Collegial advice among Russian central bankers

Former Soviet central bank governor Victor Gerashchenko about present-day CBR governor Elvira Nabiullina:

“If I were in her position, I would ask for a gun, and shoot myself.”

PS I can only imagine just how bad things would have been if Gerashchenko – who Jeff Sach once called “the worst central banker in the world” – still was in charge at the CBR.

PPS I got the story from “Russia Insider”.

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The high cost of currency (rouble) stability

This is from Reuters today:

“The Russian currency has opened higher Thursday, continuing its recovery from the biggest intraday drop since 1998 default on so-called ‘Black Tuesday’. The dollar was down 65 kopeks at the opening on the Moscow Exchange, while on the stock market, the dollar-denominated RTS index was up 6.5 percent. That’s was hours before President Vladimir Putin commenced his much-anticipated Q&A marathon, in which he’s expected to face tough economic questions about the ruble and turmoil in the financial markets. ….On Wednesday, the ruble jumped 6 percent against the US dollar to finish trading at 60.51 against the Greenback. On ‘Black Tuesday’ the ruble dipped to as low as 80 rubles against the US dollar and hit a threshold of 100 against the euro.”

So after a terrible start to the week the Russian rouble has stabilised over the past two days. However, the (temporary?) stabilisation of the rouble has not been for free. Far from it in fact. Just take a look at this story from ft.com also from today:

Russian banks are getting cautious about lending each other money, with the interest rate on three-month interbank loans hitting its highest since at least 2005. The three-month “mosprime” interbank lending rate has soared to 28.3 per cent, which is its highest since it hit its financial crisis peak of 27.6 in January 2009. The rate is also sharply higher than it reached on Wednesday – the day after the Central Bank of Russia hiked interest rates to 17 per cent to stem a plunge in the rouble – when it closed at 22.33. Stresses have been building in Russian economy because of Western sanctions and a sharp fall in the oil price But another reason for the mosprime spike is that Russian banks are unsure about the state of each other’s businesses. Russian bank customers have been rushing to withdraw their roubles out of their bank accounts and convert them to dollars or euros.

Hence, the rouble might have stabilised, but monetary conditions have been tightened dramatically. So the question is whether the benefits of a (more) stable rouble outweigh the costs of tighter monetary conditions?

We might get the answer by looking that the graph below. The consequence of higher interest rates in 2008-9 was a 10% contraction in real GDP. This week’s spike in money market rates is even bigger (and steeper) than the spike in rates in 2008-9. Is there any good reason why we should not expect a similar contraction in real GDP this time? I think not… MosPrime 3m RGDP

PS obviously I would be the first to acknowledge that money market rates is not the entire story about monetary contraction and money market rates are only used for illustrative purposes here. There are also some differences between 2008-9 and now, but it should nonetheless be noted that the recent drop in oil prices is similar to what we saw in 2008-9.

Commodity prices, currencies and monetary policy

It has been a busy year for me – it has especially been the Russian-Ukrainian crisis, which has kept me busy. However, I thought that this week would be fairly calm – I didn’t have any traveling planned, not a lot a meetings scheduled and I had not expected to be too busy.

However, things turned out very differently thanks to the spectacular collapse of the Russian rouble and a massive rate hike from the Russian central bank. After 15 years in the financial markets this is absolutely up there among the wildest things I have ever experienced.

So frankly speaking I am a bit tired and not really up to the task of writing a major blog post. However, I have a lot on my mind nonetheless so I want share a bit of that anyway.

First, in relationship to what have played out in the Russian markets recently I must say that I actually have been impressed with the Russian central bank. Yes, Monday’s 650bp rate hike in my clearly is a major policy mistake and the decision has brought more uncertainty and more financial distress rather than stability and the rate hike will just send the already badly damaged Russian economy into a even deeper recession.

But one have to see the actions of the Russian central bank in the light of political pressures the central bank is under and that is the reason I am impressed. Russian monetary policy is far from great, but other Emerging Markets central banks would probably have made significantly worse decisions in a similar political and financial environment.

Second, while Market Monetarists advocate NGDP level targeting we have been less outspoken on our support for (N)GDP-linked bonds (in fact I am not sure the other MM bloggers like NGDP linked bonds as much as I do). However, I think the logic of market monetarism also implies that we should be advocating that governments should issue bonds linked to nominal GDP.

This would not only be a useful tools for monitoring market expectations for NGDP growth, but equally it would be helpful in “synchronizing” fiscal policy with monetary policy in the sense that fiscal policy would be automatically eased then the NGDP target is undershot and tightened when the target is overshot. This would also be helpful for countries where monetary policy is in different ways restricted for example by a fixed exchange rate regime.

Third, the Russia crisis “story” and the topic of NGDP-linked bonds can be combined to a discussion of whether the Russian government should issue government bonds linked to oil prices – so when oil prices decline then debt servicing costs also decline.

Just imagine what that would have done to reduce Russian default worries in the present situation. And this of course is linked to my favourite monetary framework for commodity exporters – the Export Price Norm. Hence, had all Russian government debt been linked to oil prices and had the rouble been pegged to a basket of US dollar (80%) and oil prices (20%) then I believe there would have been a much less spectacular crisis in Russia right now.

I hope to return to all these topics in the coming weeks, but until then I want to draw my readers’ attention to a recent blog post by my friend “Hishamh” over at Economics Malaysia on the topic of Commodities and Currencies. Here is Hishamh:

There’s quite a bit of gloom in the air these last few weeks. The plunge in oil and other commodity prices, capital pulling out of emerging markets, and currency turmoil, have people getting very worried about growth prospects next year. There doesn’t appear to be a bottom yet on oil prices, and it’s anybody’s guess where all this will end up.

In Malaysia’s case, oil price depreciation and Ringgit depreciation seems like one piling on the other – the latter is making things worse (Malaysians feel relatively poorer), on top of the drop in oil and gas revenues. But conflating the two like this is wrong. The depreciation of the currency is in fact a required and necessary result of the drop in oil prices.

If the Ringgit had stayed where it had been (about MYR3.20-3.30 to the USD), the full drop in oil prices would have been transmitted directly and with full force into the domestic economy. The approximate 8% depreciation of the Ringgit over the past few months partially mitigates that income shock. Since sales of oil (and gas) are denominated in USD terms on the international markets, a cheaper Ringgit partially cushions the revenue drop in local currency terms.

Consider that oil & gas make up about 20% of Malaysian exports; commodities as a whole about a third. That means that the drop in oil prices and the depreciation of the Ringgit have been nearly symmetrical. If anything, the Ringgit hasn’t dropped far enough – my estimate is that it should be at least 3%-5% weaker.

…That suggests the last few months currency action has largely been a USD movement rather than weakness in the MYR.

There’s also the flip side that the lower Ringgit should in theory provide a boost to non-commodity exports. In this case though, I’m a bit leery of depending on this as global demand growth outside the US and UK is pretty weak, and because again this is largely a case of Dollar strength more than Ringgit weakness.

…Some have been interpreting …central bank intervention to support the Ringgit value…My view is a little more nuanced – the drop in reserves is just too small to make that conclusion.

Contrasted with the pegged FX regime of the early ‘00s, reserve movements over the past four years are just too minor to affect the FX market. Rather, what I think is going on here is that BNM is simply trying to ensure that there’s enough USD (and other currency) liquidity in the interbank market to ensure, in their words, “orderly” market conditions.

…The bottom line is that BNM is not and will not be “defending” any level of the Ringgit. And if they’re not willing to spend reserves on it, you can forget the interest rate defense (which doesn’t work anyway).

Said in another way – the Malaysian central bank (BNM) has moved closer to my ideal of an Export Price Norm and that is benefiting the Malaysian economy. This is in fact what I suggested back in 2012 that the BNM should do.

 

H. L. Mencken on the Russian central bank

 H. L. Mencken“For every problem, there’s a simple solution. And it’s wrong.”

See also here – What the Turkish central bank did a year ago the Russian central bank is doing today. Not good.

HT Josh

Political unrest is always and everywhere a monetary phenomenon – also in Greece

This is Sara Sjolin at MarketWatch.com:

Greece’s Athex Composite tanked almost 13% Tuesday — the biggest drop for the index on record, according to FactSet. The renewed jitters came after the government, in a surprise move late Monday, said it would bring forward presidential elections to Dec. 17, potentially, setting the scene for snap elections in early 2015.

Here’s why that’s important: Far-left party Syriza currently is leading the early polls and it seems likely they would win a snap election. This is how to think about Syriza:

  • The party has been calling for an end to austerity in Greece
  • Has been campaigning for market-unfriendly measures
  • Is firmly against the international bailout program that helped the country avoid a default during the depths of its financial crisis.

How bad is Greece’s Tuesday collapse? It’s worse than the 9.7% drop the market saw Oct. 24, 2010, at the peak of Greek debt worries. The drop also eclipses the 10% fall Greek markets saw in 1989 during a bout of political turmoil.

…With Greece’s problems once again in the limelight, investors all across Europe. the Stoxx Europe 600 index slumped 2.3%, while Germany’s DAX 30 index fell 2.2% and France’s CAC 40 index  gave up 2.5%.

Greek government bond yields  jumped 75 basis point to 7.90%, according to electronic trading platform Tradeweb.

So once again political news slips in to the financial section of the news. As Scott Sumner once expressed it about his studies of the Great Depression:

“And the worst part was the way political news kept slipping into the financial section. Nazis make ominous gains in the 1932 German elections, Spanish Civil War, etc, etc. In the 1930s the readers didn’t know what came next—but I did.”

I must admit that the similarities between the continued euro crisis and the situation during the 1930s worries me a great deal and my regular readers well-know that I to a large extent blame the deepening political troubles in Europe on the deep economic crisis caused mainly by extremely tight monetary conditions in the euro zone.

Just to remind everybody how bad it is in Greece. Take a look graph below comparing the real GDP lose in Austria during Great Depression and Greece during the present crisis (Year 0 is 1929 for Austria and 2008 for Greece.)

I used Austria as a comparison because the country had massive banking crisis (in 1931), had one of the deepest depressions of all of the European economies during the Great Depression and maintained the Gold Standard the longest.

Greece Austria

Given the scale of the crisis in Greece it is hardly surprising that extremist parties like Syriza and Golden Dawn are very popular parties. After all Austria disintegrated politically during the 1930s and eventually ceased to exist as an independent nation in 1938.

Oil prices, inflation and the FT’s good advice for central bankers

This is from the Financial Times’ FT View:

Pity the analyst forecasting today’s global economy. For every signal warning of stagnation there is another glowing green for go. But through this blur of clashing indicators it is possible to discern some consistent themes.

The clearest is weak inflation. The main cause is oversupply in the oil market where prices have fallen by one-third since the summer. With other commodities from cotton and hogs to wheat and soybeans similarly cheap, countries that rely on imported food and fuel have had a welcome boost.

American consumers in particular benefit from cheap fuel, which helps to explain growing momentum in the US economy. Strong jobs numbers on Friday confirmed a growing recovery. These bullish spirits are mirrored on Wall Street where the stock market has rebounded by 10 per cent since the turmoil of October.

But any student of the Great Depression would caution against seeing disinflationary forces in a purely positive light. In Japan and Europe, the persistent downwards trend in inflation is also a reflection of weak incomes. If left unchecked, this threatens to entrench a low-spending, deflationary mindset. Outside of a big slowdown, wage growth in much of the developed world has never been weaker. Even the most ambitious monetary policy can be undermined if pay packets are not growing. Instead of being spent, cash accumulates on the balance sheets of businesses unwilling to invest…

…Monetary policy provides the best key to understanding the variegated global picture. The central banks of the US, UK and Japan all adopted easier policies and were rewarded with an upturn. Given weak wage growth and a lack of fiscal support, such stimulus ought to continue.

Europe is an unhappy exception. Despite German misgivings, low interest rates are no evidence that money is too loose: nominal GDP growth stutters along at less than 3 per cent, a clear sign that the stance is much too tight. In recent years the ECB twice made the mistake of raising rates too soon, and thereby punished Europe with a deeper recession and a worse fiscal crisis. If its president Mario Draghi cannot ease policy further, the consequences will be just as serious.

The welcome boost provided by cheaper oil may help the global economy accelerate over the next year. Even Europe could participate, if only its policy makers would stop confusing the brake with the accelerator.

Do I need to say I agree with 99% of this? Yes, lower oil prices is mostly good news to the extent it reflects a positive supply shock in the oil market and yes if that was the only reason we are seeing deflation spreading then we should not worry.

However, take a look at any indicator of monetary condtions in the euro zone – the collapse in the money base since 2012, meager M3 growth, no NGDP growth, higher real interest rates, a stronger euro (since 2012) and sharply lower inflation expectations – and you should soon realise that the real deflation story in the euro zone is excessively tight monetary policy and the ECB need to do something about that whether oil trades at 40 or 140 dollars/barrel.

PS I don’t think the same story goes for the US. The recent drop in US inflation does not on its own warrant monetary easing. The Fed just needs to keep focused on expected NGDP growth and there is no signs of NGDP growth slowing in the US so I don’t think monetary policy is called for in the US.

PPS For some countries – oil-exporters with pegged exchange rates – lower oil prices is in fact monetary tightening – see here.

Oil-exporters need to rethink their monetary policy regimes

I started writing this post on Monday, but I have had an insanely busy week – mostly because of the continued sharp drop in oil prices and the impact of that on particularly the Russian rouble. But now I will try to finalize the post – it is after on a directly related topic to what I have focused on all week – in fact for most of 2014.

Oil prices have continued the sharp drop and this is leading to serious challenges for monetary policy in oil-exporting countries. Just the latest examples – The Russian central bank has been forced to abandon the managed float of the rouble and effectively the rouble is now (mostly) floating freely and in Nigeria the central bank the central bank has been forced to allow a major devaluation of the country’s currency the naira. In Brazil the central bank is – foolishly – fighting the sell-off in the real by hiking interest rates.

While lower oil prices is a positive supply shock for oil importing countries and as such should be ignored by monetary policy makers the story is very different for oil-exporters such as Norway, Russia, Angola or the Golf States. Here the drop in oil prices is a negative demand shock.

In a country like Norway, which has a floating exchange rate the shock is mostly visible in the exchange rate – at least to the extent Norges Bank allows the Norwegian krone to weaken. This of course is the right policy to pursue for oil-exporters.

However, many oil-exporting countries today have pegged or quasi-pegged exchange rates. This means that a drop in oil prices automatically becomes a monetary tightening. This is for example the case for the Golf States, Venezuela and Angola. In this countries what I have called the petro-monetary transmission mechanism comes into play.

An illustration of the petro-monetary transmission mechanism

When oil prices drop the currency inflows into oil-exporting countries drop – at the moment a lot – and this puts downward pressure on the commodity-currencies. In a country like Norway with a floating exchange rate this does not have a direct monetary consequence (that is not entirely correct if the central bank follows has a inflation target rather than a NGDP target – see here)

However, in a country like Saudi Arabia or Angola – countries with pegged exchange rates – the central bank will effectively will have tighten monetary policy to curb the depreciation pressures on the currency. Hence, lower oil prices will automatically lead to a contraction in the money base in Angola or Saudi Arabia. This in turn will cause a drop in the broad money supply and therefore in nominal spending in the economy, which likely will cause a recession and deflationary pressures.

The authorities can offset this monetary shock with fiscal easing – remember the Sumner critique does not hold in a fixed exchange rate regime – but many oil-exporters do not have proper fiscal buffers to use such policy effectively.

The Export-Price-Norm – good alternative to fiscal policy

Instead I have often – inspired by Jeffrey Frankel – suggested that the commodity exporters should peg their currencies to the price of the commodity the export or to a basket of a foreign currency and the export price. This is what I have termed the Export-Price-Norm (EPN).

For commodity exporters commodity exports is a sizable part of aggregate demand (nominal spending) and therefore one can think of a policy to stabilize export prices via an Export-Price-Norm as a policy to stabilize nominal spending growth in the economy. The graph – which I have often used – below illustrates that.

The graph shows the nominal GDP growth in Russia and the yearly growth rate of oil prices measured in roubles.

There is clearly a fairly high correlation between the two and oil prices measured in roubles leads NGDP growth. Hence, it is therefore reasonable in my view to argue that the Russian central bank could have stabilized NGDP growth by conducting monetary policy in such a way as to stabilize the growth oil prices in roubles.

That would effectively mean that the rouble should weaken when oil prices drop and appreciate when oil prices increase. This is of course exactly what would happen in proper floating exchange rate regime (with NGDP targeting), but it is also what would happen under an Export-Price-Norm.

Hence, obviously the combination of NGDP target and a floating exchange rate regime would do it for commodity exporters. However, an Export-Price-Norm could do the same thing AND it would likely be simpler to implement for a typical Emerging Markets commodity exporter where macroeconomic data often is of a low quality and institutions a weak.

So yes, I certainly think a country like Saudi Arabia could – and should – float its currency and introduce NGDP targeting and thereby significantly increase macroeconomic stability. However, for countries like Angola, Nigeria or Venezueala I believe an EPN regime would be more likely to ensure a good macroeconomic outcome than a free float (with messy monetary policies).

A key reason is that it is not necessarily given that the central bank would respect the rules-of-the-game under a float and it might find it tempting to fool around with FX intervention from time to time. Contrary to this an Export-Price-Norm would remove nearly all discretion in monetary policy. In fact one could imagine a currency board set-up combined with EPN. Under such a regime there would be no monetary discretion at all.

The monetary regime reduces risks, but will not remove all costs of lower commodity prices

Concluding, I strongly believe that an Export-Price-Norm can do a lot to stabilise nominal spending growth – and therefore also to a large extent real GDP growth – but that does not mean that there is no cost to the commodity exporting country when commodity prices drop.

Hence, a EPN set-up would do a lot to stabilize aggregate demand and the economy in general, but it would not change the fact that a drop in oil prices makes oil producers such as Saudi Arabia, Russia and Angola less wealthy. That is the supply side effect of lower oil prices for oil producing countries. Obviously we should expect that to lower consumption – both public and private – as a drop in oil prices effectively is a drop in the what Milton Friedman termed the permanent income. Under a EPN set-up this will happen through an increase inflation due to higher import prices and hence lower real income and lower real consumption.

There is no way to get around this for oil exporters, but at least they can avoid excessive monetary tightening by either allowing currency to float (depreciate) free or by pegging the currency to the export price.

Who will try it out first? Kuwait? Angola or Venezuela? I don’t know, but as oil prices continue to plummet the pressure on governments and central banks in oil exporting countries is rising and for many countries this will necessitate a rethinking of the monetary policy regime to avoid unwarranted monetary tightening.

PS I should really mention a major weakness with EPN. Under an EPN regime monetary conditions will react “correctly” to shocks to the export prices and for countries like Russia or Anglo “normally” this is 90% of all shocks. However, imagine that we see a currency outflow for other reasons – for as in the case of Russia this year (political uncertainty/geopolitics) – then monetary conditions would be tightened automatically in an EPN set-up. This would be unfortunate. That, however, I think would be a fairly small cost compared to the stability EPN otherwise would be expected to oil exporters like Angola or Russia.

PPS I overall think that 80-90% of the drop in the rouble this year is driven by oil prices, while geopolitics only explains 10-20% of the drop in the rouble. See here.

Monetary policy according to a German lawyer

This is from Bloomberg:

European Central Bank Executive Board member Sabine Lautenschlaeger said quantitative easing isn’t the right policy choice for the euro area currently, hardening a split among officials over the right response to slowing inflation.

“A consideration of the costs and benefits, and the opportunities and risks, of a broad purchase program of government bonds does not give a positive outcome,” Lautenschlaeger, a former Bundesbank vice president, said at an event in Berlin today. “There are very few shared competencies in fiscal policy. As long as this is the case, the ECB’s purchase of government securities is inevitably linked to a serious incentive problem.”

Lautenschlaeger’s comments signal she’s become ECB President Mario Draghi’s highest-ranking opponent in the debate over introducing QE to the euro area. They echo the position of Bundesbank President Jens Weidmann, who has said QE diverts attention from the need for governments to make structural adjustments to their economies.

“Long-term interest rates on Spanish and Italian (GBTPGR10) government bonds, for example, are already lower than those from the U.S. or the U.K.,” Lautenschlaeger said. “It is therefore questionable whether we should ‘depress’ interest rates for the securities class even further.”

First of all, it is very clear that Frau Lautenschlaeger thinks that quantitative easing – an expansion of the money base – is some kind of credit policy. It is not. Let me quote myself:

I have noticed that there generally is a problem for a lot of people to differentiate between monetary easing and bailouts. Often when one argues for monetary easing the reply is “we should stop bailing out banks and countries and if we do it we will just create an even bigger bubble”. The problem here is that Market Monetarists certainly do not favour bailouts – we favour nominal stability.

I think that at the core of the problem is that people have a very hard time figuring out what monetary policy is. Most people – including I believe most central bankers – think that credit policy is monetary policy. Just take the Federal Reserve’s attempt to distort relative prices in the financial markets in connection with QE2 or the ECB’s OMT program where the purpose is to support the price of government bonds in certain South European countries without increasing the euro zone money base. Hence, the primary purpose of these policies is not to increase nominal GDP or stabilise NGDP growth, but rather to change market prices. That is not monetary policy. That is credit policy and worse – it is in fact bailouts.

As the ECB’s OMT and Fed’s QE2 to a large extent have been focused on changing relative prices in the financial markets they can rightly be – and should be – criticized for leading to moral hazard. When the ECB artificially keeps for example Spanish government bond yields from increasing above a certain level then the ECB clearly is encouraging excessive risk taking. Spanish bond yields have been rising during theGreat Recession because investors rightly have been fearing a Spanish government default. This is an entirely rational reaction by investors to a sharp deterioration of the outlook for the Spanish economy. Obviously if the ECB curb the rise in Spanish bond yields the ECB are telling investors to disregard these credit risks. This clearly is moral hazard.

The problem here is that a monetary authority – the ECB – is engaged in something that is not monetary policy, but people will not surprisingly think of what a central bank do as monetary policy, but the ECB’s attempts to distort relative prices in the financial markets have very little to do with monetary policy as it do not lead to a change in the money base or to a change in the expectation for future changes in the money base.

That is not to say that the ECB’s credit policies do not have monetary impact. They likely have. Hence, it is clear that the so-called OMT has reduced financial distress in the euro zone, which likely have increased the money-multiplier and money-velocity in the euro zone, but it has also (significantly?) increased moral hazard problems. So the paradox here is that the ECB really has done very little to ease monetary policy, but a lot to increase moral hazard problems.

I can hence certainly understand if Frau Lautenschlaeger would object to credit policies to bailout nations or banks, but an expansion of the money base to curb deflationary pressures and to stabilise nominal spending growth has nothing to do with bailouts. It is just the proper policy response to a deflationary crisis – by the way caused by the ECB itself.

Second, Frau Lautenschlaeger is clearly making the common bond yield fallacy when you claim monetary policy already is easy because nominal bond yields are low. She of course should know that rates and yields are low in the euro exactly because monetary policy is extremely tight and there market expectations are for continued very low growth and inflation.

Furthermore, I am puzzled why she would make a reference to bond yields in specific countries. Monetary policy certainly is not about targeting bond yields and certainly not about targeting bond yields in individual countries in a monetary union.

Listening to some ECB official brings memories of French central bankers in the 1930s or Japanese central bankers in the 1990s. The outcome unfortunately is the same deflationary mess – and as a consequence rising debt problems.

 

Bloomberg repeats the bond yield fallacy (Milton Friedman is spinning in his grave)

This is from Bloomberg:

A series of unprecedented stimulus measures by the ECB to stave off deflation in the 18-nation currency bloc have sent bond yields to record lows and pushed stock valuations higher. “

Unprecedented stimulus measures? Say what? Since ECB chief Mario Draghi promised to save the euro at any cost in 2012 monetary policy has been tightened and not eased.

Take any measure you can think of – the money base have dropped 30-40%, there is basically no growth in M3, the same can be said for nominal GDP growth, we soon will have deflation in most euro zone countries, the euro is 10-15% stronger in effective terms, inflation expectations have dropped to all time lows (in the period of the euro) and real interest rates are significantly higher.

That is not monetary easing – it is significant monetary tightening and this is exactly what the European bond market is telling us. Bond yields are low because monetary policy is tight (and growth and inflation expectations therefore are very low) not because it is easy – Milton Friedman taught us that long ago. Too bad so few economists – and even fewer economic reporters – understand this simple fact.

If you think that bond yields are low because of monetary easing why is it that US bond yields are higher than in the euro zone? Has the Fed done less easing than the ECB?

The bond yield fallacy unfortunately is widespread not only among Bloomberg reporter, but also among European policy makers. But let me say it again – European monetary policy is extremely tight – it is not easy and I would hope that financial reporter would report that rather than continuing to report fallacies.

HT Petar Sisko

PS If you want to use nominal interest rates as a measure of monetary policy tightness then you at least should compare it to a policy rule like the Taylor rule or any other measure of the a neutral nominal interest rate. I am not sure what the Talyor rule would say about level of nominal interest rates we should have in Europe, but -3-4% would probably be a good guess. So interest rates are probably 300-400bp too higher in the euro zone. That is insanely tight monetary policy.

PPS I am writing this without consulting the data so everything is from the top of my head. And now I really need to take care of the kids…sorry for the typos.

The story of a remarkably stable US NGDP trend

Today revised US GDP numbers for Q3 were released. While most commentators focused on the better than expected real GDP numbers I am on the other hand mostly impressed by just how stable the development in nominal GDP is. Just take a look at the graph below.

US NGDP 4 pct trend

I have earlier argued that the development in NGDP looks as if the Federal Reserve has had a 4% NGDP level target since Q3 2009. In fact at no time since 2009 has the actual level of NGDP diverged more than 1% from the 4% trend started in Q3 2009 and right now we are basically exactly on the 4% trend line. This is remarkable especially because the Fed never has made any official commitment to this target.

With market expectations fully aligned to with this trend and US unemployment probably quite close to the structural level of unemployment I see no reason why the Fed should not announce this – a 4% NGDP level target – as its official target.

PS I might join the hawks soon – if the trend in NGDP growth over the last couple of quarters continues in the coming quarter then we will move above the 4% NGDP trend and in that sense there is an argument for tighter monetary conditions.

PPS I am not arguing that monetary policy was appropriate back in 2009 or 2010. In fact I believe that monetary policy was far too tight, but after six years of real adjustments it is time to let bygones-be-bygones and I don’t think there would be anything to gain from a stepping up of monetary easing at the present time.

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