Tag Archives: monetary policy

A status report on the US economy. What can we expect in 2014?

Summary:  Today we have a quick look at the US economy. Where it’s at. Grading its performance. Where it’s going.


Economic Machinery

Unavailable today; but we have guesses


  1. The slow growth recovery
  2. Good news!
  3. Bad news!
  4. Perhaps very bad news: are we like Japan?
  5. The clock runs against us
  6. For More Information

(1)  The recovery: slow steady growth

Before looking ahead, let’s look back. In November 2012 the consensus estimate of 2013 real GDP was 2.3% (Wall Street Journal survey of economists). Based on the preliminary estimates of Q4 GDP, current estimate of 2013 GDP is 2%, as of Friday. That’s reasonably close.

Is 2% good or bad? Context matters.

  • 2% growth would be horrific for China with potential growth of 5% – 7%, per capita of $6,500.
  • The US has grown at 2.2% since 2010, only slightly below the Fed’s 2.2% – 2.4% estimate of long-term GDP growth (a slowing from the post-WW2 average). So 2% is a disappointing slowdown.
  • On the other hand, 2% is slow for a recovery, especially following the deepest recession since the 1930’s.

Worse, the trend of GDP has an ugly look. Real GDP might be stabilizing at a lower level of growth. For the second time. The first slowing was after 1980 (the oddly named “Reagan Revolution”).



But real GDP is not always the relevant number. In many ways we living in a nominal world. Profits, savings and many important factors require nominal growth. Unfortunately, the nominal graph looks similar to the graph of real GDP.

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The Economist recommends taking the easy path to inflation. But what if it’s closed?

Summary:  If the great monetary experiments underway in Japan and America succeed, then the world will change. Aggressive fiscal and monetary stimulus will become routine, even normal. For better or worse. Already the normalization process has begun by people unaware that in this new century the easy path to inflation has been closed, with as yet unknown consequences.

Money whirlpool

Christian Science Monitor, 8 November 2010



  1. The world has changed, yet they still dream of monetary magic
  2. About inflation
  3. The Boomers’ secret lust for inflation
  4. For more information


(1)  The world has changed, yet they still dream of monetary magic

QE3 will raise the Federal Reserve’s assets by almost 40% in its first year. Japan has adopted an even bolder strategy. One of the two arrows of the three arrows to Abenomics is doubling the money supply in two years in order to raise inflation to 2%. If these monetary experiments work, then the world will change. Already the yearnings for inflation, simmering since the crash (but expressed in euphemisms), are now expressed openly.

Secular stagnation: The second best solution“, The Economist, 21 January 2014  — Excerpt:

WITH a string of talks and op-ed columns, Larry Summers has revived discussion in the “secular stagnation” hypothesis. Income has become concentrated in the hands of groups, like reserve-accumulating foreign governments and the rich, with low propensities to consume, the thinking goes. That has generated excess saving and pushed down real interest rates until they are substantially negative at many durations. That, in turn, has made life very difficult for central banks, which have struggled to stoke up adequate demand with nominal interest rates wedged up against zero.

Mr Summers identifies three broad solutions to the problem.

  • One is to do nothing, or not much anyway, on the demand side. This is not a particularly attractive solution, as it implies a very long slump in which incomes are lower than they need to be, unemployment is higher, and the economy’s potential is eroding.
  • Another is to raise inflation expectations in order to reduce real, or inflation-adjusted, interest rates until demand is where we’d like it to be. This policy is not without its downsides …
  • The last option to address stagnation is to have the government soak up excess savings and boost demand through deficit-financed public investment.

The third option is quite clearly Mr Summers’ preferred course of action. And it is a very attractive option. It is a rare rich country that doesn’t have a list of infrastructure needs that could justifiably be addressed in the best of times. Pulling those off the shelf and taking them on amid rock-bottom interest rates and weak demand is a no-brainer. Unfortunately, governments are discinclined to seize these opportunities. That makes it very important to sort out the relative attractiveness of alternative solutions to stagnation.

My sense is that Mr Summers reckons the inflation strategy is not as easy to deploy successfully as I make it out to be. QE purchases focused on safe assets might have an ambiguous effect on the economy: boosting asset prices through portfolio balance effects but limiting lending growth by sucking up the supply of good collateral. And as Brad DeLong notes, high inflation could conceivably undermine the safe-asset status of some government securities. Meanwhile, central banks might not be comfortable mustering the bluster to convince markets that higher inflation is ahead. And if they did, increases in long nominal rates could create their own financial difficulties.

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Wagering America on an untested monetary theory

Summary: After years of quantitative easing, with the Fed starting to slow the third great wave, officials are breaking their facade of confidence to admit what many of us have long said. They do not know how QE works, or the effects of ending it. QE is an experiment, one of the greatest economic experiments of the modern era. That is the most important thing to know about QE, and the fact most carefully hidden (until now). We might find the next few years quite exciting. Here are two articles to help you understand, and so prepare.

Money world


“We don’t understand fully how large-scale asset purchase programs work to ease financial market conditions. Is it the effect of the purchases on the portfolios of private investors, or alternatively is the major channel one of signaling?”

— William Dudley (President, Federal Reserve Bank of New York), speech at the American Economic Association Annual Meeting, 4 January 2014

“The problem with QE is that it works in practice but it doesn’t work in theory.”
— Ben Bernanke, speech at Brookings Institute, 16 January 2014

“When you believe in things that you don’t understand, then you suffer. Superstition ain’t the way.”
– Stevie Wonder, “Superstition” (1972)

(1)  Weekly comment by John Hussman (former Prof Economics at U MI, portfolio manager of the Hussman Funds), 20 January 2014 — Excerpt (red emphasis added):

What FOMC officials are really saying is that aside from a very predictable effect on short-maturity interest rates, there is no mechanistic link between the monetary base and any other variables – financial or economic – that they are trying to control. There is a sense that creating more monetary base helps stocks advance, and that this contributes to economic confidence. What’s missing is a transmission mechanism that operates through identifiable banking and economic channels – other than promoting a speculative reach-for-yield and the psychological exuberance that accompanies a bull market.

The fact is that Treasury bond yields are above where they were when QE2 was initiated in 2010, and year-over-year growth in non-farm payrolls, civilian employment, real GDP and real final sales have at best done little but hover at the thresholds that have historically bordered expansion and recession. Good economic policy acts to ease constraints that are binding, and monetary policy can clearly be useful in that regard – particularly during liquidity crises when depositors are rushing for cash. At present, however, quantitative easing acts by massively loosening a constraint that is not binding at all, drowning the economy with idle bank reserves that aren’t even desired. That’s going to have negative consequences.

… Regardless of my objections to the course of monetary policy, I think the Fed’s intentions are good, and I share Janet Yellen’s concern for the unemployed. I just believe that there is no demonstrable mechanism that reliably links the actions of the Fed to the outcomes it seeks, and that the unintended effects are greatly underestimated.

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A Fed Governor speaks honestly to us about the costs and risks of our monetary policy

Summary: Fed officials see as tools their ability to manage our confidence and expectations. This means a constant policy of exaggeration and distortion in their speeches, as truth and plain-speaking are secondary considerations. But there are exceptions. Perhaps the most famous is Bernanke’s 2002 “the U.S. government has a technology called a printing press” speech. This week as another, an even more impressive and rare example of honesty by a high government official. He warns us that the extreme monetary policy of today has costs, and might prove difficult to unwind. Let’s pay attention to his words.

Note: We tend to get our news and insights through intermediaries, who inevitably filter and distort the content. On the FM website we try to avoid this, instead giving excerpts with links to the full text.  Governor Fisher — like the IPCC, and the famous leaders of our past — speaks to us, and needs no interpreters.

Magic Hat Money

Beer Goggles, Monetary Camels, the Eye of the Needle and the First Law of Holes
With Reference to Peter Boockvar, the Book of Matthew, Sherlock Holmes, ‘The Wolf of Wall Street’ & Denis Healey

Richard Fisher, President of the Federal Reserve Bank of Dallas
Remarks before the National Association of Corporate Directors
14 January 2014

Excerpt #1:  Beer Goggles …

Two comments I recently read have been buzzing around my mind as I think about the many issues that will condition my actions as a voter.

The first was by Peter Boockvar, who is among the plethora of analysts offering different viewpoints that I regularly read to get a sense of how we are being viewed in the marketplace. Here is a rather pungent quote from a note he sent out on Jan. 2:

“… QE [quantitative easing] puts beer goggles on investors by creating a line of sight where everything looks good …”

For those of you unfamiliar with the term “beer goggles,” the Urban Dictionary defines it as “the effect that alcohol … has in rendering a person who one would ordinarily regard as unattractive as … alluring.” This audience might substitute “wine” or “martini” or “margarita” for “beer” to make it more age-appropriate, but the effect is the same: Things often look better when one is under the influence of free-flowing liquidity. This is one reason why William McChesney Martin, the longest-serving Fed chairman in our institution’s 100-year history, famously said that the Fed’s job is to take away the punchbowl just as the party gets going. {1955 speech}

Peter Boockvar is Chief Market Analyst of The Lindsey Group (bio here). Here is an early statement of his “beer goggles” theory.

Excerpt #2: Free and Abundant Money Changes Perspective, the first explicit mention I’ve seen by a Fed official of QE’s possible ill effects.

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Do we get deflation or inflation? Today we look at the darker scenario.

Summary: One example of our inability to see the world through our ideological blinders is the obsession with inflation (coming real soon, so we’ve been told for 3 years) while deflation bangs on the door. We must learn to see better. Fortunately the people running the economy see more clearly (despite the mockery and insults directed at them by the ignorant and deluded), and have taken measures to defend against deflationary forces threatening the US economy. The outcome remains uncertain, however.




Seeing the world clearly requires awareness of the full range of reasonably possible outcomes (in the far tails of the bell curve lie dragons, to discuss on another day). Those giving hysterical and insanely confident forecasts of inflation and hyperinflation are blind — and blind their fans — to the danger of deflation.

Both are outcomes are possible, perhaps sequentially.

Today we look at the analysis of one expert, Russell Napier — global strategist of CLSA.

Excerpt from “Great reset revisited”, 7 June 2013

The world has been in disinflation since 2011: deflation is next. Japan has won the currency war and its cheaper exports are forcing others to cut prices. Meanwhile, slowing growth and weakening currencies in emerging markets augur a debt crisis; and commodity prices continue to fall amid a global slowdown and rising supply. Most worryingly, both real interest rates and the US dollar are rising.

US inflation has fallen despite QE

  • QE is not delivering: the Fed’s balance sheet has grown by 18% since September 2011, while inflation has fallen from 3.9% to 1.1%.
  • The US 30-year bond yield has remained unchanged over this period: thus US real rates have risen by 280 bps {2.8%} despite QE.
  • US nominal rates bottomed a year ago and have risen by 83bps since then, while inflation has fallen by 33bps.
  • Moreover, the Treasury inflation-protected securities (TIPS) market indicates that inflation expectations are falling, while nominal yields are rising.

EM growth is slowing and exchange rates are under pressure

  • Weakening emerging-market (EM) currencies augur a balance-of-payments crisis, which means either lower domestic growth or lower exchange rates and defaults.
  • As the EM growth outlook deteriorates, global inflation will fall further.
  • EM foreign-currency bond prices are cracking, indicating that the large capital inflows that funded current-account deficits are ending. Japan has won the currency war and is now exporting deflation

On the back of yen depreciation, Japan is cutting its US-dollar selling prices.

  • Japan’s actions have forced competitors to follow suit: now Korea and China are also exporting deflation to the USA.
  • The Bank of Japan’s need to prevent JGB {Japanese government bond} yields from rising will mean ever greater intervention and even more deflationary pressure from a weakening yen.

… In 1Q 2009, this analyst tried to persuade investors that excessively easy monetary policy would likely defeat the expected deflation … The overwhelming response was that there was no way the creation of money could offset the negatives associated with the large surplus of supply relative to demand. There was huge scepticism that the Fed’s ability to alter this one variable could play much of a role in altering all the other ‘fundamental’ variables …

Today, things could hardly be more different. In conversations with investors, the opinion is regularly expressed that Ben Bernanke can accelerate or decelerate money-supply growth as required; stop the US dollar’s rise; halt deflation; contain inflation; and underwrite asset prices. Some also argue that he could intervene to stop a liquidity squeese in EMs and buy euros if necessary to prevent the breakup of the Eurozone.

… Financial history has some very simple and clear things to say on this subject. Central bankers can only target one variable at a time, and their track record in hitting just one target is extremely poor. Ben simply doesn’t have the power to fix all the things that can go wrong.

Excerpt from “An ill wind”, 25 November 2013

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Understanding the new world shown us by Larry Summers

Summary: A weakness of my posts is that they don’t adequately convey the wonders of our time, the extraordinary events, the uncertainty of future outcomes.  Today I attempt to show the amazing nature of our new economy, as highlighted in last weeks’ speech by Larry Summers. We have entered a new world, for ill or better.

"Machinery of the Stars" by alexiuss

“Machinery of the Stars” by alexiuss at DeviantArt


Olivier Blanchard is Director of Research at the IMF and a Professor of Economics at MIT. He goes to the heart of our situation in this title: “Monetary Policy Will Never Be the Same“, 19 November 2013 — “In short,  monetary policy will never be the same after the crisis.  The {IMF Economic Forum} helped us understand how it had moved, and where we have to focus our research and policy efforts in the future.”

We should listen to Blanchard. The response of the major nations to the crisis took us into a new world. Step by step monetary policies have grown bigger and stronger (in several dimensions), beyond anything previously seen in peacetime There are few signs of the world returning to normal soon.

But Blanchard’s statement is true in another way. Larry Summers’ speech opens a new perspective on our situation. The conventional view of the US is an economy in an unusually long but very slow expansion, responding to intense fiscal and monetary stimulus. Summers instead suggests that the US has fallen into the same hole as Japan did in 1989. Perhaps the entire developed world has.

More specifically, we might be in a world of secular stagnation. That the real return on capital might have dropped to zero — or gone negative. As Japan has shown, in this hole even low levels of real interest rates fail to spur investment. Monetary stimulus only blows bubbles. This condition can continue for years, until the real return on capital returns to more normal levels.

The standard Keynesian solution is — as I and so many others have advocated for so long — fiscal stimulus. Borrow at low rates to rebuild our decaying infrastructure, and do other things with a positive return to society. This helps to return the economy more quickly to a good equilibrium. It would channel the excess liquidity created by monetary stimulus into the real world, instead of boosting asset prices.

The obvious solution remains unlikely due to dysfunctional political systems in the US and Europe (it’s being used in Japan, but a corrupt political establishment is in effect burning the money).


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Larry Summers gives us the bad news. Worse, the only solution is more of the same.

Summary: Larry Summers speech last week was, IMO, a pivotal moment. It forced economists to look at the US from a new perspective, considering things that had been heretical. The previous post, Are we following Japan into an era of slow growth, even stagnation? sketched out his bold speech. Today we look at the text, with the good news (better definition of our problem) and the bad (no new solutions). This post ends with a bang (or warns of a bang, depending on your point of view).



  1. Prelude: the missing “V” recovery
  2. Larry Summers warns of the great stagnation
  3. We fight a crisis with the theories we have
  4. Bubbles to the rescue
  5. More economists jump into the debate
  6. For More Information

(1)  Prelude: the missing “V” recovery

Despite the great economic events of the past five years, economic policy and theory debates have largely run in circles. Pro and con fiscal stimulus. Pro and con monetary stimulus. Forecasts of the “V’ recovery each year; forecasts of slow growth (include me on that team).

One quiet theme has been a few of us warning that we have fallen into a situation like, in its essentials, that of Japan in the quarter-century since their 1989 bust. That’s been declared daft by mainstream economists. Until now. It’s a shattering idea, because Japan shows the intractable nature of this trap. They might have found a solution in “three arrows” of Abenomics (massive monetary AND fiscal stimulus, drastic structural reforms) — but the solution might prove ruinous. Or ineffective Or both.

The speech changed the debate. It deserves your attention.

(2)  Larry Summers warns of the great stagnation

Excerpt (lightly edited for clarity) from the transcript of Larry Summers’ speech at the IMF Economic Forum on 8 November 2013, prepared by Randy Fellmy, posted at his Facebook page. Red emphasis added.

It is a central pillar of both classical models and Keynesian models that it is all about fluctuations: fluctuations around the given mean, and that what you need to do is have less volatility. I wonder if a set of older ideas firmly rejected in {graduate monetary economics courses} — that went under the phrase “secular stagnation” — are not profoundly important in understanding Japan’s experience, and {might be relevant} to America’s experience.

… If you study the economy prior to the crisis, there’s something odd. Many people believe that monetary policy was too easy. Everybody agrees that there was a vast amount of imprudent lending going on. Almost everybody believes that wealth, as it was experienced by households, was in excess of its reality. Too easy money, too much borrowing, too much wealth. Was there a great boom? Capacity utilization wasn’t under any great pressure. Unemployment wasn’t under any remarkably low level. Inflation was entirely quiescent. So somehow, even a great bubble wasn’t enough to produce any excess in aggregate demand.

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