’t worry too much about addressing individual comments; it would work just as well to address general issues which have been raised. As long as you continue to engage with comments in some way, you’ll continue to distinguish yourself from other bloggers with respect to engagement with your blog’s community.
21. June 2012 at 23:20
Just once I would like to see Krugman go a whole week without mentioning the Republicans…
21. June 2012 at 23:51
@ Jim Glass,
“For that matter: Larry Summers … Repub secret agent?”
My view has long been that Larry Summers and Paul Volcker are both Republican secret agents. Not necessarily by intent, but in effect, yes.
@ Mark Sadowski,
“It seems to me the main problem with Obama’s economics team is the fact that, with one exception, none are economists.”
In fairness, I’m not an economist either, but I’m confident I could do a better job than the majority of economists out there. Perhaps the problem is that no one on Obama’s economics team is a MoneyIllusion reader???
21. June 2012 at 23:55
cthorm,
Do you want deciding monetary policy directly in the hands of elected officials ?
Where would you have the humans responsible for deciding monetary policy reside ? The Cabinet ?
President Ron Paul would love that. President Obama would be doing little different. President Romney, if he can be taken at his word, would tighten money.
Congress? I don’t think so.
Do you really want monetary policy becoming a political football ? Do you really want Americans seeing monetary policy through the lens of billions of dollars of what can only be base,distorted, and oversimplified political ads, designed to sensationalize ?
The thing is if Obama or any president had the guts or knowledge they could move the fed in the direction they want. He may have the guts, but It is clear by who the economic advisors he has surrounded himself with, ( Wall Street types and bankers ) that he does not have the knowledge.
The whole issue of taking power away from the FED works as a Red Herring.
22. June 2012 at 00:04
Scott,
I’ve noticed a huge surge in the number of private sector economists and financial types complaining that QE doesn’t work and that ZIRP causes financial disintermediation, etc. My guess is that the Fed is spending more time listening to private sector bankers and sees “costs and risks” in pissing them off.
We seem to be heading down the 2008 path of saying, “well, we tried monetary stimulus and it didn’t work, so let’s go the other way instead.”
22. June 2012 at 01:59
I’d also ask Bernanke why the paper he wrote on Japan, encouraging bold action far beyond what we’re seeing, does not apply to the US today.
We do appear to be in a dark age, in which history is forgotten, evidence is ignored, those who have been consistently wrong are taken seriously and those who have been right have been ignored or worse.
22. June 2012 at 02:44
foosion: http://www.businessinsider.com/ben-bernanke-just-blasted-paul-krugman-at-his-press-conference-2012-4
http://www.bloomberg.com/news/2012-04-25/bernanke-rejects-criticism-he-ignores-his-own-policy-advice.html
22. June 2012 at 02:50
Saturos: good point, and it shows that we’re not going to get a serious answer to any question put to Bernanke.
22. June 2012 at 03:37
Scott,
I’ve been reading your blog a lot lately since my new job involves tracking financial predictions and I’m interested in the implications of the EMH. Your blog combined with the commentators I spend the day listening too sometimes make me thing the Fed should do more since that’s all I heard argued all day long. This makes me fear for my sanity.
Luckily Henry Hazlitt wrote the book “Economics in One Lesson”. I think this book is the key for understanding sound economic reasoning and I come back to it whenever I feel confused by all the swirling opinions out there. I was wondering if you have ever read it? Specifically, have you ever read the chapter called “The Mirage of Inflation”? If you were to read it, it 14 well-written pages, and do a good blog post on it, I think you could understand the conservative mentality a little better and maybe even bring some of the Austrian leaning economists over to your side.
Since I know your a busy guy and may not have time, I’ll give you a little quote that sort of summarizes his position.
“In brief, they [advocates of inflation] divert both the public attention and their own from the real causes of any existing depression. For the real causes, most of the time, are maladjustments within the wage-cost-price structure: maladjustments between wages and prices, between prices of raw materials and prices of finished goods, or between one price and another, or one wage and another. At some point these maladjustments have removed the incentive to produce, or have made it actually impossible for production to continue; and through the organic interdependence of our exchange economy, depression spreads. Not until these maladjustments are corrected can full production and employment be resumed.
True, inflation may sometimes correct them; but it is a heady and dangerous method. It makes its corrections not openly and honestly, but by the use of illusion. It is like getting people up an hour earlier only by making them believe that it is eight o’clock when it is really seven” (Hazlitt 153-154).
To me this seems like a sound argument, any thoughts?
22. June 2012 at 04:09
Bill Ellis,
Ideally a rule-based program keeping MV consistent with the nominal income target. But it’s unclear that politicization would really hurt. Australia doesn’t have an independent CB and they haven’t had a recession in 20 years. Monetary policy is political and most people don’t understand it, but I bet more do than they otherwise would. Yet here we are and most economists don’t get it, they’re busy coming up with new RBC explanations for a 5 year recession.
22. June 2012 at 04:14
Been thinking about the post most of today…. two additional observations.
1)I’m gobstruck by the level of incompetence in the Oval office.
2)Krugman is just about the biggest of the BFHs (Big F***ing Hypocrites) on the planet. For 3 1/2 years, he says almost nothing to push monetary expansion (despite knowing and having published its merits) in the hopes that fiscal policy (and big government expansion) would prevail, and now when he realizes Obama is going to get whoopped he lambasts the Fed. What an a**hole.
22. June 2012 at 04:20
Jim Glass,
You cleared up a mystery for me, as to why a hard conservative one day came to Larry Summers’ defense out of the blue (I’d not said anything about Summers).
22. June 2012 at 04:46
Soltas also does not understand the TIPS bond market. He too is doing what Sumner does, which is infer from the nominal yield an equivalent inflation expectation.
Like I said yesterday here, one cannot infer expected inflation from the nominal yield on TIPS bonds.
TIPS bonds have call option prices embedded in them, because future coupons are set according to the CPI index at the time. Hence, when investors buy a TIPS bond today, they are (in part) paying a premium based on a bet of future inflation.
For example, if TIPS investors expect inflation to heat up quite substantially 5 years out, then they might be willing to pay a high premium today to get exposure to a 5 year bond whose nominal yield will increase in the future. So that will reduce the current yield of the 5 year TIPS bond, and possibly even turning it negative. But because the investor is betting on higher inflation down the road, the increase in coupons he expects will offset the current negative yield, and earn a positive nominal return by maturity.
A low current yield on any TIPS bond does NOT mean one can infer from that low yield that expected inflation is also low. This is wrong wrong wrong.
If anything, the lower the yield, the higher the expected inflation.
As I also said yesterday, TIPS bonds also have a put option embedded in them. Contrary to other inflation hedges like gold and commodity futures, TIPS bond principles are guaranteed. As a result, there is also put option premium embedded in a TIPS bond based on that guaranteed principle.
After all is said and done, there is much complexity to a TIPS bond, and we cannot simply observe the low yield and say “Aha! Expected inflation is low.”
What we should be saying is “Aha! Investors are paying a huge premium on these securities such that right now they are yielding a negative return. Why on Earth would investors be willing to earn a negative return on a bond? Something else must be going on. That’s it! It’s because TIPS bonds are bets of future inflation. Wow, with the price being so high, such that the yield is very low, or negative, investors sure must be expecting higher inflation down the road!”
22. June 2012 at 05:01
There is a further complexity to TIPS bonds. Many investors consider the CPI to be under-reporting the rate of inflation. As a result, if investors expected inflation to be 10%, 5 years out, and they think the CPI will report something like 5% inflation, then they expect future coupons to be lower than they “should be”, since they are tied to the under-reported CPI.
That means if investors want to earn a 10% actual return, then they might be willing to pay a lower price today so that they get the “missing” return through capital appreciation instead.
This of course will put pressure on the yield to increase, even though it has nothing to do with the reported CPI itself.
Call option premiums, put option premiums, CPI corrections, the list of complexities is a long one, and those who look at the low yields on TIPS bonds and say “See? Expected inflation is low!” don’t know what they’re talking about.
22. June 2012 at 05:12
ssumner:
In one sense that’s true, but it most certainly is a panacea for inadequate NGDP growth, and all the associated problems that flow from inadequate NGDP, such as above natural rate unemployment and that part of financial/banking distress that flows from falling nominal incomes.
Inflation that prevents employment being formed on the basis of unhampered demand and prices, will just result in more misallocated employment.
There are problems associated with monetary inflation that leads to “adequate” NGDP, which are of course being completely ignored.
22. June 2012 at 05:19
@MF,
1. you are correct about the “TIPS inflation floor” and the guarantee of principal being a put option, very good! (i would print and frame that its unlikely to happen again) Now tell me what the actual value of that option is (most models i have seen estimate 5-15 basis points right now at the long end, not much). {the capital loss for TIPS is a function of coupon and yield and past inflation: TIPS pay the higher of inflation-adjusted principal or par at maturity}.
i doubt this is worth much more than a few bps for a 5 yr TIPS with .125% coupon and 105.766 price.
2. For the upside, setting aside deflation, what you are referring to are not call options (the payoff is symmetrical to higher or lower inflation).
there is a differential liquidity premium (see below) that changes over time and makes it difficult to infer breakeven inflation (for example, the Cleveland Fed series uses inflation swaps and calculates very different estimate).
Setting aside the deflation aspect, what you are referring to is called the “term premium” “risk premium” or “liquidity premium” depending on who you are talking to and its not a call option premium, just a higher price(cost) for holding a less liquid security.
3. there is a tax effect which: capital gains from the CPI adding to the redemption amount vs income tax on the coupons.
http://www.frbsf.org/publications/economics/letter/2011/el2011-19.html
22. June 2012 at 05:24
and, the CPI generally overstates inflation. for Q12012, almost 1% relative to my preferred metric, the gdp deflator.
http://research.stlouisfed.org/fred2/graph/?g=8bk
22. June 2012 at 06:20
[…] Paul Krugman properly castigated the FOMC’s abdication of responsibility this week. Scott Sumner believes that Bernanke’s heart is in the right place, but his hands are tied, and is […]
22. June 2012 at 06:57
dtoh, Here’s what we know:
1. The Fed decision makers are mostly typical economists (except Bernanke)
2. Typical economists outside the Fed think they have policy about right.
You need to expalin to me wht the typical economists within the Fed mysteriously believe that policy is not right, but are doing it anyway to help Romney, despite the fact that they ruined McCain’s campaign.
Occam’s razor anyone?
MDrew, You misunderstood my earlier comments about Obama. I’ve always insisted any other President would probably have done the same thing. But that’s because I’m a political determinist. I think any other president would have gone to war with Iraq. But I still blame Bush for the war, and I still blame Obama for not focusing on the Fed.
Smart people understand that presidents have little influence on the business cycle. If FDR had been elected in 1928 we still would have had a depression. Be we should and do hold them accountable anyway. It encourages them to do better at the margin.
Philo, Good question. I doubt whether Obama even asked them if they were doves.
Jim and Cthorm, I agree.
Thanks Ben.
Liberal Roman, Sounds about right.
Mark, Very interesting. Given what I know about Obama’s views, I’m not surprised he’s more comfortable with non-economists.
Thanks Johnleemk.
Steve, What these idiots don’t realize is that the low rates reflect tight money. So they want money to be even tighter!
John Becker, Yeah, I basically agree with that, which is why I favor low and stable NGDP growth, to keep wages and prices close to equilibrium values and to avoid mal-adjustments. I’m still the University of Chicago inflation hawk that I was in the 1970s. My views haven’t changed, it’s the rest of the world that’s gone mad.
That’s also Hayek’s view, and he also favored NGDP targeting.
dtoh, In fairness he’s made some previous statements, but I agree that early on he wasn’t forceful enough on this issue.
MF, You said;
“A low current yield on any TIPS bond does NOT mean one can infer from that low yield that expected inflation is also low. This is wrong wrong wrong.
If anything, the lower the yield, the higher the expected inflation.”
Give this man a Nobel Prize! Seriously, do you think Soltas doesn’t know this?
BTW, The floor on TIPS prices is not relevant for short term estimates (say 2 yesrs), as these already are older TIPS with a lot of inflation embedded within, and little risk of droppng to the floor before maturity.
22. June 2012 at 07:18
Scott,
You break my heart here because you have so much potential. When you frame the argument that way and it almost wins me over. Then you call for more easing from the Fed. If you really believed what Hazlitt wrote there, you’d concentrate on how to fix the maladjusted wages and prices rather than arguing for more Fed bond buying like all the rest of the bumbling profession.
I think lots of liquidations are needed and still need to happen in this economy and monetary easing is the problem and not the solution. For instance, it makes no economic sense for all the best and brightest people I knew in college to be going into finance. You’d agree if you took the EMH seriously.
Look at Japan for an example of what happens when try to avoid pain through monetary and fiscal stimulus.
22. June 2012 at 08:07
I came across this today….
Obama may not want monetary economists to run monetary policy in the real world, but it turns out a company named Valve is hiring a monetary economist to advise digital distribution, digital rights management, multiplayer and communications platforms on their currency options in the virtual world:
http://blogs.wsj.com/atwork/2012/06/20/best-econ-job-ever-videogame-economist/
If they had been lanything ike Obama they would have hired a team of lawyers to do this instead.
22. June 2012 at 08:19
“If they had been lanything ike Obama they would have hired a team of lawyers to do this instead.”
if lawyers are qualified to practice economics, i should be qualified to practice law. i have read and reviewed far more corporate contracts and legal docs than your average law school grad.
22. June 2012 at 08:35
‘It seems to me the main problem with Obama’s economics team is the fact that, with one exception, none are economists.’
Probably because Obama betrays a complete lack of any knowledge of economics…or, even elementary business. He’s said that, ‘Profits eat up overhead.’ and complained that he wasn’t sold collision insurance on his $1,300 beater automobile.
One of his co-workers at his first job remembers having to explain to him what a bond was. Obama himself described that job, in his book, as being at the center of the financial universe, when it seems to have been some kind of low level editorial position at a newsletter.
22. June 2012 at 08:37
ssumner:
“A low current yield on any TIPS bond does NOT mean one can infer from that low yield that expected inflation is also low. This is wrong wrong wrong. If anything, the lower the yield, the higher the expected inflation.”
Give this man a Nobel Prize! Seriously, do you think Soltas doesn’t know this?
You have got to be kidding. I know you don’t WANT me to be right about anything, but is taking whatever side I disagree with, really the way you want to learn what is true?
Soltas said in unmistakable (well, at least I thought they would be unmistakable):
“First, a note about short-term inflation expectations. After the Fed’s statement, the market expectation of one-year inflation in the U.S. this year fell 40 percent. That’s not a typo. At yesterday’s close, it was 0.2433 percent, and today it is 0.1475 percent. These numbers come from the yield curve of Treasury Inflation Protected Securities, also known as TIPS, and its spread against Treasuries of the same maturity. The market, in other words, is betting that next year will be ever closer to deflationary, as measured by the Consumer Price Index.”
This is making the mistake of inferring lower inflation expectations from lower TIPS yields, when the opposite may very well be the case!
I know you want to promote Soltas because he has been hoodwinked by the same monetarist worldview as you. I get it. It makes you feel good. But to rhetorically ask me if I seriously think he doesn’t understand it, when the above quote makes absolutely clear he doesn’t understand it, is not the way to go about.
BTW, The floor on TIPS prices is not relevant for short term estimates (say 2 yesrs), as these already are older TIPS with a lot of inflation embedded within, and little risk of droppng to the floor before maturity
Even a TIPS bond that has 2 years to maturity contains a call option premium, which MAY rise in value if inflation expectations over the next two years rises. They may be betting on another QE for example.
22. June 2012 at 10:18
MF –
Who exactly are you arguing with? If Soltas is guilty of anything it’s being inexact by saying ‘yield curve on TIPS’ when he means ‘the spread between the yield curve on TIPS and equivalent treasuries’. But if you bothered to look at the yield curve for TIPS you would see that its negative, so Soltas’ post is clearly NOT referring to the TIPS curve alone. See the below data dump from my BBG terminal for 2 year Breakeven TIPS spreads since the end of 2010. That is market inflation expectations.
Date Last Price
2012-06-22 0.9727
2012-06-01 0.9474
2012-05-31 1.1355
2012-05-15 1.4902
2012-05-01 1.7769
2012-04-02 2.0798
2012-03-13 2.3241
2012-03-12 2.2914
2012-03-01 2.2086
2012-02-09 2.1374
2012-02-01 1.9809
2012-01-02 1.3524
2011-12-30 1.3524
2011-06-30 1.4882
2010-12-30 1.2292
22. June 2012 at 10:43
TIPS pricing
MF’s quote from Soltas in intriguing..
1 year TIPS real yield – 0.50%
1 year Treasuries yield 0.25%
BE inflation is 0.75%
Where does 0.1475 come from?
Math aside a reduction in inflation expectation from 25 bps to 15 bps is not a 40% reduction in inflation expectations; it is a 0.10% reduction in inflation expectations! A 40% reduction in inflation expectations would otherwise be known as crippling deflation.
22. June 2012 at 11:08
Doug – see the data I posted. BE was as high as 2.3241 on March 13th, and today it is 0.9727. That’s a 58% reduction peak to trough. Quibble about the math if you want but regardless in represents a major shift in inflation expectations during the last quarter.
22. June 2012 at 11:25
Cthorm:
Who exactly are you arguing with?
I thought that was obvious. Anyone who infers from declining TIPS yields a declining inflation expectation on the part of TIPS investors.
If Soltas is guilty of anything it’s being inexact by saying ‘yield curve on TIPS’ when he means ‘the spread between the yield curve on TIPS and equivalent treasuries’. But if you bothered to look at the yield curve for TIPS you would see that its negative, so Soltas’ post is clearly NOT referring to the TIPS curve alone. See the below data dump from my BBG terminal for 2 year Breakeven TIPS spreads since the end of 2010. That is market inflation expectations.
If the spread between TIPS yields and equivalent treasuries falls, due the fact that either TIPS prices rise from their previous (below equivalent treasury price) values, and/or falling equivalent treasury bond prices, you also cannot infer falling inflation expectations from this.
That’s not what TIPS yields are communicating, it’s not what the spread between TIPS bonds and equivalent treasuries are communicating. Vanilla treasuries are currently yielding less than the rate of inflation, and you think you can just infer from treasuries a baseline for inflation?
Let me explain this further, because it is terribly important.
Consider this chart of 5 year TIPS, equivalent 5 year treasury yields, and 1 year treasury yields:
http://research.stlouisfed.org/fredgraph.png?g=8bP
The naive interpretation of this chart is to say that because the spread between TIPS and 5 years is negative, that “the market expects deflation”, or at least “low inflation”. It is probably the exact opposite, as investors are paying a premium to buy the TIPS to bet on a return that they can’t get with treasuries alone.
Another naive interpretation is to say that because the 1 year vanilla bonds are yielding close to zero, that vanilla bond investors expect almost zero inflation next year, and have been expecting inflation to be almost zero since 2009.
So why then aren’t vanillas yielding more? It’s because the Fed is buying them, the market isn’t healthy, and the banks have oodles of newly printed money they have nothing to do with except buy treasuries. You cannot infer from low treasury yields “low expected inflation”, and you cannot infer from low TIPS yields “low expected inflation”, and you certainly cannot infer from a falling spread between the two “low expected inflation.”
Just look at your numbers Cthorm, and compare them with this:
http://research.stlouisfed.org/fredgraph.png?g=8bQ
Your numbers depend on TIPS yields, which don’t directly communicate the rate of expected inflation, and on equivalent treasuries, which also don’t directly communicate the rate of expected inflation.
The vanilla treasury market has been borked by the Fed, so the inflation expectation information content in them is borked, and the TIPS yields more than likely say the exact opposite of what inflation expectations are.
My guess is that inflationists WANT to use every single possible data they can to make a cause for more inflation, when often times they make unjustified leaps such as this one. I get it that inflationists want inflation, but you just can’t point to the TIPS market declining yields, or declining spreads, and say “See? We’re right. More inflation is justified.”
There is too much complexity here that is being missed in the quick analyses you and Soltas are using.
22. June 2012 at 11:27
Cthorm:
Doug – see the data I posted. BE was as high as 2.3241 on March 13th, and today it is 0.9727. That’s a 58% reduction peak to trough. Quibble about the math if you want but regardless in represents a major shift in inflation expectations during the last quarter.
No, you can’t say that. It could just as well signal increased inflation expectations. You can’t say for sure.
22. June 2012 at 12:13
MF –
“but regardless in represents a major shift in inflation expectations during the last quarter.”
That is true whether you choose to interpret TIPS spreads as a sign of increased or decreased inflation expectations.
22. June 2012 at 12:37
Cthorm:
That is true whether you choose to interpret TIPS spreads as a sign of increased or decreased inflation expectations.
Well, OK, sure. When you said “change” there I thought you were continuing with the “increased inflation expectations” as before.
If we all agree that we can’t say “increased inflation expectations”, then that is really the only point I wanted to emphasize.
If you have other information that can enable you to discern specifically increasing inflation expectations, then by all means, have at it.
22. June 2012 at 13:26
Cthorm –
If iflation expections go from 2% to 1% you call that a 50% change? What if they go from 1% to -1%? -200%? How about from -1% to 1%? Is that also a -200% change? And 0% to 1%?
Some things are fine to talk about change as a ratio, or percentage. Some things, not so good. If the units already represnt a % change, then % changes of % changes are just a little bit rediculous.
22. June 2012 at 15:19
Not to be rude Doug, but yes, I call a change in expectations from 2% to 1% a 50% change. Because that’s what a percent change is. I could just as well make the same point using percentage points (pps) or bps or prices, but percent is more convenient.
If the units already represnt a % change, then % changes of % changes are just a little bit rediculous.
That would be the second derivative, which I did not mention.
MF –
I am by no means conceding the point about how you choose to interpret TIPS spreads. People think all sorts of things I regard as kooky, but that’s their right to do so. I personally don’t find your argument persuasive or well supported by evidence.
22. June 2012 at 15:23
Not to be rude Doug, but yes, I call a change in expectations from 2% to 1% a 50% change. Because that’s what a percent change is. I could just as well make the same point using percentage points (pps) or bps or prices, but percent is more convenient.
If the units already represnt a % change, then % changes of % changes are just a little bit rediculous.
That would be the second derivative, which I did not mention.
MF –
I am by no means conceding the point about how you choose to interpret TIPS spreads. People think all sorts of things I regard as kooky, but that’s their right to do so. I personally don’t find your argument persuasive or well supported by evidence. As for evidence for my interpretation: TIPS spreads produced the same pattern in 2008. Did PCE inflation rise over the following 2 years? No, it fell, as my interpretation suggested. You can also look at what TIPS spreads did before and after QE1 and QE2 were announced.
22. June 2012 at 16:08
Cthorm-
Please humor me and work through the rest of the examples.
Suppose inflation expections go from:
1% to -1%?
-1% to 1%?
and from 0 to 1%?
Inflation is a first derivative of prices with respect to time. The change in inflation is a second derivative.
22. June 2012 at 16:56
John, You said;
“Look at Japan for an example of what happens when try to avoid pain through monetary and fiscal stimulus.”
Their NGDP is lower than in 1993. Are you joking here? 15 years of deflation, and you call that monetary stimulus? If it’s not the tightest money in world history, it’s damn close.
I want a stable monetary policy precisely because monetary instability moves wages and prices away from equilibrium.
Mark, I gave Valve some free advice last year, if I’m not mistaken.
MF, Do you ever bother to actually read what people write before commenting? Evan was talking about TIPS spreads, not the yield on TIPS. The quote you provide refutes your argument, something you are doing with distressing frequency.
Cthorm, Thanks for pointing out MF’s error, I get tired of wasting keystrokes on him.
23. June 2012 at 12:18
summner
MF, Do you ever bother to actually read what people write before commenting? Evan was talking about TIPS spreads, not the yield on TIPS. The quote you provide refutes your argument, something you are doing with distressing frequency.
Are you actually this muddleheaded? It doesn’t matter if one is talking about TIPS spreads or TIPS yields!
Short term vanilla bond yields are at next to zero. Changes in TIPS spreads are therefore a function changes in TIPS yields.
The quote I provided refutes SOLTAS’ claim that the fall in the spread somehow insinuates falling inflation expectations. No, it doesn’t. A fall in the spread can, and most likely does, signal rising inflation expectations, as investors are paying a higher call option premium embedded in the TIPS bond, because they’re betting on higher future inflation. We can’t say for sure based on the yields or the yield spreads alone.
It is absolutely astonishing how far you want to go to disagree with me just for the sake of disagreeing with me, that you display for everyone to see a truly deep ignorance on basic finance.
I mean, Soltas isn’t even the first person to make this mistake. You’ve made that same mistake a NUMBER of times on this blog. I remember them. On many occasions, you have made the argument that future inflation expectations are low because TIPS yields are low, and you have the gall to tell me “You seriously think Soltas doesn’t know that?” and “You’re wrong about everything.”
This blog is an absolute disgrace. There is no concern for the truth, there is no concern for what’s right. It’s all fake, empty, vacuous defenses of NGDP targeting garbage, regardless of how evasive and borderline intellectually dishonest you have to get in order to not appear that you have no clue what the heck you’re talking about.
Cthorm:
I am by no means conceding the point about how you choose to interpret TIPS spreads.
No, but you are conceding my point that you cannot say inflation expectations have fallen on the basis of falling TIPS yields or falling TIPS spreads (they’re essentially equivalent because short term vanilla bond rates (the one Soltas was referring to) have been virtually zero since 2010.
People think all sorts of things I regard as kooky, but that’s their right to do so. I personally don’t find your argument persuasive or well supported by evidence.
Your original claim that the data shows rising inflation expectations is not supported by the evidence! I was the one who said you can’t say this for sure. I am the one saying the evidence doesn’t support a theory being advanced. Now you’re telling me my claim that we can’t say for sure, is somehow NOT supported by the evidence? Talk about kooky.
As for evidence for my interpretation: TIPS spreads produced the same pattern in 2008.
When in 2008? Price inflation got up to over 5% during 2008.
If you look at this chart:
http://research.stlouisfed.org/fredgraph.png?g=8cY
If you notice, over 2007, TIPS yields fell, and price inflation rose. Score one for “decreasing yields signals increasing price inflation.” Then in early 2008, TIPS yields rose, and price inflation fell. Score another one for “increasing yields signals decreasing price inflation.”
But then wait. Late 2008 we saw decreasing yields and decreasing inflation. Score one for “decreasing yields signals decreasing price inflation.”
But then wait again. TIPS yields kept falling since late 2008, and price inflation has been rising since then.
Put it all together, and we have BOTH theories being confirmed here, exactly like I said. Your claim that “the same pattern took place in 2008” is falsified. We have cases of decreasing yields and increasing inflation and we have cases of decreasing yields and decreasing inflation. We also have cases of increasing yields and increasing inflation and we have cases of increasing yields and increasing inflation.
In other words, the main argument I am making that we cannot infer from TIPS yields (or TIPS spreads – nice pathetic save attempt BTW Sumner), rising or falling inflation expectations. There’s just too much going on.
Did PCE inflation rise over the following 2 years? No, it fell, as my interpretation suggested.
And yet TIPS yields fell since late 2008, despite price inflation INCREASING since then.
So your interpretation is not always true, which is the point I have been trying to make.
I am not trying to convince you that falling yields necessarily means rising inflation expectations. I am just trying to convince you, and you have since conceded, that we cannot infer either rising or falling inflation specifically, from TIPS yields alone.
You can also look at what TIPS spreads did before and after QE1 and QE2 were announced.
You mean how TIPS yields fell after the QE announcements November 28th and December 1st and December 16th, 2008? How TIPS yields continued to fall into 2009 with the announcements on 28th of January and 18th of March, 2009?
ssumner:
Cthorm, Thanks for pointing out MF’s error, I get tired of wasting keystrokes on him.
???
What error? How is saying that we cannot infer from TIPS yields, or TIPS spreads, that I am in error? It is I who have shown you, Soltas, and now Cthorm to be in error.
Somebody disagreeing with me doesn’t mean they are right. Are you having an intellectual meltdown or something? It’s like if anyone shows any hint of disagreeing with me, or thinking I might be wrong, they are like Nobel prize winners to you, who are necessarily right, and anyone who agrees with me, or thinking I might be right, you attack them and question their communicated credentials and do everything you can to get them to accept on faith not to listen to me.
Are you scared? It’s obvious you can’t win on ideas alone. Is that why you’re in panic mode of trying desperately to get everyone else to take you on faith to disagree with me or ignore me?
I mean let’s look back at what you have been saying about TIPS spreads:
“But now the price of oil is very sensitive to expected NGDP growth, and hence headline inflation (which is used in TIPS spreads) actually falls fairly fast during demand-side recessions. So any policy that prevents TIPS spreads from falling sharply will, ipso facto, sharply reduce expectations of a demand-side recession.”
You clearly make the mistake of presuming that falling TIPS yield spreads means falling price inflation expectations, when I have shown it does not necessarily mean that at all.
“TIPS spreads are telling us that inflation expectations are probably falling.”
Oh look, there it is again.
“The recent passivity by the Fed has caused TIPS spreads to plummet in the last couple days. Today for the first time that I can recall the 30 year TIPS spread fell below 2%.”
And again.
“I also tried to estimate inflation expectations from the TIPS market, which isn’t easy. I found a TIPS yielding negative 1.05%, due January 2014. Regular T-notes due at that time yield about 0.25%.”
And again.
“But the TIPS markets say even headline inflation will be under 1.5% over the next five years.”
And again.
Need I go on?
You have been trying to make it seem like he knew what I was talking about all along (“Seriously MF, you don’t think Soltas knows this?”), and yet over and over and over and over again, you inferred from falling TIPS spreads that it means falling inflation expectations. No, it doesn’t. It could very well mean RISING inflation expectations, as the embedded call option rises in value as expected inflation increases. We can’t say one or the other for sure without more information.
Are you having fun yet? Learning is HARD isn’t it? Hahaha
24. June 2012 at 14:52
S. Sumner says…
I don’t get this. Are you saying Mitt paying 14 % is the same as my household paying 28 % ? (Does that mean when we start drawing on our 401ks that will will actual be being taxed at twice the normal rate ?)
I bet the answer will go over over my head, But would anyone like to give it a shot ?
24. June 2012 at 14:56
oops…above was on the wrong thread. sorry about that.
24. June 2012 at 16:31
MF, Someday you’ll win a Nobel Prize for showing that falling TIPS spreads mean rising inflation expectations.
Bill, 401ks are not double taxed, because you weren’t taxed at all on the wage income put into 401ks. If all saving was treated like 401ks, we’d have a pure consumption tax, with no tax on capital income.
24. June 2012 at 16:44
MF, Someday you’ll win a Nobel Prize for showing that falling TIPS spreads mean rising inflation expectations.
I don’t intend to show that it means rising inflation expectations. I only intend to show that it COULD mean that. It could very well mean falling inflation expectations as well.
I guess we can utilize the form of one of your expressions and say:
“Never reason from a TIPS spread change.”
It’s like reasoning from an interest rate change, and you always say never reason from interest rates.
27. June 2012 at 19:23
MF, anybody in the market who expected inflation to be less than the TIPS spread would be buying Treasuries and selling TIPS.
27. June 2012 at 19:23
MF, anybody in the market who expected inflation to be less than the TIPS spread would be buying T-bills and selling TIPS.