Bernanke supports heretical take on inflation overshoot

My heretical take is explained here.

Bernanke’s discussion of the issue is a bit evasive — not to mention a couple weeks old.  But he recommends that the Fed be patient in tightening after zero-lower-bound episodes and explicitly relates this to the idea of price-level targeting.

It does not take a wild imagination to conclude this means he supports allowing inflation to overshoot the 2% long-term target in the late cycle to compensate for prospective (or even past, if you want to be more radical) periods of inflation undershoot.

Of course, Bernanke is not now in charge of policy, so how is this relevant?  I would note that he is now more free to express his view on than he was when he was Fed chair. And I would infer from that that the idea is probably less radical than it sounds and may have support within the current FOMC.

If the Fed wants to hit 2% on average over time, it would seem as though it would have to.  And actual Fed speech has been not-inconsistent with this take, although also not dispositive.

If my now-fairly-old take is right, then the Fed now finds itself in an awkward sitch. The Fed does not want the unemployment rate radically to undershoot the natural rate, whatever it might be.  And yet, inflation remains stuck below 2% at a time when the Fed would probably prefer it be slightly above 2%.

Life would be easier for the Fed if inflation were to start to rise again.  It would eliminate the need for Sophie’s Choice.  But if I am right that the Fed would all-else-equal prefer to see inflation above 2% in the late cycle, then that is a dovish influence and it does reduce the risk of recession in the next year or so.


Uh-oh, NY Times being liberal again

The supposedly-liberal NY Times is trying to drive up its readership and ad revenue by promoting the idea that they are guardians of truth in a world of fake news. Apparently, getting the truth is “hard” and yet now more important than ever.

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Nice idea, but not something on which the NY Times is reliably acting. They are as much a part of the corporatist fake-balance centrism as any other non-right-wing outlet.

Consider this editorial bemoaning how both Trump and Clinton need to get past the election and allow the country to come together.  It is just the usual fake-balance false equivalence plus an apparent failure to recognize that, you know, Trump is president and Clinton is not.

Six months on, both Mr. Trump and Mrs. Clinton are still waging last year’s campaign, undermining their promises to help America heal.

… Nothing in recent history can match the sorry spectacle of a sitting president so desperate for adoration and so indifferent to actual governing that the only satisfaction he can get is from perpetuating the campaign.

Yet Mrs. Clinton, a person of greater substance, also seems unable to shake free. 

This week, in a conversation with Christiane Amanpour, the television journalist, Mrs. Clinton was asked about Mr. Trump’s approach to North Korea and Syria, and about women’s rights around the world. Her insights were strained by insinuations against the president, whom she still refers to as “my opponent.”

You see, they are both the same.  Trump is destroying America’s political institutions and Hillary is still referring to Trump as “my opponent.”  Six of one, half a dozen of the other.

In fairness, The truth ® is hard to insist upon when you need to worry about revenues.  This is why I always laugh when I hear the mainstream media has a “liberal” bias.


No, it has a get-revenues bias, which requires it to tell people mostly what they want to hear and to avoid pissing off the rich, in particular.

GDP data suggest it is less a no brainer, but not yet alarming

Updated at bottom for the inflation side

Wall Street’s obsession with “current” quarter GDP estimate is probably mainly a waste of time.  Between late February and yesterday, for example, the Atlanta Fed’s GDPNow estimate fell about 200 bps, but the bond and stock markets basically went sideways.  The 10-year Treasury yield was down marginally and the S&P500 was up slightly.

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In fairness, the obsession to which I refer is probably less pervasive now than it was earlier in the cycle, even among the talking heads (such as myself), but it is still there to some extent.  You do see a lot of references to the Atlanta Fed as the quarter progresses.

From a social welfare perspective, there is probably also still too much emphasis on GDP.  However, that too seems to be fading. People increasingly recognize that GDP is not a good measure of aggregate happiness, and not just because of bean-counting minutia, like quality adjustment or path dependency in chain weighting.

More fundamentally, just for example, people are prone to jealousy, which makes adding up utility, as real GDP is meant to do, tricky! And even if people weren’t prone to jealousy (or less darkly, were cheering for their fellow man), aggregating utility is tough. In any event, nobody argues that the welfare aspect needs to be tracked quarterly.

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But the GDP release allows us to update some aggregates that may be helpful in assessing the cyclical position of the economy, developing imbalances, and the attendant risk of recession.  I like to follow the share of cyclical demand in GDP and the private sector’s financial balance implied by the (all-government) fiscal deficit and current account.  For a brief explanation of the reasons, you may see here and here.

We now have data to Q1 for the first concept and an ability to get a pretty good bead on the second, based on the movement in net exports to Q1.

On the basis of both these metrics, the risk of recession appears to have risen quite a bit from where it was earlier in the cycle I (and many others) had earlier argued that you cannot fall off the floor and that concept of a “stall speed” is not that relevant when the plane has not even really left the ground.  But such arguments are now a bit less forceful.

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The share of cyclical demand in GDP has risen, which suggests that pent-up demands are less present than they were, particularly away from housing. And the private sector financial balance is smaller, reinforcing the same point, although from a financial rather than real-economy perspective.  (Accounting relates the two, but not quite into identities.)

On the other hand, this is a case of not-as-good, rather than alarming. From the perspective of these metrics, at least, the situation does not appear yet to have become particularly dangerous. It just seems less the no-brainer than it was earlier in the cycle.

We can’t take a view on the medium-term outlook based just on these crude metrics, obviously. The approach of full employment and the Fed’s (slowly) evolving priorities are a bit of a caution, although also  not yet alarming, in large part because inflation is still too low.

But from the GDP report itself, the main points I would take away are largely shown in the charts immediately above.  And their signal evolves slowly, so it is not like we learned so much even about these in today’s release.


Afternoon Update: Quick comment on the inflation side

JPM estimates that the core PCE deflator for March will have been down 0.09% (false precision) on the month. The JPM estimate is usually pretty close, and it is good enough for me.

Today, we got the price data for Q1, although not the monthly breakdown for March in particular. But if we assume the monthly data to February will not be revised (neutral, but not realistic), then to get the already known quarterly result, we would have to pencil in a 0.07% decline March for the core deflator and roughly twice that decline for the market-price-only (MPO) component.  Just as a demonstration of mastery of Excel I do that below.

The precise monthly detail don’t matter much. Quarterly is fine, because we ain’t that smart anyway.  But my charts are monthly and using monthly avoids talking about base effects in the quarterly averages. So here is how one picture would look if we did that bit of interpolation.

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I see from a Bloomberg journalist on Twitter that MEN now hold the lowest expectation of long-term inflation on record. Not sure why men and women wold be different.  But maybe the men are extrapolating, after what has almost been a decade now of the Fed chronically missing to the downside. I doubt inflation expectations drive policy to the extent the Fed occasionally implies (when not dissing inconvenient inconvenient readings).  It is marginally corroborating is all.

Incidentally, ignore the GDP deflator — ALWAYS.  Never mind why.  Need to know basis only. And you don’t need to.




I kicked myself off Twitter cuz I was tweeting too much. But I can always resort to my blog!  This is pull not push technology, so blame yourself if you have had too much of my opining.

Eric Lonergan makes a very good point that Trichet’s refusal to do euro-QE, which I agree appears to have helped a lot, was not due to German resistance. The Germans might have been a constraint, but not a binding one, given that Trichet opposed QE anyway and criticized others for doing it.

To the extent that the discussion on Twitter was about how Trichet screwed up, which it mostly was, I think Eric’s point is dispositive, a word I just learned a couple years ago, and like. Well done.

But, I do think the Germans slowed down the approach of QE after Trichet’s departure and I do think they limited its scope and force, even when applied.

Also, check out this video, which is always a great source of amusement to me.  Here is angry Trichet, pushing back against German criticism that policy is too stimulative.  I love how he says impeccably. * He speaks far better English than I speak French, so I am not judging.  But the arrogance and anger seem to go nicely with the gallic lilt.  Fits the stereotype, fair or not.

To repeat, none of this is in opposition to Eric’s specific point about Trichet and QE itself. But separately, more broadly, the Germans resisted even Trichet’s limited efforts at conventional stimulus and I do think they slowed down Draghi.

* One thing that irritated me about Trichet at the time is that he was relating ECB policy to the inflation rate in Germany, as if policy were directed to the German inflation rate. We could easily imagine that ECB policy might have been successful if the euro-wide inflation rate were 2% and the rate in Germany were 4%. It was almost as if Trichet did not understand that Germany was part of the currency union, which as quite a feat, given that Trichet was overseeing that currency union, badly as it turned out.

Better man theorem

The Better Man Theorem (BMT) was first formalized by Beinn Bhiorach two days ago.

BMT holds that in any discussion of a macro issue, there are two purposes.  The first is to understand the issue at hand. And the second is to establish who is the better man.  Real analysis has proven that as time approaches infinity, the difference between the importance of the second consideration and the first collapses to a strictly positive value, which may itself be infinite.

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Lie to me, baby


Some people are upset that the GOP is going to lie, sorry impose dynamic scoring, to get their tax cuts for rich guys through. See, for example, here. *

FWIW, I favor a relatively orthodox approach to fiscal policy now that the US is pulling away from the zero bound.  Right or wrong, I shifted to that take a couple years ago, even though it would hurt Hillary if applied! I am not apocalyptic about it. I just have my own opinion about what relatively less shitty policy might be.

The move away from zero may be transitory, but there is no reason necessarily for fiscal policy now to look through that.  Going into the next recession and zero bound episode with a larger deficit would not be helpful.  My perspective here assumes a model of the economy, just like yours does.

I think a lot of people miss this aspect, when they just assume that there is a trade-off between a larger deficit now and the risk of returning to the zero bound. There is no obvious trade-off.  Indeed, a larger deficit now arguably raises the risk of a return to zero bound and then getting stuck there for a while.

Still, we need not be particularly bothered by scoring chicanery per se.  The media’s insistence on falling for the ruse, out of a desire for “balance”, will predictably be irksome. But the trick itself is mostly just a case of Congress lying to itself.  The weak media and Congressional lying are the problems, not the budget rule.

As I see it, there are two issues here, one to do with budget process and one to do with understanding reality.  The process issue is that dynamic scoring will allow the Congress to evade the spirit of some rules it had tried to impose on itself. If you assume that the tax cuts will pay for themselves, as Mnuchin is, and if you impose that on the scoring, then the tax cuts can be passed with less legislation and less focus on the deficit implications.

I guess some deficit purists will get upset about that, and I can see their point. But it is useful to keep in mind that this is just the usual lying. If we had a political culture able to call out the lying, then there would be no practical effect of the scoring change itself.  Let’s not miss that simple point in our usual obsessing over process.

Second and related is the issue of understanding reality, which is also no big deal.  If the scoring assumes too much growth, then people with an interest in knowing the more “realistic” deficit trajectory, can just read the Goldman reports or look up the CBO table showing the effect on the estimated budget deficit of, say, slower growth. (Even Rogoff and Reinhart could do that, probably.  Sorry. Unfair.  I am among those who think that was no big deal not permanently discrediting, but for me the humor value is very high.)

The implied more “realistic” scoring might not be reliable. But it would resemble all prior CBO and consensus estimates in that regard. Estimates that are presumably unbiased are not for that reason necessarily accurate. But there is nothing new under the sun there.

I can’t help but concluding with a reference to how this relates to my recent – and admittedly tedious – forays into MMT.  Hard as it is to get advocates to be straight on this issue, a central tenet of MMT is that it is stupid to obsess over the relation between government spending and taxation, particularly when inflation is low, like now.

So I guess the MMT guys would not be particularly fazed by this, at least from the deficit perspective. I mention this because – to me – MMT and religious believers are pretty similar. If you can just repeat back at them what they claim to believe, making it as tangible as possible, then the merit of their case becomes self-evident. Forget the sacred texts, this is what you are saying about what will actually happen. Really?  Let’s trace through that.

In fairness to MMT, many of them think themselves quite progressive, so they might not like that the tax cutting is redistributive upward. If so, I would agree with them on that. But it is a separate issue.

* The journalist’s hook is that these tax cuts are stealing money from future generations.  This is an argument that Stanley Druckenmiller trotted around to wild applause from the Villagers a while back.  Druck did not want to cut social programs because of a class interest. No, it was because he was so concerned with the future generations. Awwwwww.  So I guess we can expect Druck to start up his Can Kicks Back deficit fear mongering again and rail against the injustice of all this.  Remember, with intergenerational accounting, the “true” deficit is already $5 gazillion dollars and the real debt is $100 bazillion. Some calls are just too easy.

Torturing Alexander Douglas until he agrees

Alexander Douglas has written a post assessing the validity of the transversality condition underlying the canonical government bond pricing equation in conventional macro.

I have nothing useful to offer on transversality, the controversy around which seems to  arise because of mathematical and philosophical disputes far beyond my competence. The limit is not actually infinity, eh? I always knew calculus was just sleight of hand! *

This issue attracts my attention because it links directly to my extreme aversion to MMT and its claim that money finance can durably relax the public sector budget constraint. That claim strikes me as absurd, which is why when debating MMT guys I try to get them first to admit that MMT holds this view I ascribe to it.  But I keep failing. My experience is not that they reject my claim (about their claim) but that they ignore it.  The connection here to Douglas may not seem obvious, but please bear with me.

Alexander Douglas is a philosopher at St. Andrews who seems to do a great job of looking at economics from a critical distance, having as one of his specialties the philosophy of economics. It seems to me that he knows a lot more about economics than do the specialists from whom he humbly seeks guidance on technical matters.  Maybe at this early stage in the development of macro in particular, the big disputes are still philosophical.  Also, Douglas seems very well schooled in math, which is the language of economics, even among many of the heterodox.

Douglas claims (elsewhere) that he likes to press his take on economics only to the point where it remains applied logic — and to leave points thereafter to the specialists.  Once they bring out their “models”, particularly in macro, he is inclined to see ambiguity creeping in and to back off and watch from a critical distance. **

To me, that is a fun thought. If I read him correctly,  within the government finance debate, the ambiguities begin to creep in once the economists try (or not) to relate financial flows to real resource constraints or through that channel inflation.

I am running a great risk of putting words in Douglas’s mouth here, because what he actually emphasizes are welfare considerations, which he thinks requires heroic assumptions to model.  But I think his concern is generalizable to any depiction of the real side of economy. (If the idea of a welfare function being called “real” makes you laugh, then fine. If I knew more math I would probably agree.)

The way macro handles what I am calling the real side obviously varies, is the subject of great controversy and is one of several areas in which economists have not covered themselves in glory.  But this does not imply that the real side can be ignored and, in particular, that resource constraints are irrelevant.

For a while we thought we could dismiss the financial channel as irrelevant, and that did not work out too well. But maybe the pendulum has swung a bit too far in the other direction? We now pay more attention to financial claims and forget that they are claims on real things.

You may not agree with that, and I concede I have not argued the point very forcefully. It will either strike you or it will not.  But all of this is just by way of teeing up this excellent paragraph, which Douglas should not have put in parentheses, dammit!

(Some people have commented that this model leaves out the fact that the government has the power to create “high-powered money” with which to retire its bonds. It’s true that the textbook model doesn’t include the creation of HPM — of course the sophisticated models in the literature do. But given the optimisation assumptions, I don’t think that changes much. HPM is also just a liability of the state, and the household doesn’t want idle IOUs in its pocket at the end of time. So it will spend up all the HPM before the final moment the way you spend up all your foreign currency on the last day of the holiday — the HPM will return to the government in tax payments and get destroyed.)

Yes, some people have indeed commented along those lines. I noticed that too. And you may have noticed me noticing.

Douglas is not convinced that their claim is valid within the formal model economy he considers. And the main purpose of this meandering post is just point that out. Douglas is not hopelessly benighted and orthodox, and yet he seems to dismiss MMT as parenthetical, literally, at least in the context of this model economy.

FWIW, I would reject MMT more universally, not because of logicial difficulties that arise in a mathematical economy, but because its central practical claim ignores simple transitivity.

The orthodox view on this, which may hold even if all of orthodoxy does not, is that trying to evade the public sector budget constraint with money finance would lead predictably to inflation.  That view may be wrong, but it would be something MMT would need to address directly, rather than dismissing as a mere inflation concern, probably not relevant in the current low-inflation environment.

Even if we could get MMT to focus on this issue, and in direct debate, then there would still be plenty of controversy, because we don’t really know how to model real resource constraints very convincingly.  But at least we could get away from the silly claim that this is all just a simple confusion related to the benighted’s inability to understand reserves accounting and how the payments system works. ***

One final, late-occurring thought which I am not sure where to stick.  A standard bit of macro theory likes to relate the budget constraint to the transversality condition.  Transversality attracts a lot of criticism, I guess. But there are more than two possibilities here. We don’t have to choose between transversality and MMT. There are very good reasons for not just ignoring the path of the deficit when setting tax and spending policy.


* I was never much good at calculus, but worse still at econometrics.   It did not occur to me until long after grad school that the world does not actually produce errors. The error term is a metaphor for the stuff we don’t know.

** I don’t think Douglas is as sanguine on the state of macro as this guy!

*** I have flashed this quote from Warren Mosler before and have received perhaps fair criticism for looking at his popular work rather than his more formal work.  But I think this is so great that I can’t help myself. Sorry.  From page 12 of the “Seven Deadly Innocent Frauds of Economic Policy:”

So, how am I uniquely qualified to be promoting these proposals?  My confidence comes from 40 years’ experience in the financial and economic realm. I would venture that I’m perhaps the only per who can answer the question: How are you going to pay for it?” My book takes on this issue and encourages a return of economics study to the operational realities of our monetary system.  (p. 12)

Trivial points on the labor share

Noah Smith has a Bloomberg View article going over possible reasons for the recent decline of the labor income share of GDP.   He assesses four hypotheses,  which he calls: China, monopoly, robots and landlords.

His piece is brief and maybe familiar to many of you, so I will not bother summarizing it, except to say that the thinks the first three forces may actually be parts of one big thing, while the last is perhaps separate.

I don’t have much to add to the basic argument he presents, but would offer just three trivial observations.

First, I was struck by his claim that, “For decades, macroeconomic models assumed that labor and capital took home roughly constant portions of output — labor got just a bit less than two-thirds of the pie, capital slightly more than one-third. Nowadays it’s more like 60-40.”

I think that is right.  The models made the assumption, although not necessarily for any particularly good reason, aside from it seeming temporarily to be supported by the data and perhaps simplified the math in some cases.

Second, I am not sure we all agree on what the data are in this case.  Perhaps it is the labor share of net value added, rather than gross, that “should” be stable.  Take a look at the picture below which shows two measures of the labor share, one with gross value in the denominator, and the other with net.  Note that the gross share is close to Smith’s 60%, which may be a happy fluke.

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I focus on the domestic operations of the nonfinancial corporate sector, rather than overall economy as measured in GDP, simply because these data a readily available, presented in a way that adds up, and relatively free of some of the abstractions found in the GDP.  But full disclosure: I think the issue I am about to highlight is most pronounced in the sector I choose to picture, and the data there are not free of controversy.

Anyhow, for the domestic operations of NFCs, the labor share of net is less than 1/3 as far off full-sample average as the share of gross.  This does not mean that the issue Smith is trying to assess is mostly a statistical illusion. I am not qualified to weigh in on that. I just find it interesting.  It probably has something to do with the average life of the capital stock moving around, which I think is something you would want to consider, although not necessarily by just netting out its effect.

Third, from an income equality perspective, I don’t think the main issue here is that something called “labor” is falling behind capital and rent, although that may be happening. Some owners of labor, capital and land, i.e. people, are doing better than others.  This is another area where I would not get too attracted to essences.

‘Terminal’ funds rate

Screen Shot 2017-04-22 at 11.32.50 AMTake the eurodollar futures strip. Please.

Some interpret it as showing that the “terminal” libor rate might be around 3%, implying a peak in the funds rate of about 2 ¾%.  Maybe that would go with inflation at 1 ¾% and a short real rate of 1%, which would put a top on the expansion.

But that is not really what the futures strip implies, as the peak rate on the futures strip is certainly not the expected peak of the interest rate cycle.

Let’s ignore the probably-small risk premium for simplicity. The reason the strip understates the expected peak of the rates cycle is that the date of that peak is unknown to investors, who must price the mean of the probability distribution for rates, which has to include the idea that rates will fall after they peak.

To see this simplify radically and assume that the peak funds rate is known to be 4% and that beyond 4 years, the only possible alternative is a return to zero.  Looking 5 years ahead, if we figured the funds rate were peaking with 75% confidence, then the forward funds rate would be 3%.  The curve peaks at 3% even though we (for sake of illustration) know the peak is 4%.  Not knowing the date of the peak matters a lot.

This simple point occurred to me while thinking about the fact that credit growth appears recently to have slowed, which seems mostly a lagging indicator of the fact that pent-up demand for durable goods has finally been exhausted and some technical issues, like the bust in the energy patch and the inventory correction.

Looking forward, credit growth should tend to reaccelerate above the pace of durable goods demand growth, following the automatic re-leveraging thesis set out by Jason Benderly.  In brief, Benderly shows that the gap between credit growth and growth in the spending it finances is itself cyclical, favoring spending growth early cycle and credit late in the cycle.  Just look it up.

The problem, though, is that this is actually a negative for spending growth, because the expansion now has less pent-up demand and is more dependent on credit expansion. FWIW, this does not have me in a “panic,” but it represents the disappearance of what had been a comforting positive.

Which brings me to a point Larry Summers has made – or a point that seems analogous to one Larry Summers has made. Summers claims that real interest rates were held aloft by during the mid-2000s by bubble dynamics in housing. From this he infers that his secular stagnation thesis actually applies to before the crisis.

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Summers argues that this differentiates his take from that of, say, Reinhart and Rogoff, as set out in This Time is Different (NOT Growth in a Time of Debt).  R&R claim that economic weakness is enduring but ultimately transitory, where Summers sees it as secular, barring a major policy change.

Applying an analogy to today, I would say that the pent-up demands are largely exhausted, at least outside housing, and that wealth effects have probably also peaked.  I am not sure why the equilibrium funds rate would surge from here.

People expecting the actual funds rate to surge may see it otherwise. I would guess, though, that a big part of the case for higher interest rates is just the continued influence of Taylor Rule type reasoning. As the labor market tightens, it is natural for the real interest rate to rise. But I don’t think we are in an environment where Taylor can work, for reasons I wrote down here quite a while ago.

This does not make me want to go out and buy a bunch of bonds, even assuming I had the dough. I still view bonds as offering return free risk.

Mostly it just reinforces my take that interest rate “renormalization” remains an extremely misleading model of the rates environment. Also it would probably be good for the Fed to allow inflation and expectations of it to rise a bit before risking putting a cap on the cycle.

These thoughts are in the Summer lecture I linked to above, but I have been pushing them a while independently.