It is a basic element of logic that if A = B and B = C, then A must also equal C. In terms of action, if I do a thing and that thing always leads to a predictable outcome, not seeing that outcome causes one to question whether or not one actually did that thing. In other words, A must not have equaled B.
Central bankers all over the world are stumped. Nothing they have done has led to what was expected when one does such things. In very basic terms, we all know, as history has shown, that money printing leads to inflation. In most cases, it leads to the most extreme forms of inflation, which is why human history in financial and economic terms is really a study in how to keep official efforts from ever going in that direction (gold worked the best, which is why it survived for so long).
Yet, despite the warnings, global monetary policy went there in 2009 and hasn’t really stopped. The initial (mainstream) criticisms of quantitative easing were mostly in relation to this historical expectation for runaway inflation, the inevitable C to the money printing of B. By the middle of 2012, though, there were already indications that both QE and its mainstream critics were wrong due to one fundamental flaw. When the Fed was getting ready for QE3, it was because inflation was thought tamed and the economy itself not nearly what it should have been:
Two years ago, Federal Reserve Chairman Ben S. Bernanke suggested he would embark on a second round of asset purchases, sparking criticism in the U.S. and abroad that he risked a rapid acceleration in prices. Since then, inflation has held near the Fed’s goal of 2 percent, and bond traders predict prices will accelerate at about that rate during the next five years.
Not only was the economy “mysteriously” weak at that point, inflation was already several months into what would become a steady and persistent deceleration (50 months and counting). Even though QE3 and QE4 combined were much larger than QE1 and QE2 combined, inflation was entirely unmoved as if the latter QE’s had never occurred. How could that be? Worse, this wasn’t just limited to Federal Reserve policy; despite balance sheet expansion all over the globe we find the same lack of response.
The answers are all right there on the charts above, but rather than follow basic logic central bankers will do as they always do; search for ways to make the problem worse by not learning anything about their failure. It is the political nature of bureaucracies, though combined nefariously with the intellectual bubble of economics. As I wrote late last week in what was really the preface for this part of the discussion, basic monetary tenets are not meant to be challenged.
Economists gave up on that price stability through the gold standard because they charged gold with the crime of the Great Depression; indeed as with every other depression and bank panic before it. To sustain a little inflation, they theorized, was to buy insurance against the worst parts of the worst economies of the past. To gain a little inflation meant to destroy the gold standard. Having done that, economists like Mankiw were absolutely sure (take him at his word) that nothing more than a commitment to “a little” inflation would always be effective.
Because of that commitment, economists were sure 2008 was impossible; they even said so, repeatedly. Now in trying to explain why they were wrong about that, policymakers all over are starting to wonder whether 2% inflation was not “a little” but “too little.” An article in the Wall Street Journal Friday tries to make the case.
But in 2008, central banks around the world cut interest rates to nearly zero and printed copious amounts of money, and only lackluster growth followed. “Higher average inflation, and thus higher nominal interest rates to start with, would have made it possible to cut interest rates more,” the authors wrote, which would have made the recession less deep.
Economists like Paul Krugman have been arguing for some time for a 4% inflation target, though his initial call was related to Japan and getting that country to restart. The idea is spreading, and why shouldn’t it? It allows economists to avoid having to account for their conduct and at most suggests that they are admitting nothing more than difficulties in finding the magic number. In other words, orthodox economics isn’t wrong, the world is so complex that it is difficult even for the “experts” to identify the “right” numbers. It sounds plausible.
Last Monday, John Williams of FRBSF wrote of this policy attempt at reframing rather than restarting:
Two alternatives can be considered together or in isolation to address this issue. First, the most direct attack on low r-star would be for central banks to pursue a somewhat higher inflation target. This would imply a higher average level of interest rates and thereby give monetary policy more room to maneuver (Williams 2009; Blanchard, Dell’Ariccia, and Mauro 2010; Ball 2014). The logic of this approach argues that a 1 percentage point increase in the inflation target would offset the deleterious effects of an equal-sized decline in r-star.
In economist newspeak, r-star, or R*, is the assumed natural interest rate. They didn’t believe it was possible that r-star could fall so low let alone remain there, even though Japan pioneered the concept right out in the open. Williams’ theory, then, is consistent with Krugman and the Wall Street Journal article quoted above – a higher inflation target would allow central banks more margin for error. But it is still thought to be an error of degree, not an error of type.
Williams’ own data shows the folly of such thinking. The main clue, the only clue needed, is included in his presentation. No economist will address the obvious; that the Great Recession was not a recession. Here we have them confronting the idea as the sudden and plain drop in what they call the natural interest rate in 2008, only to calculate that it has been so far a permanent one that has been replicated all over the world. They dance around it without directly explaining it because to do so would trigger basic logic (how can there even be a globally synchronized depression? There is only one possible explanation).
Policymakers like John Williams are trying to couch varying the inflation target as if it was monetary policy evolution; it is not, far from it.
In the wake of the global financial crisis, monetary policy has continued to evolve, in this latest incarnation battling low inflation and stagnation via unconventional monetary policy actions like quantitative easing and near-zero or even negative interest rates. As we move forward, economic conditions require that central banks and governments throughout the world carefully reexamine their policy frameworks and consider further adjustments in terms of monetary policy strategy—both in its own right and as it relates to other policy arenas—to successfully navigate these new seas.
The most offensive word in that paragraph is “carefully”, as in carefully reexamine policy paradigms. Economists are proposing nothing like that, as they are only rejiggering the numbers still within their modeled philosophies that somehow survive having gotten everything so wrong (which is what the intentionally passive phrase “navigate these new seas” actually means). To “carefully reexamine” would be to revisit over and over not just why inflation has been so unresponsive on this side of the Great Recession but also why the Great Recession happened in the first place. It wasn’t supposed to be possible, and to think a 4% inflation target would have prevented it is not logic but open lunacy.
The specific point of failure for monetary policy is in the entrenched belief that monetary policy is the central piece of everything; money to markets to inflation to economy. It is a core philosophy that is derived from money printing. As Ben Bernanke exposed in his infamous November 2002 speech on the “helicopter” and deflation, “the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.” What would the world look like if that was really blustering instead of identified function?
We don’t have to wonder because it is all around us. The Wall Street Journal article talks about the Fed having acted on Bernanke’s threat, having “printed copious amounts of money” without fostering any of the economic elements that were predicted to have occurred long before now. A 4% inflation target does not reconcile this massive inequality.
From yield curves all around the world to things like eurodollar futures and swap spreads, the verdict is far simpler than groping in the dark for some magic number of just the “right” amount of inflation. If there is a lack of inflation even though central banks are and have been massively engaged, it is much consistent that central banks just aren’t so central.
These orthodox introductions of trying to find different numbers and approaches are essentially just that kind of mathematics; they are necessary adjustments being forced upon them by the simple logic equations above. The great problem of our time is that despite being mathematically proven unequal, economists refuse to do anything more than keep up GIGO (garbage in, garbage out). The 4% inflation target is but the latest piece of garbage intended to go into the unbalanced equations that we already know will come out in the same way. The answer is to actually balance the equations and the models such that they reflect the reality we find, not tinkering with the formulas that continue to place monetary policy and central banks in the politically powerful middle.
There is already a lost decade (and maybe a half more before it) in our past, and who knows how many more in the future so long as basic logic is ignored in favor of political expediency. Central bankers will not stop; they will only follow the Bank of Japan into the long nightmare. Unlike Japan, however, the entire global economy stuck in this monetary trap of eurodollar ignorance will not just go on decade after decade. The global social order is nowhere near as stable as Japanese culture to withstand such long-term malfeasance.
The eurodollar system may indeed rise and fall before anyone ever knew it was there, an intentional outcome of monetary policy that seeks central banks for the central economic role. The people may not know now nor ever know about the eurodollar, but they are already strain under its consequences and those of policymakers who refuse basic logic, science, and moral requirements. A 4% inflation target is abhorrent not because it might prove to be “too much” inflation, but rather, as QE, it will never get there. It is another waste of precious time that can only distract from true monetary reform (stability).