Gone fishing

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Not really gone fishing. Just getting away from screens, hopefully for an extended period.

But here is a nice picture of the Margaree River on Cape Breton Island in Nova Scotia, where you could go fishing if you wanted. With any luck I will find myself near there soon.

Well, the Fed said

This post is ostensibly about how the Fed does not have its hair on fire about the declining unemployment rate and associated tightening of the labor market.  I will get to that extremely obvious point below, even at great risk of boring you.

But what this post is really about is how Fed watchers, including in academia, pay far too much attention – and deference – to what the Fed says, and don’t pay enough attention to what the Fed is doing or what is happening in the actual world.

We saw this in the extreme gullibility around the following claims, among others:

Monetary policy is “extremely accommodative”, whatever that means.

QE is a very potent tool, the use of which requires caution.

In a pinch, the Fed might do h money. LOL

Away from zero bound, policy will basically follow the logic of a Taylor Rule, although the unemployment coefficient and equilibrium real rate estimate are variable.

Inflation expectations are not too low. Rather, the invisible inflation risk premium in the bond market has fallen. And that decline of the invisible inflation risk premium is obviously not something policy needs to react to.

In fairness, there are two forms of gullibility operating here. The first is that the intellectuals believe the Fed believes what it says. And the second, is that they take they Fed’s word as authoritative. That’s the main issue. It is only the specific manifestation of the gullibility that varies.

Which brings me to what this post is meant to be about.  Recently Narayana Kocherlakota and Brad Delong have been complaining that the Fed is placing too much emphasis on the presumed establishment of full employment and not enough on the chronic inflation undershoot when setting policy.

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Kocherlakota and Delong both make the good point that the level of unemployment (or alternative measures of slack) consistent with full employment  is not well known.  Amen. I would add that there is some fuzziness around what the concept even means and how that relates to policy.  And Kocherlakota – bless him – sees straight through the nonsense claim that the bond market is basically pricing that the Fed will succeed in its stated objective. No it ain’t.

But these guys both pay far too much attention to the Fed’s claims about its intentions to avoid a potentially-destabilizing undershoot of the unemployment rate.

I think the Fed is probably right when it says that a steep decline of the unemployment rate below its “full-employment” level could be destabilizing, even if not accompanied by an immediate rise of inflation.  In my view, the Fed leadership is telling a coherent story here.

And the way they are managing that awkward trade-off seems sensible.  They are apparently trying to slow the tightening of labor market conditions, but not actually to stop it until they see evidence of a compelling inflation response.  This is a hell of a backward looking way to run a railroad, but it beats the others.

Importantly, then, they do not have their hair on fire about falling unemployment, whatever they might say.  The labor market has been tightening rapidly in recent months and the Fed is acting as though their intention might be to slow that rate of tightening, certainly not to halt it or reverse it.

The Fed leadership has made the judgment call that raising rates is required to achieve this moderation in the pace of tightening. Or at least that is my judgment of the judgment they are making. We don’t really know: I am just extrapolating ex post results from the past roughly two years of somewhat hawkish Fed talk.

But that’s sort of the point. We don’t really know.  Just because the Fed says they are doing something does not mean they are actually doing it? Let me turn this on you, dear reader. Do you think the Fed is acting to stop the decline of unemployment at some horizon relevant to policy decisions today, like Delong and Kocherlakota seem to assume they are?

One final thought. It occurs to me that I might be doing to Delong and Kocherlakota what they are doing to the Fed, that is taking their words too seriously. Maybe D & K know what the Fed is actually doing here, but are trying to swat down hawkish sounding Fed language before it has the chance to do real damage. If so, then it is me who the naïve one, not them.

But they are not important enough for me to do the Vulcan mind meld on. At their current level of influence, I am too lazy to go much beyond what they say, which seems wrong.

 

The debt debate is relevant now

Take a look at the chart below.  I suspect it might generate a couple reactions in many of you.

The first could be, wow those are some ugly colors right there.  Fair point. Green for go and red for stop is pretty cheesy.

The second might be, stop trying to scare the shit out of us: you sound like Larry Kotlikoff or –even worse — Stan Druckenmiller before Trump got elected and it was all ok for some weird reason.

But please bear with me. I am not one of those guys.  In my view, the US has plenty of fiscal capacity, and I was actually down with attempts at fiscal stimulus when the US economy was in liquidity trap, and stimulus would not all predictably be just offset by the Fed.

Screen Shot 2017-05-30 at 10.13.39 AMThe point of the chart is only to say that the question of fiscal capacity is relevant now, particularly with the US Congress debating whether to implement fiscal “stimulus” — to Fed rate hikes 😉 — which may or may not be be offset by cuts to entitlement programs.  We could easily imagine a combination of policy changes that would push the federal debt/GDP ratio to a record high within a decade. Is that ok? Opinions vary.

Some economists will tell you that this does not matter and that obsessing about the path of the debt/GDP ratio just reflects a misunderstanding of how the payments system works. For example, MMT holds that the US fiscal capacity is not limited by the size of the debt per se, although the deficit may need to be tightened occasionally if aggregate demand growth is running too hot.

An alternative, weaker-form, argument to which I subscribe is that the US has plenty of spare fiscal capacity. Any mistakes made today are not likely to cause immediate trouble, but would be unhelpful from a longer-term perspective.

Moreover, we ought not rely on the bond market “vigilantes” to warn us if we are acting improperly.  Among other considerations, the bond market might easily price the (contractionary) effects of eventually dealing with the deficit through orthodox means. The bond market vigilante story is not only stupid and demonstrably wrong, but it is also an affinity fraud.  “Clients” like to hear how heroic and important to society they are.

MMT seems right, then, that the bond market will not freak out soon, at least not over the debt.  It is just that the reasons for this — and the implication – are different from what MMT would describe.

We can reserve that important debate for another time. The purpose of this brief post is just to point out that this debate is currently relevant. It is not some abstract academic thing that looms 20 years out.

One caveat here is that my take on the importance of this issue is not falsifiable, which I readily concede is a big weakness.  If I am right about this, and if we get the ill-timed fiscal stimulus — to Fed rate hikes 😉 — anyway, it is easily conceivable that the bond market stays serene, with yields backing up only by enough to stabilize the macro backdrop in the short to medium term. That result would be consistent with both MMT and my take.

I am not sure what to do about that. In real time, which is what matters for policy implementation, this stuff is just not falsifiable, at least if my view of the world is right. [1] But I will have some speculations and argument about this later.

[1] If the fiscal alarmists were right, then the rising debt would trigger an immediate crisis in the bond market, followed presumably the need for a correction, which would be painful. But, fwiw, I share with MMT enthusiasts the view that those guys are nuts and/or totally full of shit about what they even believe. They have gone utterly silent since the election, predictably.

Addendum

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Here is a picture of CBO’s long-term baseline, out to 2040. I did not want to go out all the way to 2040 in my simulations because I did not want to appear alarmist. We all agree that such runaway debt is unlikely to happen, which is actually the serious point I want to make.  If the debt cannot run away, then we need to consider now what that means for  policy and not just pretend that the “payments system” will make it all ok.

But this chart gives you a sense of the longer-term history. And unsurprisingly, the CBO forecast numbers look like my second highest simulation.  No additional fiscal ease; passive widening of the deficit in response to “demographics” and real rates back to the economy’s growth rate.

One final point, yes, there is great uncertainty around these numbers.  But if the base case is both fair and troubling, then I am not sure that symmetrical uncertainty around that would be a feature.

——————-

The prevalence of “and” in this note is less than 2%. Drop the mic.

Corporate stuff

I thought I would take a break from making fun of MMT, Trump and the human nature bulls to do some economics, which is probably too strong a term.

But here are a couple pictures based on the profits data included in last week’s revisions to the Q1 GDP figures.  In my view, bean counting the GDP add-up is mainly a waste of time, but there is some interesting stuff in the National Accounts.  How could there not be?

Here is the first thing to catch my eye, in part because I am inclined to look for it.   Early this cycle, real output from the domestic operations of nonfinancial corporations was booming, far outpacing the tepid recovery in overall GDP.  The GDP figures distracted a lot of equity types from the fact that the fundamental cyclical driver of profits was performing very strongly and was grounds for optimism.

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Margins went up too, which the bears were oddly inclined to dismiss as not really counting (WTF?), but margins are cyclical and responded to the output boom in the part of the economy that was not being held back by the aftermath of the housing bubble collapse.  I am still not sure if this simple historical point has been internalized, even by the bulls.

The thing is, though, that story is now very stale, as measured corporate sector output is now lagging the overall GDP.  I am not confident the lag will continue. But it does seem that the period of corporate outperformance is long past. Basically, we have already had the bounce in goods demand, driven by the renormalization (or partial renormalization) of all forms of investment, including in consumer durables.

Second and predictably related, profit margins have been coming down.  I am not a fan of margin mean reversion. To me it is more useful to look out the window at the cyclical drivers of margins and ask if they point up or down. Recently, they have pointed down, because we are past mid cycle, so I have looked for narrower margins.  But I would not have guessed – did not guess – that the compression would be this quick.

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Measurement is always an issue here. In particular, I would not be shocked if Brad Settler Setser – an expert in this area – were to point out that there is some goofy invoicing going on US corporate transfer pricing, which is holding down both measured exports and domestic profits.  One way to get around this would be to look at overall profits and not just domestic. But I am not sure what the denominator should be there.

Maybe I should do some simulations incorporating Setser’s estimates into the profit story. Sorry, too lazy. I don’t get paid for this. I doubt it would overturn the basic story. Maybe it would make these data look closer to what I would have guessed.  If you are getting paid to do actual work, get on it.

Separately, this has nothing to do with the cycle or market, but the fact that margins are back to the neighborhood of “average” gives me even greater skepticism that looking at the labor income share (which is supposedly depressed) tells us anything about anything, including income distribution.

The abstraction of “factors of production” may be a bit dated for the modern economy. If I wanted to be a dick, I would even say it is Marxist, but I am just your humble and objective analyst.

I may have more on this later. I am pretty sure the rich guys are rich because of aspects of their sitch that are not well described by “factors of production.”

Liberals losing the plot

Your take is not the”tolerant” one

In my view, there is some excellent work being done on the near left to resist the collapse of the Republic. Actual centrists (as opposed to self-regarding, fake-balance centrists) have also been doing some admirably patriotic stuff.  Obviously, I will not try to list the accomplishments. There are at least 150 million sane politically-helpful people in the USA.

But a lot of liberals just can’t resist the urge first to prove how clever they are, which can occasionally force them to lose the plot.  Here I will give a couple examples in order hopefully to nudge the wrong-doers into more patriotic behavior.

I have noticed recently some public intellectuals on the left enjoying a spirited debate about who is and who is not a “neoliberal” and whether the term itself connotes a progressive view of politics.  I think they should redirect their focus to what is actually going on in the world and apply their sharp minds to convincing people to act in ways that would improve things.

For example, instead of asking if support for the ACA is “neo-liberal”, they could write some essays patiently explaining why its going away would hurt actual people.  I know those essays seem already to have been written, but there is nothing wrong with repetition – or a successful effort at distillation and clarification.   Besides, the bar set by a semantics debate is easily cleared.  Pretty much any effort would be more helpful.

This second one is going to seem more controversial.  It challenges, rather than flatters, cherished hopes and is not calculated mostly to win your approval.  The generalization that all Republicans are evil is silly and easily falsified.  We all greatly admire the heroes in Portland.  But let’s leave discussions of who is this or that to the right. Righties just love giving themselves stay-out-of-jail-free cards by opining on how the latest bad actor is fundamentally a “good person” whose actions do not reflect his essential character. WTF?

As the sane conservative, David Frum, has mentioned on Twitter, “you are what you do.”  Perhaps he shares my view that Forrest Gump was the second greatest epistemologist in history, behind the pragmatists who are all tied for first.  (Aside: liberals please resist temptation to debate about whether the guy following several tied for first is actually second.)

Who you are is a meaningless abstraction. And in politics what matters most are the effects of your actions.  People who are still down with the Republican tribe and plan to vote Republican in the next mid-term election seem to me to be enabling Trump.  It does not matter if they are good people, although there is apparently a ready market for suggestions that they must be. What matters is the effect of their behavior. Leave the rest to St. Peter.

Maybe the too-clever liberals believe that conservatives remaining loyal to the Republican party are not really enabling Trump or that doing so would be no big deal anyway.  FWIW, I would be happy to be challenged on my take on that.  It might pull me out of my own great depression.

What is weird, though, is seeing liberals who share my take on the practical issue getting distracted by who these folks actually are.  Nor is the too-clever liberal take really the tolerant and nonjudgmental one. It blithely passes judgment on who is and, by implication, who is not a “good person.”  It would be more helpful to focus on the effects of actions and resist the normative impulse until assessing the effects themselves.

Don’t say, Tom and Dick are good, even though they are supporting Trump. Point out that they are enabling Trump, leave aside what that says about them, and focus on whether the effects of their enabling are good or bad.  True, at some point, you do need to go full normative. No avoiding that. But delay that satisfaction just one step, in the interest of America and the world.

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Judge what he does, not who or what “he is”

Remedial remittance arithmetic

As a follow-up to my rant earlier today, I thought I would write down what determines Fed profitability and thus remittances to the Treasury.  Maybe, I could try the tougher task of being correct, rather than just critical.  I have been whining a lot lately, you twelve may have noticed.

Bloomberg spreading nonsense still ticks me off, but it ain’t about Bloomberg, in fairness. I have developed an allergy to journalists getting simple stuff wrong in the past year. But it matters more in politics, than in finance.  So I should be clear that I pick on Bloomberg only because they cover stuff I would claim to understand and where normative issues are most easily bracketed.

Here I am just going to ignore two things that deliver a bit of slippage between Fed profitability and remittances. First, remittances need not be timed to the achievement of profits, which seems neither feature nor flaw, to me. Second, some might say that not all profits earned at the Fed are returned to Treasury, because the Fed pays “dividends” to private banks for their capital. I view that as a fixed cost.  In any case, it is small beer by the standards of the trend in Fed profits and the variation around it. So I ignore it, along with timing issues.

When the Fed has a normal balance sheet comprising only bills on the asset side and no interest-bearing reserves on the liability side, the source of Fed profitability is simply the gap between market interest rates and the zero cost of finance the Fed pays on currency (and much less importantly) reserves. Traditionally, this is called seniorage on “the” monetary base. But I am going to call it pure seniorage, to distinguish it from another source of profitability that has arisen recently, when the Fed has had a balance sheet that has been abnormal, at least by historical standards.  Importantly, the interest elasticity of demand for base money is low enough, i.e. close enough to zero, that pure seniorage correlates positively with rates, at least with rates in their plausible range and at horizons long enough to be relevant for budget analysis. People get that backwards.

We may describe the Fed’s balance sheet as “abnormal”, at least by convention, when the size of the asset side exceeds that required to meet currency and non-interest-bearing reserves demanded at the target fed funds rate.  Recently, the abnormal balance sheet has involved a large stock of interest bearing reserves (and other interest bearing liabilities, which we will set aside for simplicity) on the liability side and longer-maturity government-like debt on the asset side.  We call that QE.

In this environment, there is – or more strictly, may be — a second source of profitability, that arising from positive carry.  Lets’ call that trading profitability, because it involves a speculation on the path of short-term interest rates, which – in fairness – the Fed may be uniquely qualified to engage in.  (Hence the rates signal aspect of QE.)  And let’s be careful to distinguish it from what I am calling pure seniorage.

I think people, such as for example Stephen Stanley, sometimes overlook that the source of trading profitability is not the low-level of the fed funds rate or thus the low rate paid on excess reserves. And nor is it the positive slope of the yield curve.  To see this easily, just imagine a counterfactual (or recent experience) in which the slope of the curve less than fully compensates for a possible rise of short-term interest rates.  In such an environment, carry trades held to maturity of the asset leg would generate losses.

I guess how you analyze trading profitability is a matter of (modeling) taste.  But these three sources sum, by construction, to all of it. We can think of trading profitability as reflecting three things:

  • Luck
  • The Fed’s forecasting edge
  • The term premium in the yield curve

The first factor cannot be relied upon going forward. At some level this is painfully obvious. But I think some of those claiming that a lower balance sheet just necessarily means less profits / remittances may be forgetting this and just extrapolating the history of the past decade, during which carry trades – of the sort QE represents or, hell, is – have been very profitable.

The second factor is perhaps a bit more reliable, at least at short horizons, on the grounds that the Fed has a better insight into the path of the funds rate over the very near term than the market does.  But, the Fed demonstrably does not have a better view than the market at even medium term horizons, as the history of the past decade has shown clearly.

And whatever the Fed’s medium term advantage might have been, the escape from zero bound will predictably make it less compelling. In the interest of time and not losing the plot, I will leave figuring out why that is the case as an exercise for the reader.

So that leaves us with the third item.  The term premium is a very important determinant of the prospective profitability of carry traders, particularly among those – like myself – who still have some modicum of respect for the idea that the fixed income market might often be roughly efficient.

One problem is that term premium is not directly observable and there are good grounds for skepticism about attempts to estimate it.  Right now, the term premium does not seem to be very large, I would point out with appropriate humility.

But the point is that the Fed cannot control the term premium, even with QE, I would say. And for those who say that the Fed can control the term premium with QE, then even spotting that premise does not get you very far in this context. After all, asset rundown would raise the term premium, and thus lift the prospective profitability of the remaining carry trade, arising out of the remaining QE assets. For example, if cutting QE assets in half raises the term premium from 0 to 50 bps, that is a win for total remittances over time.

I have said it before and I will say it again. QE will have been conceived, implemented, scaled up, tapered and run off before the consensus even has the remotest clue of what QE is or how it affects things.  Getting its effect on Fed remittances wrong in just par for the course.  For me, that is a recurring theme.

Yeah, that’s the main point. Whatever your take, even if you insist on holding to the wrong one, all this remittance stuff is peanuts relative to the broader trends in the budget and egregious lying about them.  It is interesting much more as an example of how QE is intellectual kryptonite, turning even sensible people’s brains to mush.

Please, Bloomberg, just stop and do some reading

Probably temporary, tweet support

To the extent that Fed remittances reflect balance sheet policy, they are profits on an interest rate bet that the Treasury can replicate if it wants to.  Mnuchin has expressed a strong desire to do the opposite of that trade, by lengthening maturity, which you should consider in this context to be reverse-QE.

If balance sheet run-off and explicit maturity lengthening are too much for him, Mnuchin can adjust. It is up to him, especially if the Fed moves slowly via a passive run-down.  Hell, Mnuchin can go full-retard QE by just issuing 100% bills. Fun fact: Former Treasury Secretary Summers has actually recommended that.

Away from the interest rate bet driver of remittances, higher short-term interest rates would lift, rather than reduce, pure seniorage.  Rates going up slightly if the economy seems to need that is neither up to Yellen nor a drain on the budget.

Then there’s the big picture: there is a $2 trillion error in the budget, which is so egregious I did not get it, even when it was explained to me and even though I am a card carrying Trump hater. My eyes just refused to see that level of dumb. It is far more important than remittances, even on your wrong view of how they work.

“Obama regime”? Really? Stephen Stanley? Really?

Citi humblebrag about their silly surprise indicator

This post is not that relevant. It is largely a reflection of a bad habit of leaning into unimportant things pretending to be important. So you have been warned. Maybe equities will go down for another reason. No view.

Before I get around to making fun of Citi’s humblebrag about their economic surprise index, I just want to point out that the recent collapse of the Citi index has not been confirmed by a similar index produced by Goldman.  Indeed, the Goldman US “MAP” is in the top quartile of its range, although there is something going on in China and India, apparently.

I prefer the Goldman index to the Citi because it includes only real activity indicators and is not affected by inflation data, negative surprises around which are probably not even bearish equities, because they slow the Fed.

Separately, and secondarily, the GS index does not assign 90 different weights to each release and is available both as a 3-month rolling window and as the underlying daily results.  This latter advantage allows us to tell if recent moves in the 3-month aggregation reflect recent developments or just base effects. However, it is not relevant to the contrast I draw between the Citi and GS surpise indices, both of which are conventionally presented as a 3-month window.

I don’t want to show the GS series because it is provided to me by Goldman as a courtesy, presumably because I used to “work” “on” Wall Street in the distant past and because I happen to be a fan of their chief economist. Goldman may be the vampire squid, but their macro econ team is best of class.  It is high quality squid. Anyhow, if you are curious about this call your friendly Goldman sales rep – or just take my word for it.

Ok, now to making fun of Citi for their humblebrag.  I see in an FT Alphavile article, kindly brought to my attention by Joe Little (thanks, Joe) that Citi is leaning into the idea that weakness in their indicator is bearish.

The Citi Economic Surprise Index is a perfect example of unique proprietary design which has almost no bearing on those who discuss it. The models were built by quantitative analysts in Citi’s FX unit and were structured for currency trading. Thus, if the CESI wiggles one way or another, investors get signals to buy the yen or the euro or the loonie, etc. It was not meant to be used for stock prices or for Treasuries, but coincident rather than causal relationships are relied on even if they have no consistency whatsoever. For example, Figures 1 and 2 show the relationship between the S&P 500 and the 10-year yield versus the CESI over the past five years. If one looks at just nine months, the gap looks worrisome for stocks (see Figure 3) but not necessarily for 10-year Treasuries (shown in Figure 4). Unfortunately, we find that the narrative becomes the dominant feature, not the historical trading evidence.

That is great, if extremely belated, but the problem is that they leave a clear impression that the Citi index is designed to provide input into timing in currencies.  I have never seen evidence that that works, although this may be just a reflection of my own ignorance – and currently being out of it.

But I can tell you this.  The weights that Citi assigns to the data surprises are a function of fitting the magnitude of the surprise to roughly instantaneous reactions of dollar currency pairs.  The index, then, is inherently backward looking. If the fit were perfect, it would just look like roughly 3-month changes of the trade-weighted dollar index, which would be helpful – even in currencies – how?

For me, there is no compelling evidence that the Citi index is “wrong”, athough I prefer the GS series, which seems cleaner – as a measure of the backward looking question of how the activity data have been surprising.  But the way these series are abused and mischaracterized is a sight to behold.

As I mentioned in an earlier post, with pseudo-academic flare flair, * they appeal to our System I, not system II. That is a flaw, not a feature. If they are going to be pseudo-quant, I sure as hell give myself the freedom to be pseudo-academic in describing them.

* If you put pseudo-academic in front of a noun, prolly best to the spell the noun right.

Two paper rule and MMT

Update on May 25:  “Intellectual horror show”

Brian Romanchuk has taken me up on my request for confirmation that MMT actually holds the position I had assumed it does on an important and currently-relevant policy issue.  The position is that policy makers (and those seeking to influence them) should utterly ignore the path of the debt/GDP ratio when setting spending and taxation.

Here is Brian in his own words. For context, I had asked him — or really any other MMT advocate — if they could confirm they agreed with an assertion I was inclined to ascribe to them. Brian was very precise in his reply, scratching out bits he disagreed with and adding detail/correction as required.

Screen Shot 2017-05-25 at 10.29.57 AMI am pretty sure Brian’s response includes reckless policy advice, for which a public intellectual should be held responsible.  (I too am responsible for what I say, but just do not rise to the level of public intellectual.)

How you get to that advice, how many agreeable academics you can cite in getting to it, the width of the mud moat you put around it, and how you might mischaracterize the views of those who disagree are — practically speaking — almost irrelevant. What matters is the advice, particularly if taken.

Brian had earlier told me that he was not convinced that the MMT perspective offered any additional “policy space”, but that it was nevertheless analytically insightful.  That take seemed more benign.  The passage above implies that the policy space is itself The Vasty Deep.

MMT comprises many ideas *, and I have tried to be clear that I do not disagree with all of them.  Partly this is because they occasionally seem sensible if not unique to MMT (e.g. loans create deposits) or not worth arguing about (e.g. whether this or that idea can be traced to Keynes). Besides, my knowledge is very limited and this ain’t about me.

Moreover, MMT has been on the side of the angels recently, arguing during the teens that austerity was mistimed and misguided, particularly among “sovereigns” issuing their own currencies. To my mind, that was very constructive. And they get extra points for being so cocky! If you are right, cocky is a feature.

But to argue that spending and taxation decisions should be set utterly without regard to the path of the debt/GDP ratio seems reckless. And I would like to shine a light on that — most practically relevant — aspect of what MMT is currently pushing.  They have been very loud on the point and the first step to correcting them is to get clear they own it. (In fairness to them, maybe they have always been clear. I did not want to assume.)

As for Noah’s original point about not needing to read anything you think is probably stupid, I see that among the scholars and voracious readers from MMT residing over at Brian’s blog five** clicked on what I had actually written.  I am not even sure if those were among the guys who so loudly complained about my piece.  Please keep us up on the importance respecting others’ views, guys. You are a light unto the world.

On the other hand, maybe MMT is just more discerning than I realized.  It would be hypocritical to claim they need to read what they are already certain and agreed is stupid. Caring about the path of the public debt is stupid, apparently.

* Thanks to one of the less-hyperventilating commenters to Brian’s site for mentioning this paper by three prominent MMT advocates.  It seemed like a fine paper, but just didn’t happen to address the main policy issue, as I see it, at least directly.  My one quibble is that the authors complain, inevitably, about being misunderstood.  That goes to why I prefer the stark question over the vast literature or “sacred texts”, as I have called them. A direct answer can avoid misunderstanding.

Original post:

From Krugthulu, screenshot:

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That passage really reminds me of MMT, as did Noah’s original post.  I am not interested in the vast literature there and Noah has crystalized for me why I don’t need to be.  *

I read Warren Mosler’s Innocent Frauds, and pointed out some nonsense there, to which I got, that is not part of the formal vast literature, it is just his popular work.  But public intellectuals are responsible for what they try to convince the public of. And why would the content of the popular work vary from the formal? Opinions vary, but it is a red flag if they do so within one person.

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But this debate can be simplified by getting straight to the central point, at least as I see it. MMT advocate do you agree with the following statement, which is an attempt to summarize what I think I have heard your peeps saying?

The public sector budget constraint is either non-existent or a trivial accounting identity with no practical implication.  Accordingly, tax and spending policy should be set without  any regard to the deficit and long-run trajectory of the debt/GDP ratio.  Fiscal policy may occasionally need to be tightened, but the signal for that would be only an acceleration of inflation to an undesirable pace. Worrying about the trajectory of the debt itself is merely a reflection of a misunderstanding of how the payments system works, and is pointless.

Full disclosure: the question is meant to be a trap. But it is simple and pretty close to a yes / no.  Maybe I could complicate it a bit by asking, if not, then how not? And precisely, without deflection.  If not two papers, then one answer.

* Noah did not address MMT in his post, but reading it the school popped into my head and stuck.  Amusingly, the very first note in his comments went to MMT and drew Noah out on it. Agree. 

Doesn’t seem to work on the way down, either

My friend, Dennis at ISI, directed some traffic to a piece I wrote five months ago leaning into the idea of using the Citi Economic Surprise index as a market timing indicator.  Why would the market react predictably to old news? It doesn’t seem to.

At the time I wrote the post, the surprise index had just moved higher, which got people excited the market would rally.  Ok, it ended up doing so, but seemingly not because of that indicator.  At short horizons, on my simple calculations, rises of the CESI above zero from meaningfully below have been a contrary indicator, although extremely unreliably, even as that.

In this note, I would like to address the current concern, that the decline of the CESI is a bad omen.  I don’t currently have a market view; been that way for a while. [1] But the CESI does not seem to work on the way down either.

I will get to the tedious task of “testing” the CESI in a second. But before turning to that, I would like to speculate on what might actually draw attention to this silly CESI thingy.  Take a look at this chart, which shows the Citi surprise index to yesterday.  Look at that steep plunge.  That looks pretty unnerving, eh?

Screen Shot 2017-05-19 at 8.30.11 AM

The line was high and now the line is low. But let’s back that up.  More than half of that decline, i.e. to the thick horizon line, was inevitable at some point, simply on the basis that the data would eventually be inline, the definition of unremarkable.

The remaining bit reflects that the data have missed recently. Or at least that they have missed according to the CESI hodge-podge, which includes inflation as well as activity indicators, and has the bizarre feature of assigning 90 different weights over time to one economic release.

But never mind that.  This index is built not to work on the System II part of your brain, but on the System I, the plains ape bit.  You see that steep decline and you think, oh my god, things are really going to hell here.  But just ask yourself, because you probably remember, was there some huge disappointment – or set of disappointments – in the data recently, which went miraculously unnoted by others?

The obvious retort is that by “quantifying” these issues we can identify an accumulation of evidence that people have actually missed. That is the marketing pitch. But there is no compelling reason to believe it is true or ever any evidence offered in support of it.

Ok, now to the dreary bit of testing it. I did one whole test, which is one more than you will see from advocates of the CESI. I looked at whether declines of the CESI from above +50 to below zero predict changes of the S&P500 index over 3 or 6 months. No, they do not – or have not.

Screen Shot 2017-05-19 at 8.30.21 AM

I looked at declines from above 50 because I wanted to eliminate whip saws, which typically do not attract the attention even of the street. I wanted to look at declines from “meaningfully” above zero to below. But you could easily imagine another threshold or even an infinity of other ways to test this.  I chose one.  Given how strong the priors are against the idea that such a silly thing would predict, choosing more than one test might be data mining. But by all means, fill your boots.[2]

[1] Or more precisely equities seem to me to be indistinguishable from fairly priced to deliver subpar returns. They looked that way 15% ago too. My ability to distinguish is pretty limited.

[2] You might also want to check my results.  I did not actually right a bunch of if statements to find when my condition was satisfied.  Rather, I just eyeballed the chart and physically looked at the data. Reinhart-Rogoff risk would be high here.