Are the Green Shoots for Real?

Joe Weisenthal has a number of post arguing that data are showing the green shoots of a robust recovery.  I hope he is right, but am leery of jumping the gun in believing a real recovery is underway.  There is still a shortage of safe assets and liquidity demand remains elevated. What would really convince me that a strong recovery were underway would be a marked improvement in two forward-looking indicators. The first one is a question on the Thompson Reuters/University of Michigan Survey of Consumer Sentiment where households are asked how much their nominal family income is expected to change over the next 12 months.  The figure below average response for this question up through February, 2012.

This figure shows that during the Great Moderation period (1983-2007) households expected their dollar incomes to grow about 5.3% a year. This relative stability of expected nominal income growth  is a testament to the success of monetary policy during this time. However, since 2008 households have expected 1.6% dollar income growth on average.  Until this changes, there is no way a recovery will take hold.  And yes, this speaks poorly of Fed policy since 2008. (My access to this data is limited by a 6-month lag.  So if you have access to this data, please let me know the latest numbers.)

The second indicator is simply the 10-year treasury yield.  As I noted many times before, this interest rate is currently at historic lows largely because of the weak economy, not the Fed (i.e. the short-run natural interest rate is depressed due to an increase in desired savings and/or a decrease in desired investment).  If the economic outlook were to improve, then the 10-year yield would go up because of higher expected real growth as well as some higher expected inflation.  And yes, the Fed could do more here by raising  expectations of future nominal income growth.  An explicit nominal GDP target should do the trick:

So until these two forward-looking indicators meaningfully turn around, I will remain hopeful but uncertain about our recovery. 

Where I Have Been

Sorry for the blogging hiatus.  I have been busy with other projects--I am seeking tenure after all and have to produce research that counts toward that goal--and activities. Some of these activities have been several trips to Capital Hill to do briefings on nominal GDP targeting to Congressional and Senate staffers.  One of those trips was yesterday, with Scott Sumner and I presenting to a group of about 70 staffers.  Former Dallas Fed President Bob McTeer moderated.   Here are the slides I used in my talk and here is Scott's new paper on NGDP targeting.  We had a good time and hopefully changed some thinking on the Hill.  Thanks to John C. Goodman and the NCPA for making this happen. 

 

PS. Too bad Bob McTeer is not still the Dallas Fed President.  He is a great monetary economist.  Be sure to check out his blog.

More NGDP Targeting Concerns: Gavyn Davies Edition

Gavyn Davies has a new column where he responds to Michael Woodford's call for a NGDP level target.  Davies is always a good read, but this time he raises some concerns about NGDP level targeting that are unwarranted.  He claims  that the Fed may be uncomfortable with a NGDP level target because it might unmoor inflation expectations, it might be seen as time-inconsistent with the Fed's long-run objectives, and finally it may be too late to return NGDP to its pre-crisis trend.  While understandable, the first two concerns are without merit under NGDP level targeting.  This approach to monetary policy actually anchors long-run inflation expectations and provides a credible way to commit.  The last concern has more merit, but even here it is not a clear-cut case. Let's look at each of these concerns in turn.

Was Hyperinflation the Intended Outcome?

The Wall Street Journal reports on the protests sweeping through Tehran:

Protests over the plunging Iranian currency erupted on Wednesday around Tehran's main bazaar, the country's commercial hub, as escalating economic woes become a rising political challenge.

The demonstrations marked the first time in three decades that the conservative merchant classes, a backbone of the Islamic Revolution in 1979, have publicly turned against the government.

Steve Hanke shows that the currency plunge is closely tied to the imposition of sanctions and that the extent of the plunge amounts to a new case of hyperinflation:

 When President Obama signed the Comprehensive Iran Sanctions, Accountability, and Divestment Act, in July 2010, the official Iranian rial-U.S. dollar exchange rate was very close to the black-market rate. But, as the accompanying chart shows, the official and black-market rates have increasingly diverged since July 2010. This decline began to accelerate last month, when Iranians witnessed a dramatic 9.65% drop in the value of the rial, over the course of a single weekend (8-10 September 2012). The free-fall has continued since then. On 2 October 2012, the black-market exchange rate reached 35,000 IRR/USD – a rate which reflects a 65% decline in the rial, relative to the U.S. dollar.

Move over Zimbabwe, Iran is the new poster child of hyperinflation.

Question: was this hyperinflation part of some grand plan coming out of the CIA/Defense Department/State Department?  Did economists in these institutions foresee that the sanctions would eventually push the state into creating a hyperinflationary environment?  Was it part of the plan?

Assorted Musings

Here are some assorted musings:

1.  I owe Fed chairman Ben Bernanke an apology.  Based on David Wessel's book, Larry Ball's paper, and the inconsistencies between Bernanke's old and new work, I was convinced that Bernanke was being too nice of a guy at the Fed.   Jon Hilsenrath, however, shows in a recent piece that I was wrong.  Bernanke, in his own way, manned up and convinced the FOMC to do QE3.  Yes, a few years too late and not quite a a NGDP level target, but it is a start.  Bernanke now needs to finish his job by convincing the FOMC to now adopt a NGDP level target.  See Matt O'Brien for more on how Bernanke transformed the FOMC.

2. Matt Yglesias reminds us that the Reserve Bank of Australia is probably the best central bank in the world.  Australia has not had a recession in over 20 years, an outcome Yglesias attributes to sound monetary policy. A related question that has vexed me is how Australia has been able to run almost 60 years of current account deficits. Josh Hendrickson thinks that given the relatively stable macroeconomic environment in Australia, foreigner investors have come to view the Australian dollar as a reserve currency of sorts and are glad to hold Aussie assets.  What do you think?

3.  Apparently many observers, like CNBC's Rick Santelli, were upset that Ben Bernanke claimed in  a recent Q&A that Milton Friedman would endorse his views.  Joe Weisenthal reports:

[Bernanke] pointed out that Friedman advocated QE for Japan during its struggle against deflation and weak growth. He also recalled one of  Friedman's most important lessons, that low interest rates...Bernanke said specifically, when citing the lesson of Milton Friedman: "We didn't allow the fact that interest rates were very low to fool us into thinking that monetary policy was accommodative enough."

As I have noted before, Milton Friedman probably would have advocated systematic, rules-based polices that would have restored aggregate nominal income to its pre-crisis path. 

4.  Andy Harless explains that the Fed is the one institution that could meaningfully respond to the worst case outcome for the fiscal cliff:  

[I]t’s hard to think of any feasible monetary policy action that would both be strong enough and have a sufficiently quick impact to offset the fiscal cliff directly.  But what matters more for monetary policy is not the direct effect but the effect on expectations.  Surely the Fed could alter expectations of future monetary policy in such a way that the resulting increase in private spending would be enough to offset the decreased spending due to fiscal tightening. 

He goes on to argue that the Fed adopting a NGDP level target that aims to put nominal spending back on its pre-crisis path would be just such a policy.  However, he is not hopeful it will happen.  Scott Sumner agrees.  This discussion highlights the Fed's ability to offset adverse fiscal policy shocks.  It is also highlights why it is hard to measure the size of the fiscal policy multiplier if the Fed is offsetting such fiscal policy shocks.  However, if Harless is correct, we will have a natural experiment of sorts later this year that will allow us to get a better glimpse of the size of the fiscal policy multiplier.

Is the Fed Buying Up All the Treasury Debt?

No, according to the data provided by SIFMA.  The Fed actually holds a relatively small share of total marketable treasury securities:

The other big holders include foreigners, households, mutual funds, banks, and pensions.  So don't blame the Fed for the low yields on Treasuries.

Facts for Jame Bullard

St. Louis Fed President James Bullard just delivered a speech where he claims that U.S. monetary policy has been stellar over the past four years.  In fact, he says monetary policy was "close to optimal." Yes, I about chocked too after reading that line.  His view is that (1) the Fed kept the price level on its long run trend and that (2) there was a reduction in U.S. potential output that undermines that case for looking at NGDP being below trend.   Consequently, there is nothing to the claims of insufficient aggregate demand.  It is all structural, end of the story.   

This is not the first time Bullard has made claim (2), but it is the first time he has combined it with the claim that the Fed has been doing a fine job since 2008.  Scott Sumner has already responded and I am sure others will too.  My response to Bullard is that your theory cannot explain an important development that have been ongoing since 2008: the elevated demand for liquidity.  If we are simply on a new growth path and the Fed has done a fine job with monetary conditions, then why is the demand for safe assets still so pronounced?  Below are five facts about this ongoing demand for liquidity:

Fact 1

Households and other retail investors have been increasing their holdings of FDIC-protected saving deposits at an usually rapid rate.  This surge in saving deposit growth starts during the crisis in 2008 and still is growing.  Since that time, households have acquired almost $2.4 trillion worth of saving deposits.

Fact 2

Households have been one of the biggest purchasers of U.S. treasuries over the past 4 years.  Through direct purchases, households have gone from holding $264 billion in 2007:Q4 to $1.3 trillion in 2012:Q1. If mutual funds purchases of treasuries reflect indirect household purchases, then household holdings have grown from $647 billion in 2007:Q4 to $2.2 trillion in 2012:Q1. This is more than double the Fed's increase in treasury holdings.  Only foreigners have bought more. (Update: these numbers were based on SIFMA data thru 2012:Q1.  The Q2 data shows major revisions such that direct household holdings went from $202 billion in 2007:Q4 to $878 billion in 2012:Q2.  Including mutual fund purchasers of treasuries put household holdings at $584 billion in 2007:Q4 and $1810 billion in 2012:Q2. These combined purchasers are still  more than the Fed's, but not double. Interestingly, these revision show the Fed's holdings at about 15% of total marketable treasuries.  So much for the Fed buying up all the deficit)

Fact 3

Household holdings of liquid assets as a percent of total assets soared in 2008 and have yet to come down.  Household porfolios, therefore, are still inordinately weighted toward safe, liquid assets and have yet to undergo the type of portfolio rebalancing associated with a robust recovery  (i.e. a rebalancing of portfolios away from low yielding, liquid assets to higher yielding, riskier assets will spawn indirect effects on aggregate nominal spending via balance sheet and wealth effects and directly through purchases on capital.  See here for evidence on this portfolio channel).

Fact 4

Interest rates on safe assets are at historical lows.  Given the facts 1-3 above,  it should be evident that these low interest rates are  the result of an elevated, ongoing demand for safe assets.   As noted above, the biggest purchasers of U.S. treasuries has not been the Fed over the past four years.    So don't blame the Fed.

Fact 5

Since the start of the crisis in 2008, movements in the stock market and expected inflation have been highly correlated as seen here.  This is an unusual relationship that only started during the crisis and continues to this day.  Thus, whatever caused it to happen in 2008 is still with us today.  The easiest interpretation that is consistent with facts 1-4 above is that spike in demand for safe, liquid assets that began in 2008 has yet to subside.  Here is why: any rise in expected inflation that would reduce this intense demand for liquid assets and thereby raise the expected future nominal income, would also raise expectations of higher future stock prices.  In anticipation of this development, investors buy stocks in the present (see David Glasner).  Thus, expected inflation and stock prices are currently related.  Since liquidity demand still remains elevated, there apparently hast not been a big enough increase in expected future nominal income to break this relationship.

Those are the facts.  They all indicate there is still an elevated demand for liquidity that is slowing the economy. Now here is the thing.  By changing expectations about the path of future nominal income, the Fed could reduce this demand for liquidity and spark a recovery in nominal expenditures.  Specifically, by setting a NGDP level target, the Fed could increase both the certainty and expected amount of future nominal income.  This would increase demand for credit today and kick start the private creation of safe assets.  It also would decrease the demand for safe assets.  That the Fed has not done this and, as a result, there is still elevated liquidity demand screams Fed failure, not success.  

 Now this is not to say there are no structural problems. Only that there still remains a sizable excess demand for liquidity that is constraining aggregate nominal spending.  My hope is that James Bullard and others who share his views will wrestle with these facts that point to this safe asset demand problem.