ECRI looks at our Great Monetary Experiment: It’s Too Big to Fail

Summary: The Economic Cycle Research Institute (ECRI), who correctly predicted the slow recovery, explains the slow growth in which the US and Japanese economies are mired, and the fantastic monetary experiment waged by central banks to prevent them slumping into recessions.

Appreciate the wonders of our time.

"Machinery of the Stars" by alexiuss
Machinery of the Stars” by alexiuss at DeviantArt.

The recovery since 2008 has been difficult for predictions, both by bulls and bears. The bulls have repeatedly predicted accelerated growth and rising inflation. But the bears too-often predicted a recession (boldness is often expensive for forecasters). In September 2011 the ECRI staff predicted a recession in 2012. They repeated that call in the following months, and in November 2012 said the recession had began in July.

A few of us correctly predicted continued slow growth — no boom, no recession (e.g., see this from August 2013) — and our similarity to Japan (see this of mine from September 2014).

On balance the bears have more accurately seen the big picture than the bulls. Paul Krugman, Larry Summers, and the ECRI (me, too) saw this secular stagnation (see this from November 2013). And growth has been slow. Over the past 10 years (Q1 2006 to Q1 2016) real growth in gross domestic income (GDI) has been 2.3%/year. More importantly, growth in GDP per capita has been only 1.2%/year. As for the future, the Fed expects even slower long-term growth in real GDP — only 2%.

So we should listen to the ERCI’s perspective on the US economy, the Fed’s efforts to stimulate it, and the global economic context. The West is running one of the greatest economic experiments in history, with high stakes.

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Grand Experiments That Are Too Big to Fail.

Reposted with their generous permission.
ECRI, 28 January 2016

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As the great and the good gathered in Davos to ponder the next big thing, the pummeling of global equity markets brought key assumptions into question. Yet, their collective heads stayed buried in the snow with regard to the big ideas from years past, namely, the three grand economic experiments launched by the U.S., Japan and China following the Global Financial Crisis.

The fate of the global economy depends on the success of these unconventional efforts to boost economic growth. Yet all three ventures are now in danger of failing because none of them addresses the fundamental challenge of structurally slow growth.

The first grand experiment began in 2008, when the Fed embarked on its zero interest rate policy (ZIRP) and unleashed quantitative easing (QE) to depress interest rates further. Since then, each time economic growth has faltered, the Fed has doubled down –– with QE2 in 2010, “Operation Twist” in 2011, and the unlimited bond-buying program dubbed QE3 in 2012. Finally, with economic growth improving in 2014, the Fed resolved to start a rate hike cycle in 2015, ending seven years of ZIRP.

Almost immediately after the first rate hike, newfound recession fears have put many on edge. Of course, economic cycles are inevitable in market-oriented economies, which alternate between periods of rising and falling growth. Some of these slowdowns end in “soft landings,” others in recession. But it is clear from our cyclical viewpoint that the Fed started hiking rates unusually late, a year inside a slowdown.

The data show U.S. growth slowing throughout 2015, according to the broad coincident indicators of aggregate output, employment, income and sales used to decide official business cycle dates. For instance, year-over-year (YoY) growth is at 1½-year lows for GDP and nonfarm payroll jobs, let alone industrial production growth, which is at a six-year low. Still many, including the Fed, expect growth to bounce back. But unless that happens soon, its rate hike plans will likely be overwhelmed by the sustained cyclical downturn in growth.

The grand experiments in USA and Japan.

A central goal of the Fed’s grand experiment has been to demonstrate that –– given sufficiently aggressive and timely QE –– the U.S. would not “become Japan,” returning repeatedly to ZIRP and QE. They have been blazing a path that the Bank of England and the European Central Bank hope to follow, expecting an eventual return to “business as usual.” However, if the Fed cannot begin a true rate hike cycle after seven years of ZIRP –– a prospect made more real by volatile equity markets –– it would force others to reconsider the risks of their own economies “becoming Japan.”

“Abenomics” is another grand experiment, launched three years ago with a promise to leave Japan’s “lost decades” behind. Its “three arrows” included not only unprecedented QE, but also muscular fiscal policy and structural reforms. Its success would show policymakers everywhere the way out, even if their economies did “become Japan.”

However, Abenomics is also tottering. In 2014, Japan experienced its fourth recession since 2008 before barely avoiding a fifth one in 2015. Meanwhile, CPI inflation remains near zero, and household spending, which makes up nearly 60% of its GDP, has dropped over 4% since early 2014.

The potential failure of these two grand experiments –– in the U.S. to avoid “becoming Japan,” and in Japan to exit its “lost decades” –– is ominous. A third grand experiment, launched in China following the Global Financial Crisis (GFC), involved not only massive monetary easing, but truly colossal fiscal stimulus that included pouring more concrete in the three years ending in 2013 than the U.S. had in the entire 20th century. The resource bust that followed has sent deflationary shockwaves around the globe, and the repercussions are not over yet.

Years of robust growth had fostered the belief that China was led by infallible technocrats who always knew what levers to pull, and when. But their handling of the stock market crash and exchange rate volatility since the summer has undermined confidence in China’s ability to pull off a tricky transition to a consumer-driven economy.

Business cycles: we had these nice cycles in the good old days.

The Business Cycle

A slowing world economy.

Policymakers need to confront the inconvenient truth that long-term trend growth is declining practically everywhere. Recent Fed minutes have begun that process, acknowledging that the equilibrium real rate, which “currently is close to zero … would likely remain low relative to [pre-GFC] estimates” if “productivity does not pick up and if demographic projections … are borne out.” That “might increase the frequency of episodes in which policymakers would not be able to reduce the federal funds rate enough to promote a strong economic recovery … in the aftermath of negative shocks.”

The math is too simple to ignore. Potential labor force growth will average ½% per year for at least the next decade, and U.S. labor productivity growth may well stay around ½% a year, its rough average for the last five years. These add up to 1% long-term potential GDP growth, which actual GDP growth can surpass only temporarily during a cyclical upswing – and certainly not during a cyclical slowdown. This is a challenging problem, with demographics practically set in stone, and a boost to productivity growth realistically possible only in the long run.

Consequently, after years of ZIRP and QE attempting to pull demand forward from the future, central banks are increasingly powerless when it comes to the economy itself. They can “print” money, but not economic growth. The world is watching, so those who are thought to walk on water cannot afford to be seen to have feet of clay.

If U.S. growth keeps slowing this year, recession risk will rise, and the Fed will likely revisit ZIRP, in one way or another. The failure of Abenomics is not inevitable, but appears increasingly probable. And while China is not yet facing a hard landing, growth continues to slow, raising legitimate concerns about its leaders’ capability to avoid one.

By clinging to unrealistic growth expectations, the economic establishment has effectively bet everything on the success of these grand experiments, and the risk of losing that bet is rising inexorably. Ultimately, only policies that genuinely address the challenges of demographics and productivity have a chance to succeed. It is high time for that discussion to begin.

———————— End of ECRI report ————————

About the Economic Cycle Research Institute

The ECRI is an independent research institute. Their indicator systems predict the timing of changes in an economy’s direction, before the consensus of economists. It is one of the three best-known non-government publishers of leading indicators, along with the Conference Board and the OECD.

The ECRI’s co-founder was Geoffrey H. Moore.  From his March 2000  NY Times obituary  ”In a sense, he was the father of the leading indicators as we know them today,” said Anirvan Banerji, co-director of research with Dr. Moore at the ECRI. The successor to the forecasting tools he developed is ECRI’s Weekly Leading Index (WLI). From 1949 to 1978 Moore set the start and end dates of recessions for the National Bureau of Economic Research (NBER). When they created a committee for this, he was its senior member. Using the same approach, ECRI has long determined recession start and end dates for 20 other countries that are widely accepted by academics and major central banks as the definitive international business cycle chronologies.

For information about their approach, see their About page.

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17 thoughts on “ECRI looks at our Great Monetary Experiment: It’s Too Big to Fail

  1. Thanks for printing this, FM, but it misses the most important part of the story, which is Europe.

    Since the article was printed in January, it has slowly become evident that the biggest problem in the overall world fiscal structure is that the United States of Europe (another massive “too big to fail” experiment), without a constitution or a unified popularly supported central government, has major cracks in its foundation that are slowly overwhelming the benefits of the institution, the British Exit vote this week is just another symptom of deeper problems that must be addressed to prevent an eventual collapse. In the meantime Europe is exporting its stagnation problems to the US and China, which narrows the list of options for dealing with problems in those countries.

    This problem is undermining confidence in the ability of the Fed to return the US economy to a normal (aka pre-2000) situation. For the past 9 years the US markets have hung on every nuance of every statement that the Fed might make. Faith in the Fed is one of the few remaining supports for the US stock market and that is weakening every time a foreign government lowers its interest rates further below zero. When (not if) faith in the Fed drops below a currently unknowable point, the bottom will fall out of the market.

    Because the links between Wall Street and Main Street have been weakened, I cannot say what will happen beyond that point but it is unlikely to be good.

    The only organization that has the power to overcome a lack of faith in the US Federal Reserve is Congress, but faith in that organization has long since dropped below the minimum credibility point. Will the President usurp the Constitution to save it? Stay tuned as events unfold.

    1. Pluto,

      “it misses the most important part of the story”

      All essays have to have boundaries. None describes the Cosmic All; all omit to describe important aspects of the situation: the personalities, the theory, the politics, etc.

      In any case, this is specifically about the monetary experiment being being conducted by the BoJ and Fed. Yes, the world has other economic problems. No, they are not the subject of this ECRI report.

      “it has slowly become evident that the biggest problem in the overall world fiscal structure is that the United States of Europe ”

      It’s not a fiscal problem. Despite the loudly stated myths, the crisis in the PIGS was not caused their imprudent fiscal deficits. The problem is monetary union with both political & economic integration.

      “This problem {politics of the EU} is undermining confidence in the ability of the Fed to return the US economy to a normal (aka pre-2000) situation.”

      I doubt that europe is the cause of our slow growth. The US economy flat-lined in 2005 (real GDI and real per capita), crashed in 2008, and has grown only slowly since then. The EU problems emerged only in early 2010 (the first Greek bailout was in April).

      “This problem is undermining confidence in the ability of the Fed to return the US economy to a normal (aka pre-2000) situation.”

      Rightly so. Belief that the Fed’s monetary policy can fix this is delusional, with little support in theory and none in history.

      “For the past 9 years the US markets have hung on every nuance of every statement that the Fed might make”

      Investors are a herd of ignorant sheep. In the 1980s they hung on every bit of data about the money supply as signals about the future economy. They might as well have been watching variations in barometric pressure.

      “Faith in the Fed is one of the few remaining supports for the US stock market”

      That seems unlikely to me. More unlikely is that you have any evidence for this theory.

      “Because the links between Wall Street and Main Street have been weakened,”

      They have not weakened. There was never a strong correlation between measures of “main street” and “wall street”. Stock prices vary according to a varying set of influences, in varying ways — most notably interest rates (sometimes together, sometimes inversely), the dollar, changes in the CPI, and profits of large corporations (the only one of these factor with a fixed relationship).

      “The only organization that has the power to overcome a lack of faith in the US Federal Reserve is Congress”

      I can’t even imagine what that means.

    2. FM: “I doubt that europe is the cause of our slow growth.”

      Agreed, but the actions the Europeans are taking, primarily below zero interest rates and ramping up an aggressive bond-buying program when evidence from Japanese and US efforts show it doesn’t work very well and the side effects are worse than the disease, are limiting the options of the Fed.

      FM: “Rightly so. Belief that the Fed’s monetary policy can fix this is delusional, with little support in theory and none in history.”

      Agreed but that theory seems to be very important to the investors. In defense of the investors, they have little choice of groups in which to have faith because Congress, which has far better tools to solve the problem, is determined to do nearly nothing.

      FM: “Investors are a herd of ignorant sheep.”

      Agreed, but their collective actions shape an important part of the history of the world at this time.

      Pluto: “Faith in the Fed is one of the few remaining supports for the US stock market”
      FM: “That seems unlikely to me. More unlikely is that you have any evidence for this theory”

      I will address that in a response to Breton. For now I will tell you that I am calling the current record-high stock prices the “Fed Bubble.”

      Pluto: “The only organization that has the power to overcome a lack of faith in the US Federal Reserve is Congress”
      FM: “I can’t even imagine what that means.”

      My comment was rather badly worded but I intended to mean that Congress could be spending money to improve our infrastructure and increase aggregate demand, which is the heart of the issue. But I agree that this seems unlikely.

    3. Pluto,

      These are deep matters, but I doubt you have much evidence for most or any of these theories. I’ll just mention a few points.

      “Agreed, but the actions the Europeans are taking, primarily below zero interest rates and ramping up an aggressive bond-buying program when evidence from Japanese and US efforts show it doesn’t work very well and the side effects are worse than the disease

      That’s probably all wrong. There is much evidence that the natural rate of interest is near zero. Certainly there’s no evidence that the Fed’s QE depressed rates — or that the end of QE has increased rates. There is little evidence that programs of the BoJ, Fed. or ECB have had ill side-effects — despite hysterical making stuff up by conservatives (remember the certain hyperinflation that began in 2012?).

      “Agreed but that theory seems to be very important to the investors”

      Probably not. But determining what “investors” (a heterogenous crowd, the opposite of a unitary entity) want or like is difficult. It’s fun for stock market gurus to write about, but much of what they write results from making stuff up — or overheard chatter at the Kit Kat Club (the now closed Wall Street dive). I suggest leaving such speculation for those who get paid to write fun stuff, or Prof Xavier.

      ‘record-high stock prices the “Fed Bubble.””

      Almost certainly wrong. Probably just more conservatives nonsense, now that their confidence screams of HYPERINFLATION have proven false, they’ve shift to a new baseless story.

      “that Congress could be spending money to improve our infrastructure and increase aggregate demand, which is the heart of the issue.”

      That certainly would do zip to boost confidence in the Fed. It’s worth doing — fixing our infrastructure while borrowing costs are nil — but is at best a temporary stimulus. It is certainly not a cure for secular stagnation.

    4. In general I am not going to respond to your comments, FM because you and I are not generally in disagreement but there is one comment I would like to highlight.

      Pluto: “Agreed, but the actions the Europeans are taking, primarily below zero interest rates and ramping up an aggressive bond-buying program when evidence from Japanese and US efforts show it doesn’t work very well and the side effects are worse than the disease

      FM: “That’s probably all wrong. There is much evidence that the natural rate of interest is near zero. Certainly there’s no evidence that the Fed’s QE depressed rates — or that the end of QE has increased rates.”

      I was not stating that the below zero interest rates or the bond-buying program would raise interest rates. I agree with you that the natural interest rate is currently near zero and will likely stay there for some time.

      My point was that every time the Europeans lower their interest rates they are raising the US interest rates by comparison. Perhaps an example will help explain my point: If the US has an interest rate of 1% and the Germans have an interest rate of 0% and they lower it to -0.5% they have effectively raised the US interest rate by comparison and the US dollar gets stronger (which hurts aggregate demand for US products) and foreign reserves move into the US for safety or to chase yield.

      This reduces the opportunity for the US to raise interest rates to undo the flood of excess cash floating around the world looking for yield or to cushion against a future recession.

    5. Pluto,

      “This reduces the opportunity for the US to raise interest rates to undo the flood of excess cash floating around”

      No, it doesn’t. Also…

      • Most of the developed nations are at the zero bound, and have been for years. Policy rates have just followed natural rates down, to negative real rates — and even to negative nominal rates
      • Foreign exchange flows have been largely determined by other factors since the crash. For example, the flows out of Greece in the past few years and China today have nothing to do with interest rates.
    1. Breton,

      (1) Start research to determine what’s causing the slow growth. Now everybody is obsessed with monetary policy magic beans, so there’s little research (i.e., garage research, one or two people teams working on their own, with little funding) on deeper diagnosis — let alone cures.

      When that’s done we can talk about step two. Can’t cure what we don’t understand.

    2. I have been studying this issue for some time and, if you will tolerate the theories of a reasonably well-educated layperson, I will share my thoughts with you.

      The heart of the problem is slow growth. If you follow Keynes and his acolytes, this is caused by lack of demand. The other major theory is that the lack of growth is caused by a lack of confidence by business managers in the economic future. Since the implications of the second theory can be used by Wall Street to help sell people stuff at the high prices, it is the more commonly discussed theory even though the track record of people who base their predictions on it is abysmal at best.

      By contrast, the Keynesian predictions have been pretty accurate so I will base my recommendations on their theory. Looking around, the upper class doesn’t spend a lot of their assets in ways that tend to increase aggregate demand. The middle class is fracturing and doesn’t have a lot of spare cash. The poor are in terrible shape and never had much to begin with. Wage growth is low and people are still dropping out of the workforce. Not much help from the consumer.

      Investors have put much of their assets into stocks, which paid off pretty well from 2009-14 but hasn’t done very well in the last couple of years. Critics of the Fed say this is because the Fed has not established a business climate that will persuade companies to spend money. I say that factories are running at 75% of capacity, companies did a lot of modernization in the 2008-10 period, profits have been falling for the last couple of years, and they borrowed large amount of money for “financial engineering.” Businesses are still in reasonably good shape but they have no reason to spend money right now and lots of good reasons to not spend money.

      This leaves the government. The Fed since 2008 has been trying to save the US economy almost unaided by Congress but has slowly come to realize that their efforts have mostly made the 1% even more wealthy and has left investors in a potentially precarious position.

      Congress has the power to spend lots of money and there are a very large number of good projects: physical and internet infrastructure that would pay for themselves many times over a period of 30+ years. But Congress is very anti-Keynesian these days so action is unlikely at best.

      Another major issue is that the population is getting older, our healthcare costs are going up, workforce participation is going down and we need to discover why young men in particular are dropping out of the work in record numbers.

      Finally there is the issue of increasing automation. This makes production cheaper, which is good, but loses us jobs which drives down aggregate demand which is really bad.

      It seems like I have painted myself into a corner but that is because I have been looking inside the box. A solution exists but it is outside of the standard theories and I do not know what it is at this time. The states should start experimenting to see what does and does not work. About all I can predictably say is that tax cuts primarily for the rich and government spending cuts are guaranteed to make things worse.

    3. Pluto,

      As one of those early in predicting the out-of-consensus slow growth scenario (no boom or normal growth, no crash), I have followed this before “secular stagnation” became trend. Unfortunately economists’ understanding of this problem has not developed much beyond those described in this post: Has America grown old, and can no longer grow? Or are wonders like the singularity in our future?, 28 August 2012. I quoted this grim conclusion:

      “These include demography, education, inequality, globalization, energy/environment, and the overhang of consumer and government debt. A provocative “exercise in subtraction” suggests that future growth in consumption per capita for the bottom 99% of the income distribution could fall below 0.5 %per year for an extended period of decades.”

      — “Is U.S. Economic Growth Over? Faltering Innovation Confronts the Six Headwinds“, Robert J. Gordon, National Bureau of Economic Research, August 2012.

      For more about this I recommend these:

      For a deeper understanding I recommend these two books: Are we Doomed to Secular Stagnation? Limitations of Supply-Side Economic Policies by Uwe Petersen (2014) and the highly rated Secular Stagnation: Facts, Causes and Cures by editors Richard Baldwin and Coen Teulings (2014).

    4. I was also studying “secular stagnation” before it was popular although I did not come up with a snazzy name for it like Larry Summers did. I recall the shock when I first heard Summers’ speech. My first thought was, “Hey, other people are thinking the same thing! And they’re respectable!”

      You will notice that my “in the box” thinking mirrored your comments about permanent slow growth. I remain convinced that there is a solution to secular stagnation but do not have the time or the resources to find it. This is why I recommend that the states start experimenting with something other than cutting taxes for the wealthy (I’m looking at you, Kansas. That didn’t work very well for you, did it?) or cutting services (Walker’s plan to zero out funding for state parks will probably not succeed but it will further reduce the quality of life enjoyed by the citizens of Wisconsin, what a small-minded jerk).

      It is possible that in the worst case we can only find most comfortable way to endure secular stagnation but I hope to do better. There is no reason to delay the experiments any longer, time is not on our side on this issue.

    5. Pluto,

      “I did not come up with a snazzy name for it like Larry Summers did.”

      “Secular stagnation” — both the term and theory — originated with Alvin Hansen in 1938.

      “about permanent slow growth.”

      None of the causes given by mainstream economists are permanent. The demographic wave of aging will pass. Technology will begin to advance again — the signs of a new industrial revolution suggest this has already began. Globalization is a transitional phase. etc.

      “There is no reason to delay the experiments any longer, time is not on our side on this issue.”

      How would you reply to a doctor who said that a cure was needed for a new disease, so he wanted to experiment with your daughter? Research — empirical and theoretic — is needed before doing more policy initiatives, such as the GOP’s mad spinning of the policy dials in Kansas, Arizona, etc.

  2. “Start research to determine what’s causing the slow growth. Now everybody is obsessed with monetary policy magic beans, so there’s little research (i.e., garage research, one or two people teams working on their own, with little funding) on deeper diagnosis — let alone cures.”

    energy and demography

    here for historical approach: website of Peter Turchin, a scientist studying mathematical modeling and statistical analysis of the dynamics of historical societies. He is a professor at the U CT in the departments of ecology, mathematics, and anthropology.

    here for link between energy and economy: Surplus Energy Economics by Tim Morgan (former head of reserch at Tullett Prebon, a London money broker)

    here for demography The Final Fall: An Essay on the Decomposition of the Soviet Sphere by Emmanuel Todd (La chute finale: Essais sur la décomposition de la sphère Soviétique),

    and here: “Russia’s Demographic Problems Started Before the Collapse of the Soviet Union” by by Guillaume Vandenbroucke in Economic Synopsis of the St. Louis Fed, 23 Feb 2016.

    1. Paolo,

      Thank you for the interesting links. I’ve cleaned up your text, to make it easier for others to read.

      Professor Turchin’s work looks fascinating.

      The two works about the fall of the USSR are also interesting, but of no obvious relevance to the slowing growth of the US since roughly 1970.

      Tim Morgan gets some good press for his work, such as this in the Economist. It’s a provocative analysis.

  3. demografy and slower growth: we go with usa.

    in early 1970, from 3 milion B/d us import became 6.5 kb/d (1975 1979): probably this give a reason.

    on the demografy side, in 1986 a record of more than 2 million people was added in the 25-64 age group (oecd data here) but after every years us population growth slower and slower: in 1996 the growth 25-64 was lower than half compared to 1986 and in the 2005 for the first time population growth is due more for the over 65 age group. in 2009 and every years after to 2013 population growth in 25-64 age group was below 0.

    from 2000 to 2014 total federal debt growth to 18T: economy is based on consumption: there are a lot of factor but old man consume less than young: so energy stress (record price and same quantity but incresing lower quality) and population stress push consumption down and debt skyrocket to fill the gap. the same is true for every developed country: the year of turning point change but when old people start to growth more then young debt skyrocket and economy go close to stall speed: China turning point 2010-2011 Japan 1991 (as two example) (fell free to work on my comment. it’ s not a trouble

    1. Paolo,

      For decades economists have been aware of demographic effects on the economy, and can measure them quite accurately. They are a factor in the slowing, but a minor won.

      The Federal debt is $13.9T (the $5.4T of intragovernmental debt is meaningless, just like IOUs you owe yourself). It has had zero effect on the US economy. Among other evidence, the near-zero interest rate on treasuries shows that there is as yet no problem. A relevant metric is the debt to GDP ratio, which remains not only far below that of other developed nations — but also below the 90% level that some believe (with little evidence) is a red line.

      “economy go close to stall speed:”

      There is no such thing as a “stall speed” for a developed economy. That was a controversial theory several years ago; the slow but non-recessionary growth in Europe and the US has disproved it. See tomorrow’s post for more about this.

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