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December 2018
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Crazy aunt out of the closet

In a presentation to this year’s annual meeting of the American Economic Association, Alan Blinder argues that the circumstances—low inflation and low nominal interest rates, persistent excess capacity, and fiscal policy paralyzed by large debts—that have forced central banks to operate through unconventional policy will be a recurring feature of the economic landscape. “We can’t stuff the crazy aunt back in the closet”.

According to Economist Magazine, of the rich world’s four major central banks, Britain’s and Japan’s already have their policy rates stuck near zero and the fourth, the European Central Bank (ECB), is likely to get there this year. Meanwhile, the balance-sheets of all four institutions have ballooned as they expand the volume and range of assets and loans they hold (see charts below).

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Whatever central bankers do, they cannot repair problems best fixed by politicians, such as America’s incoherent fiscal policy or Europe’s fractured institutions. Asked about the ECB’s aggressive new lending to banks, Masaaki Shirakawa, the governor of the Bank of Japan, said it could “buy time”. But he warned it could backfire if politicians fritter away whatever time the central bank has bought. Unfortunately, that risk is never low.

 

Jim Grant comments on Bernanke Fed

Jim has some sharp criticism on Ben Bernanke, and he thinks Fed’s QE3 is coming.

 

Bernanke’s first ever press conference

First ever press conference by a Fed Chairman. From CNBC:

Part 1

Part 2

Comments on Bernanke from some big market players – take note of Bill Gross’ view on inflation expectations.

Reinhart comments on Bernanke’s Fed

Vincent Reinhart discusses the Fed’s monetary policy outlook – Fed first need to unload its balance sheet before raising rates.

Maybe “stagflation” is for real…

Yield curve is telling a very different story than the stock market.  Echoing Meltzer’s earlier piece, “Bernanke’s 70s show“, maybe stagflation is for real…reports WSJ:

Treasurys may be signaling trouble.

[AOT]

The market is behaving in ways that suggest investors are starting to fret over the potential for stagflation in the U.S.

Consider the Treasury “yield curve.” It refers to the difference between short-term and long-term interest rates on U.S. Treasury debt.  Typically, as the economy is expanding, this curve has an upward slope, and is usually at its steepest during the earliest stages of a recovery.

Eventually, investors anticipate the Fed will begin raising interest rates to stave off inflation. That tends to lift short-term rates, compress long-term ones, and generally flatten the curve, or even invert it if investors expect the outcome could be recession.

Lately, with the U.S. growth outlook improving, the slope of the curve hasn’t started flattening, as might be expected at this point in the recovery. Instead, it has gotten steeper.

Earlier this week, the spread between two-year and 30-year Treasury yields hit a record-wide four percentage points, notes RBS Securities. At the same time, the implied annual inflation rate over a five-to-10 year horizon, based on Treasury yields, has moved up above 3% and towards levels last seen before the Fed’s previous rate-rise cycle began in mid-2004.

Investors, in other words, don’t expect the Fed to be as aggressive as in the past in raising rates—even as they see inflation on the rise.

“I think the Fed’s credibility is in question here,” says Priya Misra, head of rates strategy at Bank of America Merrill Lynch.

Or perhaps investors simply realize the Fed has put itself between a rock and a hard place. The U.S. unemployment rate is currently 9.4%, after all. It was at 5.6% in June 2004.

In a twist, the best scenario for the U.S. now is that interest rate increases in China, Brazil and other emerging markets rein in global cost pressures, giving the Fed—and the recovery—some breathing room.

The U.S. needs strong growth more than ever, especially with limited appetite for serious fiscal overhaul, to assuage the market’s other worry: wide deficits and heavy debt.

The clock is ticking.

Catherine Mann: Fed should give up its job rate target

Interview of Cathy Mann at Brandeis University.  She noted there was inconsistency in the Fed’s monetary policy —given the current unemployment rate, the Fed can’t be fighting inflation and unemployment at the same time — Either the Fed will have to give up their target on unemployment rate (6%), or they’ll have to give up their inflation target.   And since neither QE1 or QE2 did much to job creation, it’s better to give up the target on unemployment rate, rather than letting the market form expectations that inflation is going to get out of control.

Overconfident Ben Bernanke

In the following video, Ben Bernanke answers questions from Paul Ryan (R-WI). Paul asked some really sensible questions. Bernanke remains largely too confident. This is generally not a good sign.

Allan Meltzer, a historian specialized in the Federal Reserve system, in the following WSJ piece, shares his historical view on the Fed and inflation outlook. He thinks Bernanke Fed will put us on another “70s show”.

In the 1970s, despite rising inflation, members of the Federal Reserve’s policy committee repeatedly chose to lower interest rates to reduce unemployment. Their Phillips Curve models, which charted an inverse relationship between unemployment and inflation, told them that inflation could wait and be addressed at a more opportune time. They were flummoxed when inflation and unemployment rose together throughout the decade.

In 1979, shortly after becoming Fed chairman, Paul Volcker told a Sunday talk-show audience that reducing inflation was the best way to reduce unemployment. He abandoned the faulty Phillips Curve thinking that unemployment was the enemy of inflation. And he told the Fed’s staff that while he thought highly of their work, he did not find their inflation forecasts useful. Instead of focusing on near-term output and employment, he changed the Fed’s policy to put more emphasis on the longer-term reduction of inflation. That required a persistent policy that President Reagan supported even in the severe 1982 recession.

We know the result: Inflation came down and stayed down. The Volcker disinflation ushered in two decades of low inflation and relatively steady growth, punctuated by a few short, mild recessions. And as Mr. Volcker predicted, the unemployment rate fell after the inflation rate fell. The dollar strengthened.

That was not unprecedented. The Phillips Curve often fails to forecast correctly. Spanish inflation has increased in the last year while the unemployment rate rose above 20%. Britain also has rising inflation and rising unemployment. Brazil lowered inflation and unemployment together. There are many other examples if only the Fed would look at them.

Throughout its modern history, the Fed has made several of the same policy mistakes repeatedly. Two are prominent now. It concentrates on near-term events over which it has little influence, and neglects the longer-term consequences of its operations. And it interprets its dual mandate as requiring it to direct all of its efforts to reducing unemployment when the unemployment rate rises. It does not have a credible long-term plan to reduce both current unemployment and future inflation, so it works on one at a time. This is an inefficient way to achieve a dual mandate. It failed totally during the Great Inflation of the 1970s. I believe it will fail again this time.

Commodity and some materials prices have increased dramatically in the past year. Countries everywhere face higher inflation. Despite the many problems in the euro area, the dollar has depreciated against the euro, a weak currency with many problems, suggesting that holders expect additional dollar weakness. Imports will cost more.

I believe it is foolhardy to expect businesses to absorb all the cost increases by holding prices unchanged. And loan demand has started to pick up, increasing the amount of money in circulation. It is a big mistake to expect that the U.S. will escape the inflation that is now rising throughout the world.

Because the Fed focuses on the near term, it tends to ignore changes in money-supply growth. This, too, is a mistake. Sustained inflation always follows increases in money-supply growth. Sustaining negative real interest rates (i.e., adjusted for inflation), as we have now, will cause this.

The Fed should make three changes. First, it should increase the short-term interest rate it controls to 1%, which would show that it is aware of the inflation risk and will act promptly to counteract it. Current low interest rates are an opportunity for the Fed to start reducing excess reserves.


Bernanke ’60 Minutes’ Interview

Ben Bernanke’s second interview ever.

He declares, “we are not printing money”, because money supply is not moving. (I laugh…)

Mr. Bernanke called the inflation fears “way overstated” and said he had 100% confidence he could act quickly enough to keep prices in check. “We’ve been very, very clear that we will not allow inflation to rise above 2% or less,” he said. “We could raise interest rates in 15 minutes if we have to. So, there really is no problem with raising rates, tightening monetary policy, slowing the economy, reducing inflation, at the appropriate time.”

I am troubled by his 100% over-confidence. Yes , the Fed could raise interest rate in 15 minutes, but will the Fed raise interest rate when the inflation passed 2% yet unemployment rate remained very high still?

This video interview will become an evidence of the Fed’s overconfidence in a few years time.

Stephen Roach: Fed’s policy impatient and reckless

The Fed is repeating its mistakes – interview of Stephen Roach of Morgan Stanley:

Bernanke: Why QE2?

Bernanke explains the Fed’s action:

The FOMC intends to buy an additional $600 billion of longer-term Treasury securities by mid-2011 and will continue to reinvest repayments of principal on its holdings of securities, as it has been doing since August.

This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

John Ryding comments: