Macro Issues

To link inflation and unemployment, you don´t need the Phillips Curve

Recently Joe Gagnon of the PIIE (Peterson Institute for International Economics) has used both the US and Japan to argue that there is no inflation puzzle. In other words, the Phillips Curve is alive and well. In the US piece, Gagnon writes: Some economists are puzzled over why US inflation has remained low while the economy has reached, or even exceeded, potential employment. Commentators have argued that central banks are wrong to place too much faith in the Phillips curve model, in which inflation responds to deviations from potential employment…, Yet inflation is behaving exactly as the Phillips curve would…...

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“Cost-push” & “Cost-pull” theories of inflation

In the 1960s and 1970s, “cost-push” was the great explainer of inflation. On the pro side, a group of highly influential economists: Paul Samuelson – Nobel winner James Tobin – Nobel winner Walter Heller – CEA Chair Gardner Ackley – CEA Chair Arthur Okun – CEA Chair Arthur Burns – Fed Chair On the contra side, advocating monetary causes for inflation, an almost lone voice: Milton Friedman – Nobel winner Just one example from the “cost-push” side: As late as 1979, just as Paul Volcker was getting appointed Fed Chair and about to start a monetary experiment to curb inflation,…...

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The DWL Cycle

Deepest (contraction) Weakest (recovery) and (soon to become) Longest (expansion). There are some interesting features to the DWL cycle. As the chart below indicates, the DWL cycle started off very mild, being one of the mildest three quarters into the recession. Then, when many of the other cycles were beginning their expansion phase, the DWL cycle turned markedly “south”. Why? That´s the moment the Fed, having tightened monetary policy on account of a misguided worry about headline inflation, which was being buffeted by the ongoing oil shock, decided to “micromanage” the economy by providing “rescue services”, mostly to the financial…...

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The flattening yield curve: What it means

In an economy with an interest rate policy target (most countries, including the US), rates, in general, give us a straightforward forecast of the most likely value for future policy rate level. We currently have a situation in the US Treasury market where yields are compressing together across maturities, i.e. the yield curve is flattening. The compression is most pronounced in the near-dated end, where 1- and 2-year instruments are yielding much closer to 5-year bonds than they were in, say, 2014. The yield curve is not currently flat, just moving closer to a position of moderate flatness, indicating that…...

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Why has output expanded slowly in this cycle? A market monetarist perspective

To many, this fact remains a puzzle, especially because the unemployment rate has returned to pre-crisis levels. Maybe by looking at another “deep recession moment” we may “solve” the puzzle. The 1981-82 recession and ensuing recovery comes to mind as a possible control. The first chart compares the two downturns. The 1981-82 downturn was much more acute. That contrasts with the 2007-09 downturn, which was initially quite tame. Why the “delayed” reaction? A possible answer looks to what was happening to monetary policy (NGDP growth). Initially, in both instances, NGDP didn´t change much. However, keep in mind that just prior…...

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There’s no “Conundrum”

As recounted by Greenspan in chapter 20 of his memoir “The Age of Turbulence”: “What is going on? I complained in June 2004 to Vincent Reinhart, director of the Division of Monetary Affairs at the Federal Reserve Board. I was perturbed because we had increased the federal Funds rate , and not only yields on ten-year treasury notes failed to rise, they’d actually declined. It was a pattern we were accustomed to seeing only late in a credit-tightening cycle, when long-term interest rates began to fully reflect the lowered inflation expectations that were the consequence of the Fed tightening. Seeing…...

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The Fed embraces the Phillips Curve to everyone´s chagrin

And on they go in the wrong direction. In the news conference Wednesday, however, Yellen defended the Fed’s policy of gradual rate hikes as forestalling a situation that could be much more damaging for disadvantaged groups. “We want to keep the expansion on a sustainable path and avoid the risk that … we find ourselves in a situation where we’ve done nothing, and then need to raise the funds rate so rapidly that we risk a recession,” she said. “But we are attentive to the fact that inflation is running below our 2 percent objective.” William Dudley, president of the…...

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Puzzling Surprises

Lael Brainard, a prominent member of the Fed’s board of governors, made the following admission in a recent speech, highlighting what policymakers see as economic puzzle: “At a time when the unemployment rate has fallen from 8.2% to 4.4%, core inflation has undershot our target for 58 straight months.” And: Albert Edwards, strategist at Societe Generale, is equally flummoxed: “It is incredible to think that this US recovery, the third longest in history, has seen core PCE barely exceed its 2% target and for only three months in 2012. That shows how deeply entrenched deflationary pressures are.” What is an “incredible puzzle”…...

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In trying to “square the circle”, the Fed is courting disaster!

Tim Duy summarizes the problem as the Fed sees it: The Federal Reserve can’t catch a break on the inflation numbers, which are simply not helping in its drive to normalize monetary policy. Monetary policy makers have three possible responses to the weak inflation data. First, they can define down the extent of an acceptable miss on their target. Second, they can dismiss the numbers as transitory and focus instead on full employment. Third, they can rethink their estimates of full employment and the subsequent implications for the path of interest rates. Early indications are that the Fed will pursue…...

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Unfathomable Monetary Policy Parameters

While Stanley Fischer defended central bank discretion, John Williams, of the San Francisco Fed defended a change in the monetary framework and strategy, arguing for a change in the monetary policy target, from inflation targeting to price level targeting: It’s been said that “getting over a painful experience is much like crossing monkey bars. You have to let go at some point in order to move forward.” Now that we’ve gotten the monkey of the recession off our backs, we have the luxury of being able to look to the future. This presents us with the opportunity to ask ourselves whether…...

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