Must-Read: Tim Duy: Fed Once Again Overtaken by Events

Must-Read: That the Brexit crisis would happen was unforeseeable. That the odds were strongly that some negative shock would hit the global economy was very foreseeable indeed. And yet the Fed since 2014 has been actively making sure that it is unprepared.

10 Year Treasury Constant Maturity Rate FRED St Louis Fed

Starting with Bernanke’s abandonment in 2013 of a policy bias toward further expansion and acceptance of a need for interest rate normalization and the resulting Taper Tantrum, there has been a dispute between the markets and the Fed. The markets have expected the Federal Reserve to try to normalize interest rates and fail, as the economy turns out to be too weak to sustain higher rates. The Federal Reserve has always expected to be able in less than a year or so to successfully liftoff from zero and embark on a tightening cycle, raising interest rates by about one percentage point per year.

The markets have been right. Always:

Tim Duy: Fed Once Again Overtaken By Events: “A July hike was already out of the question before Brexit, while September was never more than tenuous…

…Now September has moved from tenuous to ‘what are you thinking?’… as market participants weigh the possibility of a rate cut…. Internally they are probably increasingly regretting the unforced error of their own–last December’s rate hike…. Uncertainty looks to dominate in the near term. And market participants hate uncertainty. The subsequent rush to safe assets… is evident…. Direct action depends on the length and depth of the financial turmoil currently underway. I think the Fed is far more primed to deliver such action than they were a year ago. And that… will minimize the domestic damage from Brexit.

The Fed began 2015 under the direction of a fairly hawkish contingent that viewed rate hikes as necessary to be ahead of the curve on inflation. Better to raise preemptively than risk a sharper pace of rate hikes in the future…. [But] asset markets were telling exactly the opposite, that there was far less accommodation than the Fed believed. Fed hawks were slow to realize this, and, despite the financial turmoil of last summer, forced through a rate hike in December. I think this rate hike had more to do with a perceived need to be seen as ‘credible’ rather than based in economic necessity. I suspect doves followed through in a show of unity for Chair Janet Yellen. They should have dissented.

Markets stumbled again in the early months of 2016, and, surprisingly, Fed hawks remained undeterred. Federal Reserve Vice Governor Stanley Fischer scolded financial market participants for what he thought was an overly dovish expected rate path. And even as recently as prior to the June meeting, Fed speakers were highlighting the possibility of a June rate hike, evidently with the only goal being to force the market odds of a rate hike higher. But I think that as of the June FOMC meeting, the hawkish contingent has been rendered effectively impotent…. I suspect the Fed will be much more responsive to the signal told by the substantial drop in long-term yields that began last Friday (as I write the 10 year is hovering about 1.46%) then they may have been a year ago….

I expect some or all of…. Forward guidance I. Fed speakers will concur with financial market participants that policy is on hold until the dust begins to settle…. Forward guidance II…. Watch for the balance of risks to reappear – it seems reasonable to believe they have shifted decidedly to the downside. Forward guidance III. This would be an opportune time for Chicago Federal Reserve President Charles Evans to push through Evans Rule 2.0. No rate hike until core inflation hits 2% year-over-year…. Forward guidance IV. A lower path of dots in the next Summary of Economic projections to validate market expectations…. Rate cut. Former Minneapolis Federal Reserve President Narayana Kocherlakota argues that the Fed should just move forward with a rate cut in July. I concur…. If all else fails. If some combination of 1 through 5 were to fail, the Fed will turn to more QE and/or negative rates…

I am thinking of Stan Fischer on January 5, 2016 on interest rates:

Well, we watch what the market thinks, but we can’t be led by what the market thinks. We’ve got to make our own analysis. We make our own analysis, and our analysis says that the market is underestimating where we are going to be. You know, you can’t rule out that there is some probability they are right because there’s uncertainty. But we think that they are too low…

Even though the markets had been right and the Fed wrong for the previous three years, as of January 2016 Fischer was claiming that market expectations were irrationally pessimistic and that the Fed understood the state of the economy.

I would very much like to hear Stan Fischer give a speech early next month laying out how he has over the past six months marked to market his beliefs about the state of the economy and the correct economic model.

Must-Read: FOMC: Press Release–June 15, 2016

Must-Read: Somebody really should have dissented from this press release: if 0.5% is the forecast of the appropriate Fed Funds rate in 2018, zero is the appropriate Fed Funds rate now.

But who? Charlie Evans or Lael Brainard? I would bet Lael, based solely on the Fed convention that a Governor’s dissent is a much bigger deal than a Regional Bank President’s dissent. But that is only a guess: I do not know…

Https www federalreserve gov monetarypolicy files fomcprojtabl20160615 pdf

FOMC: Press Release–June 15, 2016: “The pace of improvement in the labor market has slowed while growth in economic activity appears to have picked up…

…Inflation has continued to run below the Committee’s 2 percent longer-run objective, partly reflecting earlier declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation declined; most survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months…. The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market indicators will strengthen. Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term…. Against this backdrop, the Committee decided to maintain the target range for the federal funds rate…. In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation…. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data…

Must-Read: Larry Summers: Fed’s Current Strategy Ill Adapted to the Realities

Must-Read: Larry Summers is right.

If the Phillips Curve today still had the short-run slope in the gearing of expected inflation to recent past inflation that it appeared to have at the start of the 1980s, there might–but only might–be a case for the Federal Reserve’s current policy.

There is no reason for internal comity between the Board of Governors and the regional bank presidents to be a concern: Bernanke and Yellen have now had three full regional bank-appointment cycles to get bank presidents who are on the same page as the Board of Governors. The Federal Reserve always has and is understood to have the freedom to raise interest rates to maintain price stability when incoming data suggests that it is threatened: there is no need for talk to highball the chances of future rate increases when the current data flow does not suggest it will be needed. Thus I see no reasons at all to support a Fed policy posture other than that one that Larry Summers recommends: “signal[ling] its commitment to accelerating growth and avoiding a return to recession, even at some cost in terms of other risks…”

Larry Summers: Fed’s Current Strategy Ill Adapted to the Realities: “The current hawkish inclination of the Fed, with its chronic hope and belief that conditions will soon permit interest rate increases, is misguided…

…The greater danger is of too little rather than too much demand. A new Fed paradigm is therefore in order…. I would guess that from here the annual probability of recession is 25-30 percent. This seems to me the only way to interpret the yield curve. Markets anticipate only about 65 basis point of increase in short rates over the next 3 years. Whereas the Fed dots suggest that rates will normalize at 3.3 points, the market thinks that even 5 years from now they will be about 1.25 percent. Markets are thinking that recession will come at some point and when it does rates will go to near zero…. This implies that if the Fed is serious… about having a symmetric 2 percent inflation target then its near-term target should be in excess of 2 percent. Prior to the next recession–which will presumably be deflationary–the Fed should want inflation to be above its long term target…. The Fed’s dots forecasts refer to a modal scenario of continued recovery… [with] inflation rising to 2 percent only in 2018. Why shouldn’t they prefer a path with more demand, inflation at target sooner, more stimulus as recession insurance, and a small margin of extra inflation as a buffer against the next recession?….

The logic that led to the adoption of the 2 percent inflation target years ago suggests that it is too low now…. The case for a positive inflation target balances the benefits of stable money with the output cost of lowering inflation and two ways that positive inflation is helpful—the periodic need to have negative real rates, and inflation’s role in facilitating downward adjustment in real wages given nominal rigidities. All of the factors pointing towards a higher inflation target have gained force in recent years…. Experience has proven that Yellen was correct to be skeptical of the idea very low inflation rates would improve productivity. And it is plausible that the error in price indices has increased with the introduction of new categories of innovative and often free products…. If a two percent inflation target reflected a proper balance when it first came into vogue decades ago, a higher target is probably appropriate today….

Long term inflation expectations are depressed and declining…. The Fed has in the past counterbalanced declines in market inflation expectation measures by pointing to the relative stability in surveys-based measures. This argument is much harder to make now that consumer expectations of inflation have broken decisively below their all-time lows even as gas prices have been rising…. The Fed’s summary employment conditions index has been flashing yellow since the beginning of the year. Declines in this measure have presaged recession half of the time and uniformly been followed by rate reductions rather than rate increases….

The right concern for the Fed now should be to signal its commitment to accelerating growth and avoiding a return to recession, even at some cost in terms of other risks. This is not the Fed’s policy posture. Watching the Fed over the last year there is a Groundhog Day aspect. One senses they really want to raise rates and achieve a more ‘normal’ stance. But at the same time they do not want to tighten when the economy may be slowing or create financial turmoil. So they keep holding out the prospect of future rate increases and then find themselves unable to deliver. But they always revert to holding out the prospect of rate increases soon, partly for internal comity and partly to preserve optionality. Over the last 12 months nominal GDP has risen at a rate of only 3.3 percent. We hardly seem in danger of demand running away. Today we learned that Germany has followed Japan into negative 10 year rates. We are only one recession away from joining the club…

Tim Duy’s Five Questions for Janet Yellen


A very nice piece here from the very-sharp Tim Duy:

Tim Duy: Five Questions for Janet Yellen

Next week’s meeting of the Federal Open Market Committee (FOMC) includes a press conference with Chair Janet Yellen. These are five questions I would ask if I had the opportunity to do so in light of recent events.

(1) 1. What’s the deal with labor market conditions? You advocated for the creation of the Federal Reserve’s Labor Market Conditions Index (LMCI) to serve as a broader measure of the labor market and as an alternative to a narrow measure such as the unemployment rate. The LMCI declined for five consecutive months through May, the most recent release…. On June 6, however, you said that:

the job market has strengthened substantially, and I believe we are now close to eliminating the slack that has weighed on the labor market since the recession.

The LCMI signals that although the economy may be operating near full employment, it is now moving further away from that goal. Is it appropriate for the Fed to still be considering interest rate hikes when your measure is moving away from the goal of full employment? Or have you determined the LMCI is not a useful measure of labor market conditions?

(2) Has the effect of QE been underestimated? Since the Fed began and completed the process of ending quantitative easing (QE), the dollar has risen in value, the stock market rally has stalled, the yield curve has flattened, broader economic activity has slowed, and now we are experiencing a slowing in labor market activity. These are all traditionally signs of tighter monetary policy, but you have insisted that tapering is not tightening and that policy remains accommodative. Given these signs, is it possible or even likely that you have underestimated the effectiveness of QE and hence are now overestimating the level of financial accommodation?

(3) Optimal control or no? The Fed appears determined to hit its inflation target from below. In other words, the central bank is positioning policy to tighten despite inflation currently running below the 2 percent target in order to avoid an overshoot at a later date. In the past, however, you argued for an ‘optimal control’ approach that anticipated an explicit overshooting of the inflation target in order to more rapidly meet the Fed’s mandate of full employment. Under optimal control, it seems that given stalled progress on reducing underemployment, coupled with deteriorating labor market conditions, the Fed should now be explicitly aiming to overshoot the inflation target by keeping policy loose. Do you believe the optimal control approach you previously advocated is wrong? If so, what caused you to change your mind?

(4) An Evans Rule for all? Chicago Federal Reserve President Charles Evans remains concerned about asymmetric policy risks. Persistently below target inflation risks undermining the public’s belief that the Fed is committed to reaching its target. Such a loss of credibility hampers the ability to subsequently meet the central bank’s target. In contrast, the well-known effectiveness of traditional policy tools means there is less upside risk to inflation. Consequently, he argues for an updated version of the Evans Rule (or an earlier commitment to not hike rates as long as unemployment exceeded 6.5 percent and inflation was below 2.5 percent).
Specifically, Evans said:

In order to ensure confidence that the U.S. will get to 2 percent inflation, it may be best to hold off raising interest rates until core inflation is actually at 2 percent. The downside inflation risks seem big — losing credibility on the downside would make it all that more difficult to ever reach our inflation target. The upside risks on inflation seem smaller.

Recall that in your most recent speech you indicated unease with inflation expectations and — at least implicitly — recognized the asymmetry of policy risks:

It is unclear whether these indicators point to a true decline in those inflation expectations that are relevant for price setting; for example, the financial market measures may reflect changing attitudes toward inflation risk more than actual inflation expectations. But the indicators have moved enough to get my close attention. If inflation expectations really are moving lower, that could call into question whether inflation will move back to 2 percent as quickly as I expect.

This — especially when combined with your past support for an optimal control approach to policy — suggests that you should be amenable to adopting Evans’ position. Do you support Evans’ proposal that the Fed should stand down from rate hikes until the inflation target is reached? Why or why not?

(5) Just how much do you care about the rest of the world? Earlier this year, Federal Reserve Governor Lael Brainard suggested that the many developed economies operating at or below zero percent interest rates reduces the central bank’s capacity for raising rates:

‘Financial tightening associated with cross-border spillovers may be limiting the extent to which U.S. policy diverges from major economies…

At last September’s FOMC press conference, you said that you thought the global forces were insufficient to restrain the path of U.S. monetary policy. In response to a question about ‘global interconnectedness’ preventing the U.S. from ever moving away from zero percent interest rates, you said:

I would be very surprised if that’s the case. That is not the way I see the outlook or the way the Committee sees the outlook. Can I completely rule it out? I can’t completely rule it out. But, really, that’s an extreme downside risk that in no way is near the center of my outlook.

Given the events of the past six months — especially the refusal of longer-term U.S. Treasury yields to rise despite repeated hints of monetary tightening — have you reassessed your opinion? Do you view the risks of such an outcome as greater or lower than your assessment made last September?

Bottom Line: Most of these questions try to push Yellen to explain her past positions in light of the current data and actions. I think understanding how and why her positions change is critical to understanding how the Fed reacts to the conditions facing it. Making the so-called ‘reaction function’ clear remains the most important piece of the Fed’s communication strategy.

These five questions–“What’s the deal with labor market conditions?… Has the effect of QE been underestimated?… Optimal control or no?… An Evans Rule for all?… Just how much do you care about the rest of the world?”–are the right questions to ask. And Tim’s bottom line–“Push Yellen to explain her past positions in light of the current data and actions. I think understanding how and why her positions change is critical…. Making the so-called ‘reaction function’ clear remains the most important piece of the Fed’s communication strategy”–is the right bottom line.

After all, does this look like an economy crossing the line of potential output in an upward direction with growing and substantial gathering inflationary pressures to you?

Change in Labor Market Conditions Index FRED St Louis FedNewImage

The Federal Reserve is simply not doing a good job of communicating its reaction function. It is not doing a good job of linking its model of the economy to current data and past events. Inflation, production, and employment (but not the unemployment rate) have been disappointingly low relative to Federal Reserve expectations for each of the past nine years. These events should have led to substantial rethinking by the Federal Reserve of its model of the economy. And yet the model set forward by Yellen and Fischer (but not Evans and Brainard) appears to be very much the model they held to in the late 1990s, which was the model they believed in in the early 1980s: very strong gearing between recent-past inflation and expected inflation, and a Phillips Curve with a pronounced slope, even with inflation very low.

Unless my Visualization of the Cosmic All is grossly wrong along the relevant dimensions, this is not the right model of the current economy. There was never good reason to think that the bulk of the runup in inflation in the 1970s was due to excessive demand pressure and unemployment below the natural rate–it was, more probably, mostly due to supply shocks plus the lack of anchored expectations. Only if you highball the estimate of the Phillips Curve’s slope for the 1970s can you understand the fall in inflation in the early 1980s as due overwhelmingly to slack, rather than ascribing a component to the reanchoring of inflation expectations. Thus the way to bet is that the economy on its current trajectory will produce less upward pressure on current inflation and also on inflation expectations than the Federal Reserve currently projects.

But how will it react when the data once again disappoints Federal Reserve expectations–as it has? In June 2013, the Fed was predicting that annual GDP growth during the 2013-2015 period would average 2.9%, with longer-run growth of real potential GDP averaging 2.4%. Instead, annual growth has averaged 2.3% (or 2.2%, if estimates for the first half of 2016 are correct). Nor did it perform better on other measures. The Fed predicted an annual inflation rate, based on the personal consumption expenditures index, of 1.9% for 2015. The true number was 1.5%. Similarly, its average projection of the federal funds rate for 2015 was 1.5%. The figure is currently 0.25%. This three-year period, starting in 2013, in which the economy undershot the Fed’s expectations, follows a three-year period in which the economy likewise fell short of the Fed’s forecast. And that period followed a three-year period, starting in 2007, in which the Fed massively understated downside deflationary risks.

Yet the prevailing model does appear to be the model of the early 1980s. It continues to gear inflation expectations at unrealistically high levels based on past inflation. And it continues to rely on the unemployment rate as a stand-in for the state of the labor market, at the expense of other indicators. So the big questions are: Will that commitment break? What would make them revise their models of the economy? And how will those model revisions affect their policy reaction function map from data to interest rates?

In an environment of economic volatility like the one in which we find ourselves today, a prudent central bank should do everything it can to raise expected and actual inflation, in order to gain the ability to stabilize the economy in any direction. If interest rates were well above zero, the Fed would have scope to raise them further in case of overheating or to lower them in response to adverse demand shocks.
But the Fed continues to neglect asymmetry, considering it only a second- or third-order phenomenon. It is not pushing for inflation at or above its target, even as optimal-control doctrines that themselves neglect asymmetry call for such a trajectory. Instead, by tightening policy by an amount that it cannot reliably gauge, it is narrowing its room for maneuver.

Looking at the current composition of the FOMC does not add to confidence:

  • On the left, Lael Brainard and Charles Evans certainly understand the situation–and have been right about almost everything they have opined on over the past eight years. Dan Tarullo shares their orientation, but these are not his issues.

  • On the right, Robert Kaplan and Patrick Harker replace hawks who were always certain, often wrong, and never open-minded–and are the products of failed searches: a job search is not supposed to choose a director of the search-consultant firm or the head of the search committee. Jeffrey Lacker and James Bullard and their staffs have been more wrong on monetary policy than the average FOMC member over the past eight years, but do not appear to have taken wrongness as a sign that their views of the economy might need a rethink. Esther George and Loretta Mester and their staffs feel the pain of a commercial banking sector in the current interest-rate environment, but I have never been convinced they understand how disastrous for commercial banks the medium- and long-term consequences of premature tightening and interest-rate liftoff would be.

  • In the neutral center, Jerome Powell does not appear to have views that differ from those of the committee as a whole. These are not Neel Kashkari’s issues: he is too good a bureaucrat to want to dissent from any consensus or near consensus on issues that are not his. And I simply do not have a read on Dennis Lockhart and his staff.

  • The active center is thus composed of Janet Yellen, Stanley Fischer, Bill Dudley, Eric Rosengren, and John Williams. Market risk and confusion is generated by uncertainty about their models of the economy, uncertainty about how they will revise their models as the data comes in, and uncertainty as to how they will react in committee, with six voices to their right calling for rapid interest-rate normalization and only three voices to their left worrying about asymmetric risks and policy traction.

When I listen to this center, one vibe I get is that the asymmetries are really not that great. Janet Yellen this March:

One must be careful, however, not to overstate the asymmetries affecting monetary policy at the moment. Even if the federal funds rate were to return to near zero, the FOMC would still have considerable scope to provide additional accommodation. In particular, we could use the approaches that we and other central banks successfully employed in the wake of the financial crisis to put additional downward pressure on long-term interest rates and so support the economy–specifically, forward guidance about the future path of the federal funds rate and increases in the size or duration of our holdings of long-term securities. While these tools may entail some risks and costs that do not apply to the federal funds rate, we used them effectively to strengthen the recovery from the Great Recession, and we would do so again if needed…

Another vibe I get is more-or-less what Bernanke said back in 2009:

The public’s understanding of the Federal Reserve’s commitment to price stability helps to anchor inflation expectations and enhances the effectiveness of monetary policy, thereby contributing to stability in both prices and economic activity…. A monetary policy strategy aimed at pushing up longer-run inflation expectations in theory… could reduce real interest rates and so stimulate spending and output. However, that theoretical argument ignores the risk that such a policy could cause the public to lose confidence in the central bank’s willingness to resist further upward shifts in inflation, and so undermine the effectiveness of monetary policy going forward. The anchoring of inflation expectations is a hard-won success that has been achieved over the course of three decades, and this stability cannot be taken for granted. Therefore, the Federal Reserve’s policy actions as well as its communications have been aimed at keeping inflation expectations firmly anchored…

I cannot help but be struck by the difference between what I see as the attitude of the current Federal Reserve, anxious not to do anything to endanger its “credibility”, and the Greenspan Fed of the late 1990s, which assumed that it had credibility and that because it had credibility it was free to experiment with policies that seemed likely to be optimal in the moment precisely because markets understood its long-term objective function and trusted it, and hence would not take short-run policy moves as indicative of long-run policy instability. There is a sense in which credibility is like a gold reserve: It is there to be drawn on and used in emergencies. The gold standard collapsed into the Great Depression in the 1930s in large part because both the Bank of France and the Federal Reserve believed that their gold reserves should never decline, but always either stay stable of increase.

And I cannot help but be struck by the inconsistency between the two vibes. The claim that we need not worry about asymmetry because we are willing to undertake radical policy experimentation fits very badly with the claim that we dare not rock the boat because the anchoring of inflation expectations on the upside is very fragile. Combine these with excessive confidence in the current model–with a tendency to make policy based on the center of the fan of projected outcomes with little consideration of how wide that fan actually is–and I find myself with much less confidence in today’s Fed than I, four years ago, thought I would have today.

Must-Read: Ben Eisen: Newest Inflation Expectations Likely to Trouble the Fed

Www sca isr umich edu files tbcpx1px5 pdf

Must-Read: Ben Eisen: Newest Inflation Expectations Likely to Trouble the Fed: “The Federal Reserve probably won’t like the latest data out of the University of Michigan on Friday…

…inflation expectations over the next five to ten years dropping to 2.3% in June, a record low…. That’s on top of market-based inflation expectations that have also fallen over the past month…. When Federal Reserve Chairwoman Janet Yellen spoke on Monday, she drew attention to inflation expectations as a key input in actual inflation. She said:

It is unclear whether these indicators point to a true decline in those inflation expectations that are relevant for price setting; for example, the financial market measures may reflect changing attitudes toward inflation risk more than actual inflation expectations. But the indicators have moved enough to get my close attention. If inflation expectations really are moving lower, that could call into question whether inflation will move back to 2 percent as quickly as I expect….

The market is taking note as well. Benchmark 10-year Treasury note yields dropped to their lowest of the day after the data and recently traded at 1.63%, a new low for the year on a closing basis…

Inflation Becomes Key as Investors See Economic Weakness MoneyBeat WSJ

Must-Read: Steve Goldstein: Fed’s Lael Brainard Calls for ‘Waiting’ as Labor Market Has Slowed

Https www federalreserve gov monetarypolicy files fomcprojtabl20151216 pdf

Must-Read: If people on the FOMC had known late last November that the first half of 2016 would be as bad as it is shaping up to be–a GDP growth rate that looks to be 1.7%/year rather than 2.4%/year, and a PCE-chain inflation rate of not 1.6%/year but 0.8%/year–how many of them would have pulled the trigger and gone for an interest rate increase last December?

I confess I do not know why Lael Brainard is saying “there is uncertainty that future data will resolve in the near-term and so we should wait” rather than “if we knew then what we know now we wouldn’t have raised rates in December, and so we should cut”:

Steve Goldstein: Fed’s Lael Brainard Calls for ‘Waiting’ as Labor Market Has Slowed: “Brainard, who’s the first Fed official to speak since the Labor Department…

…reported just 38,000 jobs were added in May, said the central bank should wait for more data on how the economy is performing in the second quarter, as well as a key vote by Britain on whether to leave the European Union. ‘Recognizing the data we have on hand for the second quarter is quite mixed and still limited, and there is important near-term uncertainty, there would appear to be an advantage to waiting until developments provide greater confidence,’ Brainard said at the Council on Foreign Relations. She said she wanted to have a greater confidence in domestic activity, and specifically mentioned the uncertainty around the Brexit vote, as reasons to pause at the next Federal Open Market Committee meeting, which is due to end June 15…

Must-Read: Timothy B. Lee: The Economy Just Got Its Worst Job Report in Years

Must-Read: The way to bet is that two-thirds of the surprising component of this month’s employment report will be reversed over the next quarter or so.

Nevertheless: does anybody want to say that the Federal Reserve’s increase in interest rates last December and its subsequent champing-at-the-bit chatter about raising interest rates was prudent in retrospect? Anyone? Anyone? Bueller?

And does anybody want to say–given that the downside risks we are now seeing were in the fan of possibilities as of last December, and given that the Federal Reserve could have quickly reacted to neutralize any inflationary pressures generated by the upside possibilities in the fan last December–that the Federal Reserve’s increase in interest rates last December and its subsequent champing-at-the-bit chatter about raising interest rates was sensible as any form of an optimal-control exercise?

And we haven’t even gotten to the impact of the withdrawal of risk-bearing capacity from the rest of the world that happens in a Federal Reserve tightening cycle…

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Timothy B. Lee: The Economy Just Got Its Worst Job Report in Years: “The US economy created 38,000 jobs in May, the slowest pace of job growth in five years…

…Not only did job growth fall well short of economists’ expectations in May, the Labor Department also revised its estimates for March and April job growth downward by a total of 59,000…. One factor is the strike among Verizon workers, which cost the economy about 34,000 jobs. Those jobs should reappear in future reports…. There’s other bad news…. Over the last six months, the economy had started to reverse a years-long decline in the labor force participation rate…. But the latest report shows the economy has given most of those gains back, with the labor force participation rate falling from 63 percent in March to 62.6 percent in May…

Must-Read: Narayana Kocherlakota: There Goes the Fed’s Credibility

Must-Read: By now we can no longer understand the Federal Reserve Chair as needing to maintain harmony on a committee that has on it many regional reserve bank presidents who have failed to process the lessons of 2005-2015. By now all the regional bank presidents are people whom the Federal Reserve Board has had an opportunity to veto:

There Goes the Fed s Credibility Bloomberg View

Narayana Kocherlakota: There Goes the Fed’s Credibility: “The Federal Reserve promised to keep its preferred measure of inflation…

…close to 2 percent over the longer run…. Some would say that central banks are out of ammunition…. Actually, though, the Fed has been deliberately tightening monetary policy over the past three years. Just last week, Chair Janet Yellen made a point of saying that the Fed intends to keep raising interest rates in the coming months….

Would it have started pulling back on stimulus in May 2013 if its short-term interest-rate target had been at 5 percent instead of near zero, and if it hadn’t been holding trillions of dollars in bonds? I strongly suspect that the Fed would instead have added stimulus by lowering interest rates…. The Fed’s current course is driven not by the state of the economy, but by a desire to get interest rates and its balance sheet back to what is considered ‘normal.’ Savers, bankers and many politicians agree with this objective…. The Fed, however, promised to focus on actual economic outcomes….

Investors’ doubts [about the Fed] aren’t surprising, given the Fed’s focus on ‘normalizing’ interest rates rather than on hitting its inflation target. Such concerns will create an extra drag on the economy if and when bad times do come. In other words, the Fed’s willingness to renege on its promises seems likely to make the next recession worse than it otherwise would be.

Helicopter Money!: No Longer So Live at Project Syndicate

For economies at the the zero lower bound on safe nominal short-term interest rates, in the presence of a Keynesian fiscal multiplier of magnitude μ–now thought, for large industrial economies or for coordinated expansions to be roughly 2 and certainly greater than one–an extra dollar or pound or euro of fiscal expansion will boost real GDP by μ dollars or pounds or euros. And as long as the interest rates at which the governments borrow are less than the sum of the inflation plus the labor-force growth plus the labor-productivity growth rate–which they are–the properly-measured amortization cost of the extra government liabilities is negative: because of the creation of the extra debt, long-term budget balance allows more rather than less spending on government programs, even with constant tax revenue.

Production and employment benefits, no debt-amortization costs as long as economies stay near the zero lower-bound on interest rates. Fiscal stimulus is thus a no-brainer, right?

Perhaps you point to a political-economy risk that should economies, for some reason, move rapidly away from the zero lower bound their governments will not dare make the optimal fiscal-policy adjustments then appropriate. But future governments that wish to pursue bad policies no matter what we do today. And offsetting this vague and shadowy political-economy risks is the very tangible benefit that fiscal expansion’s production of a higher-pressure economy generates substantial positive spillovers in labor-force skills and attachment, in business investment and business-model development, and in useful infrastructure put in place.

Truly a no-brainer. The only issue is “how much?” And that is a technocratic benefit-cost calculation. Rare indeed these days is the competent economist who has thought through the benefit-cost calculation and failed to conclude that the governments of the United States, Germany, and Britain have large enough multipliers, strong enough spillovers of infrastructure investment and other demand-boosting programs, and sufficient fiscal space to make substantially more expansionary fiscal policies optimal.

This is the backdrop against which we today find aversion to fiscal expansion being driven not by pragmatic technocratic benefit-cost calculations but by raw ideology. And so we find my one-time teacher and long-time colleague Barry Eichengreen being… positively shrill: While “the world economy is visibly sinking”, he writes:

the policymakers… are tying themselves in knots… the G-20 summit… an anodyne statement…. It is disturbing to see… particularly… the US and Germany [refusing] to even contemplate such action, despite available fiscal space…. In Germany, ideological aversion to budget deficits… rooted in the post-World War II doctrine of ‘ordoliberalism’… [that] rendered Germans allergic to macroeconomics…. [In] the US… citizens have been suspicious of federal government power, including the power to run deficits… suspicion… strongest in the American South…. During the civil rights movement, it was again the Southern political elite… antagonistic to… federal power…. Welcome to ordoliberalism, Dixie-style. Wolfgang Schäuble, meet Ted Cruz.

Barry, faced with the triumph of sterile austerian ideology over practical technocratic economic stewardship, concludes with a plea:

Ideological and political prejudices deeply rooted in history will have to be overcome…. If an extended period of depressed growth following a crisis isn’t the right moment to challenge them, then when is?

Barry will continue to teach the history. He will continue to teach that expansionary fiscal and monetary policies in deep depressions have worked very well, and that eschewing them out of fears of interfering with “structural adjustment” has been a disaster. But this is no longer, if it ever was, an intellectual discussion or debate.

So perhaps there is a flanking move possible. “Monetary policy” and “fiscal policy” are economic-theoretic concepts. There is no requirement that they neatly divide into and correspond to the actions of institutional actors.

German, American, and British austerians have a fear and suspicion of central banks that is rooted in the same Ordoliberal and Ordovolkist ideological fever swamps as their objections to deficit-spending legislatures. But it is much weaker. It is much weaker because, as David Glasner points out, fundamentalist cries for an automatic monetary system–whether based on a gold standard, on Milton Friedman’s k%/year percent growth rule, or John Taylor’s mandatory fixed-coefficients interest-rate rule–have all crashed and burned so spectacularly. History has refuted Henry Simons’s call for rules rather than authorities in monetary policy. The institution-design task in monetary policy is not to construct rules but, instead, to construct authorities with sensible objectives and values and technocratic competence.

And central banks can do more than they have done. They have immense regulatory powers to require that the banks under their supervision to hold capital, lend to previously discriminated-against classes of borrowers, and serve the communities in which they are embedded as well as returning dividends to their shareholders and making the options of their executives valuable. And they have clever lawyers.

Their policy interventions have always been “fiscal policy” in a very real sense. They collect the tax on the economy we call “seigniorage”. There is no necessity that they turn their seigniorage revenue over to their finance ministries. Their interventions have always altered the present value of future government principal and interest payments.

Mid nineteenth-century British Whig Prime Minister Robert Peel was criticized by many for putting too-tight restrictions on crisis action in the Bank of England’s recharter. His response was that the new charter was written to cover eventualities that people could foresee. But that should eventualities occur that had not been foreseen, the only hope was for there then to be statesmen who were willing to assume the grave responsibility of dealing with the situation. And that he was confident there would be such statesmen.

Yes, it is time for central bankers to assume responsibility and undertake what we call “helicopter money”.

It could take many forms. It depends on the exact legal structure and powers of the central banks. It also depends on the extent to which central banks are willing, as the Bank of England did in the nineteenth century, to undertake actions that are not intra but ultra vires with the implicit or explicit promise that the rest of the government will turn a blind eye. The key is getting extra cash into the hands of those constrained in their spending by low incomes and a lack of collateral assets. The key is doing so in a way that does not lead them to even a smidgeon of fear that repayment obligations have even a smidgeon of a possibility of becoming in any way onerous.

Must-Read: Nick Bunker: What’s the deal with U.S. wage growth?

Must-Read: Suppose you put someone in cryogenic sleep a decade ago, woke them up today, showed them this graph:

Graph Employment Cost Index Total compensation All Civilian FRED St Louis Fed

and said: “The U.S. Federal Reserve still has the same 2%/year inflation target it had in the early 2000s. Do you think it should raise or lower interest rates in June?”

I cannot think of a single reason why such a person would say “raise interest rates” (unless, of course, their compensation was an increasing function of the interest rate).

Nick Bunker: What’s the deal with U.S. wage growth?: “The U.S. unemployment rate has been at or under 5 percent for more than six months…

…But… neither inflation nor wage growth has picked up considerably, despite expectations that they would…. First… the unemployment rate may be slightly overstating the health of the country’s labor market. Measured by the employed share of workers ages 25 to 54, the labor market has a long way to go before it hits a level usually associated with strong wage growth…. Adam Ozimek… points out that… low inflation has an impact on wage growth, because employers will be less willing to pass along wage hikes to prices, and employees will need less of a wage increase…. A third argument is that… low measured wage growth is due in part to low-wage workers moving into full-time employment…. Already-full-time employees are seeing rising wages, that growth is masked by the entrance of lower-earning workers…. It seems likely… that… five percent just isn’t what it used to be…