Summary: Understanding events requires not just see what’s happening today and guessing about the future, but also grading past expectations vs the actuals. Otherwise we live in the now, like cats, with little ability to shape our world. This is one way, perhaps the best way, to evaluate experts in fields other than our own. Doing so takes us from the warmth of their confident words, and opens us to see surprises, valuable since experts seldom confess to them. Today we’ll examine the big macroeconomic surprise in 2013, and its warning.
“Perchance he for whom this bell tolls may be so ill, as that he knows not it tolls for him; and perchance I may think myself so much better than I am, as that they who are about me, and see my state, may have caused it to toll for me, and I know not that.”
— John Donne (1572-1631), Devotions Upon Emergent Occasions
- The big macroeconomic surprise of 2013
- The ECRI points to Japan
- Larry Summers points to Japan
- Other economists speak up
- For More Information
(1) The big macroeconomic surprise of 2013: falling inflation
This graph of US inflation tells an interesting story. In 2011, as inflation rose, conservatives prepared themselves for the I-told-you-so rapture of dollar collapse and hyperinflation (this was the opening salvo, on 11/15/10). Niall Ferguson cleared a space on his mantel for a Nobel. But inflation peaked in January 2012, entering a steep decline. In the 4th quarter of 2012 everybody expected that the Fed adding a trillion dollars to its balance sheet would change that. So far it has made little difference.
This is Core Personal Consumption Expenditure Index, which provides one of the best available measures of inflation and its momentum.
This is a shocking surprise. The Fed began the third round of quantitative easing (QE), a form of unconventional monetary policy, in September 2012 at $40B/month, and boosted it to $85B in December. Here’s what economists expected to see in 2013, as measured by the Core Personal Consumption Expenditure Index:
- Fed Survey of Professional Forecasters as of November 2012: 1.9%
- Fed forecast as of their meeting on 12 December 2012: 1.6% – 1.9%
After a year of QE, the Fed pumping out a trillion dollars, economists have lowered their forecasts for inflation. We live in a world of wonders.
- Fed Survey of Professional Forecasters as of August 2013: 1.3%
- Fed forecast as of their meeting on 18 September 2013: 1.2% – 1.3%
Take a moment to absorb this. For five years inflation has been below the Fed’s 2% floor, despite three rounds of QE. That’s bad. They set a floor for a good reason: deflation is lethal for a high-debt economy like ours. A steady 2% inflation does little or no harm (despite giving conservatives reason to whine about the 20th century’s drop in the US dollar (during which time the US became the world’s superpower). A 2% floor gives the Fed a cushion of time to act when it’s breached, and time for their actions to have effect.
What insights can we draw from this? Opinions differ. There is one theory, obvious for several years but seldom mentioned (too scary): we now follow Japan down a path of slow growth and deflationary tendencies. In June 2010, during the euphoria about our “V” shaped recovery, I wrote about it: We are following Japan’s path of decline. The real test comes later this year.
After three years of slow growth despite intense stimulus, now a few bold economists warn us of this danger.
(2) The Economic Cycle Research Institute points to Japan
“Becoming Japan – part 2“, ECRI, 4 November 2013:
Earlier this year we pointed out that, with the U.S. and other major Western economies experiencing slower growth in the last five years than Japan in its lost decades, long-term trend growth had already downshifted around the world, resulting in weaker recoveries and more frequent recessions than most had expected when the 21st century began. Following Japan’s lost-decades example, the policy response has been more and more quantitative easing, which has been unable to break this pattern.
Rather, in the U.S. and the Eurozone, the central banks are increasingly failing to meet critical inflation target mandates. In reality, these major economies are already like Japan in its lost decades, recalling the economic truism that recession kills inflation.
Indeed, harmonized CPI inflation fell to just 0.7% in the Eurozone in October. But in the U.S. it had already fallen to 0.8% by September, when inflation in both economies dropped below that in Japan.
Ominously, ECRI’s Future Inflation Gauges remain in cyclical downturns in both the U.S. and the Eurozone. Thus, in the coming months, inflation is likely to fall further below their official targets in both economies.
For more about this see the ECRI’s “Becoming Japan – part 1” (30 July 2013).
(3) Larry Summers points to Japan
“Larry Summers just confirmed that he is still a heavyweight on economic policy“, Miles Kimball (Prof Economics, U MI), Quartz, 15 November 2013 — Excerpt:
After his praise of Fischer, Summers gives a conventional account of the financial crisis in the fall of 2008 and the largely successful efforts to contain that crisis. But the rest of his speech goes in surprising directions.
Summers emphasizes the possibility of “secular stagnation” like that the Japanese economy has suffered in the last two decades. The extent of Japan’s stagnation is breathtaking: In 2013, the Japanese economy is only half the size economists in the 1990’s predicted it would be by now. Even here in the US, GDP is falling further and further behind what we would have predicted just a few years back, and the fraction of the population that has a job has hardly recovered at all in the past four years, despite the fact that the financial crisis was well-contained by November 2009.
What lies behind the stagnation the Japanese economy has suffered in the last two decades and that Summers fears for the United States? What can we do about it? Read the rest of the article at Quartz, or watch his speech:
(4) Other Economists Speak Up
Summers legitimized this question. Now other economists speak up.
- “A Permanent Slump?“, Paul Krugman, op-ed in the New York Times, 17 November 2013
- “Secular stagnation: The solution that cannot be named“, Ryan Avent (journalist), The Economist, 17 November 2013
- “Focus on NGDP expectations, not interest rates“, Scott Sumner (Prof Economics, Bentley U), The Money Illusion, 17 November 2013
- “Are real rates of return negative? Is the “natural” real rate of return negative?“, Tyler Cowen (Prof Economics, George Mason U), Marginal Revolution, 18 November 2013
- Brad DeLong (Prof Economics, Berkeley) comments at the Washington Center for Equitable Growth, 18 November 2013
(5) For More Information
(a) Posts about Japan:
- We are following Japan’s path of decline. The real test comes later this year., 23 June 2009
- As Japan sails into the shadows, let’s wish them well and wave good-by, 14 July 2009
- Japan can again become the land of the rising sun. We should watch and learn from them., 1 November 2012
(b) Posts about inflation:
- Inflation is coming! Or so we’re told. Instead look at the evidence., 7 February 2011
- Inciting fear of inflation in our minds for political gain (we are easily led), 28 February 2011
- Update on the inflation hysteria, the invisible monster about to devour us!. 15 April 2011
- Conservatives were correct: we have record-breaking inflation! What’s next?, 14 June 2013 — Record low inflation
- Lessons from the failed forecasts of inflation since the crash, 5 October 2013