Belongia and Ireland on the Fed’s Romanace with the Phillips curve

There is no doubt that I believe that the Federal Reserve under the leadership of Fed Chair Janet Yellen has kept monetary conditions too tight and I have particularly blamed Yellen’s 1970s style obsession with the Phillips curve for this.

Michael Belongia and Peter Ireland have a very good comment over at Manhattan Institute’s E21 site on exactly this topic. Take a look for yourself here.

PS see some of my earlier posts on Yellen and the Phillips curve here and here.


Egypt floats the pound – now it is time to implement a rule-based monetary policy framework

This morning we got some very good news out of Egypt as this statement was released by the Egyptian central bank:


I have to say I agree with everything in the statement and I think it is the only right thing to do.

The pound almost immediately dropped 48% against the US dollar on the news.  There is no doubt that this in many ways will be unpopular in Egypt and we are likely to see a rather sharp initial spike in Egyptian inflation, which certainly will have short-term negative impact on the purchasing power of many Egyptians.

This is certainly regrettable, but we have to remember what the alternative was. The alternative was to continue the present policy of trying to ‘peg’ the Egyptian pound at a far too strong level and by doing so continuing to tighten monetary conditions.

The result of artificially trying to keep the pound (too) strong has been that we have seen a continued rather sharp slowdown in aggregate demand in the Egyptian economy at a time where we also have seen a rather significant negative supply shock from the continued very high level of political uncertainty and the lack of substantial economic reforms.

Therefore we have effectively entered a situation of stagflation in recent years – where a negative supply shock has pushed up inflation and continuous monetary tightening is causing growth to slow.

By floating the pound at least the downward pressure on aggregate demand growth will disappear.

Weak political structures and a weak economy necessitate a weak currency

There is no doubt that the fact that the pound today was halved in values in a matter of minutes will be a major shock to many (most) Egyptians. However, it is important to remember that if a country has weak political institutions and a weak economy then a weak currency is also a necessity.

Hence, the drop in the pound today really is not a result of the fact that the Egyptian central bank has floated the pound. This was not a devaluation – this was the market determining what the fundamental value of the pound should be given the state of the Egyptian economy and quality (or rather lack of quality) of Egyptian institutions.

Therefore, Egyptian policy makers should certainly not try to prop up the pound by returning to FX interventions. Rather Egyptian policy makers should ensure currency stability though economic and political reforms.

Egypt has a massive economic potential with the largest population in Northern Africa and a strongly growing labour force the country should easily be able to grow by at least 6-8% if not faster. The Egyptian government therefore should do everything to unleash this potential by implementing bold economic reforms.

I would particularly focus on eliminating all tariffs on trade and dramatically opening up the Egyptian economy for trade and investments. Furthermore, government-owned companies should be fully privatized as soon as possible and finally the legal framework has to be significantly strengthened so the rule of law applies and the projection of private property is strengthened significantly.

Such reforms would give a marked boost to the supply side of the economy and lift potential growth significantly, which in turn would help boost the currency without having to tighten monetary conditions. Said in another way if you want a stronger currency implement massive structural reforms rather than tightening monetary conditions.

Time to implement a rule-based monetary policy framework

Freeing up capital movements and allowing the pound to float freely is the first step in a necessary monetary reform. However, it should not be the final step. Rather the Egyptian central bank now should focus on formulating a clear rule-based monetary policy framework that will ensure nominal stability in Egypt.

I would certainly recommend a framework where the Egyptian central bank targets nominal GDP growth rather than inflation.

The main reason I prefer a nominal GDP target to an inflation target is that in a low-income country – particularly in one which hopefully undergoing structural reforms – a lot of the short-term movements in inflation is driven by supply side factors (for example changes in food prices and variation in political uncertainty). The central bank should not react to such shock and the best way to avoid that is targeting NGDP rather than inflation.

However, that does not mean that we cannot think of a long-term “inflation target”. Rather it might make sense to set NGDP growth targets for example every five years based on a expectation about trend real GDP growth in the economy and what long-term inflation you might have.

Hence, presently the IMF expect long-term real GDP growth of 5-6% (in 2020-2021). Given the extremely high growth rate in the labour force this is not particularly optimistic. An assumption of 5% real GDP growth therefore does not seem completely unrealistic over the medium-term given the present structures in the economy (but with less political uncertainty).

If we then say that we would like to see inflation of 5% (half of what we have seen in the recent years) then that would mean that the Egyptian central bank should target around 10% nominal GDP growth. 

This is in fact more or less the present growth rate of nominal GDP, which would make it a natural starting point for a new target for the central bank.

There are of course some very serious challenges with targeting nominal GDP in a country like Egypt, but I would not overestimate these challenges and the fact is that targeting inflation in a country with a lot of supply side driven variation in particularly consumer prices is no less of a statistical challenge.

Now lets hope that Egyptian policy makers are open for taking the next steps – massive structural reforms and the implementation of a new monetary policy framework. The sooner the better.


I have noticed that a number of news stories today have said that the Egyptian central bank “devalued” the pound. This is not correct. A devaluation of the currency is an active (typically discretionary) act of the central bank to weaken the currency.

This is not what the Egyptian central bank did today. Rather the the central bank gave up targeting the exchange rate and instead allowed the currency to float freely. The result was a depreciation (not a devaluation) of the currency.


Swedish monetary conditions are becoming too easy

Believe it or not – there is a country in the world where I now believe that monetary policy is becoming (moderately) too easy. Yes, that is correct – I will not always say that monetary policy is too tight. The country I talk about is Sweden. More on that below.

Assessing monetary conditions

I strongly believe that the assessment of the monetary stance of a country should not be based on for example looking at the level of nominal interest rates, but rather on whether or not the country is on track to hitting the central bank’s nominal target in lets say 12-18 months.

A way of assessing that is of course to look at market inflation expectations (if the central bank targets inflation as in the case of Sweden’s Riksbank). If inflation expectations are below (above) the target (for example 2%) then monetary conditions are too tight (easy).

An alternative to this approach is to look at other monetary indicators – for example money supply growth, nominal GDP growth, interest rates and the exchange rate. And this is exactly what we are doing in our (Markets & Money Advisory’s) upcoming publication on Global Monetary Conditions.

Policy consistency  

Hence for all of the nearly 30 country we analyse in the publication we look at the four monetary indicators mentioned above and compare the development in these indicators with what we believe would be consistent with the given central bank’s inflation target.

This means for example in the case of money supply growth we determine what money supply growth rate is consistent with the Riksbank’s inflation target of 2% given the trend in real GDP growth and and then trend in money-velocity. If the actual money supply growth rate is faster than our “policy consistent” growth rate then monetary conditions are too easy.

We have then calibrated the four indicators individually so a “zero” score is the policy consistent monetary stance and we think of the range between -0.5 and +0.5 as a “neutral stance”.

Four Swedish indicators

Below you see the development in the four monetary indicators for Sweden:


What we are seeing is that both money supply growth and nominal GDP growth have been faster than the policy consistent growth rate since 2014-15 and the key policy rate has been below the  policy consistent level since mid-2014.

In terms of the exchange rate it has been the last of the four indicators to turn in a more “accommodative” direction, but recently the exchange rate development has also helped ease monetary conditions in Sweden.

Based on these four indicators we create a composite indicator for Swedish Monetary Conditions.


As mentioned above the indicator is calibrated so that zero is monetary conditions, which is consistent with the Riksbank’s 2% inflation target. If the indicator is above (below) then the Riksbank is more likely to overshoot its inflation target in the medium-term.

We see that Swedish monetary conditions essentially have been too tight since mid-2009, but we also see that since late-2013 monetary conditions have become less tight and in the past two years or so we have been in the “neutral” range (above -0.5) and we are now approaching +0.5 meaning we are moving out of the “neutral” range and into the “too easy”-range.

Riksbanken needs to tighten monetary conditions

Riksbanken without a doubt has been one of the best performing central banks in the world in the post-2009 period and particularly the performance over the last couple of years has been very positive in the sense that inflation expectations seem to have become somewhat unanchored in recent years in the US and the euro zone, while the Riksbank has been able to ensure nominal stability and ensure that inflation expectations have been close to 2%.

However, we now – based on our monetary indicator analysis of Sweden – believe that the Riksbank is beginning to overdo it on the “easy side”. It is certainly not dramatic and there are absolutely no reason for the Riksbank to slam the brakes on and if the Riksbank is credible it is likely that the markets will do most of the job tightening Swedish monetary conditions – most likely through a stronger Swedish krona, but if that does not happen the Riksbank likely will have to more forcefully start to express concerns that monetary conditions are becoming too accommodative.

Finally, compared to this analysis the Riksbank’s monetary policy announcement last week seems to have been overly dovish. That said given the track-record of the Riskbank I don’t believe that it is about to make a major policy mistake, but I would certainly expect it to scale back on the dovish signal going forward.

Want to know more?

If you want to more on our Global Monetary Conditions publication (we still need a sexy title) and discussion the indicators or have suggestions please contact me ( or my colleague Laurids Rising (

The publication will be a monthly and will likely be priced around EUR 2000 for 12 months.

Read more on the publication here and here.




Venezuela can’t defy gravity

This is from my latest article over at Geopolitical Intelligence Services:

It wasn’t that long ago that socialists all over the world were celebrating Venezuela as an economic success story. But economists knew the country was less a success than a mirage.

The semblance of success was supplied by dumb luck, in the form of a sharp and continuous rise in oil prices during the 2000’s. That created a windfall for Venezuela, which has the biggest proven oil reserves in the world.

By now it should be blatantly obvious to even the most diehard socialist that Venezuela’s “Bolivarian revolution” has been an economic and social disaster.

Since 2013, the country’s real gross domestic product has dropped nearly 20 percent. Inflation has spiked and could very well explode into hyperinflation if President Nicolas Maduro’s regime does not change course – and soon. The Venezuelan bolivar has plummeted and ordinary citizens are above all anxious to get their hands on some good old U.S. doll

Read the rest here.

It’s time to rediscover ECB’s reference value for M3 growth

A couple of days ago I read an interview with ECB’s former chief economist Otmar Issing about the euro crisis. I frankly speaking didn’t find the interview particularly interesting and Issing brings little new to the discussion.

Issing rightly repeats the worries about moral hazard problems and he is critical about the ECB’s credit policies even though it is clear that he fails to point to the difference between credit policies (which central bankers should stay far away from) and monetary policy (which central banks have a mandate to conduct).

Even more depressingly Issing completely fails to recognize the monetary nature of the euro crisis.

This is particularly depressing given Otmar Issing certainly knows his monetarist theory and he used to be know as the monetarist at the ECB.

It was Otmar Issing who famously put monetary analysis based on the quantity theory of money at the centre of thinking in the ECB’s early days. Hence, Issing was the main architect behind ECB’s so-called two pillar strategy. The one pillar was that the ECB should look at a broad range of economic indicators when assessing the monetary policy stance. The second pillar was the monetary pillar which emphasized monetary (essentially montarist) analysis.

What happened to the reference value for M3 growth?

At the core of the monetary pillar was what came to be known as the reference value for M3 growth.

This is how the ECB (read Otmar Issing!) used to define the reference value:

This reference value refers to the rate of M3 growth that is deemed to be compatible with price stability over the medium term. The reference value is derived in a manner that is consistent with and serves the achievement of the Governing Council’s definition of price stability on the basis of medium-term assumptions regarding trend real GDP growth and the trend in the velocity of circulation of M3. Substantial or prolonged deviations of M3 growth from the reference value would, under normal circumstances, signal risks to price stability over the medium term.

So what we are talking about here is the growth rate of M3, which over the medium-term will ensure 2% inflation given the trend-development in money demand (trend real GDP growth and trend-velocity growth).

We can operationalize this by looking at the equation of exchange (in growth rates):

(1) m + v = p + y

Where m is M3 growth, v is the growth rate of M3-velocity, p is inflation (in the GDP deflator) and y is real GDP growth.

If we define v* as trend growth in M3-velocity and y* as trend/potential real GDP growth and finally assume inflation should hit the inflation target of 2% then we can re-write (1):

(1)’ m + v* = 2% + y*

Re-arranging further we can get a target for M3 (m-target), which will ensure 2% inflation over the medium-term:

(2) m-target = 2% + y* – v*

The ECB used (2) to calculate the reference value for M3 growth by assuming v* was around -1/2% and y* was 2%, which would give you a reference value of 4.5%.

The ECB kept this target constant over time despite the fact that neither the trend in velocity nor the trend in real GDP growth are constant over time.

If we instead want to take into account changes in v* and y* over time we can try to “estimate” these variables by applying a Hodrick–Prescott filter (HP filter). Somewhat simply said a HP filter is just a sophisticated moving average.

Introducing the policy-consistent M3 growth rate

While Otmar Issing might have given up on monetary analysis I have not. In fact monetary analysis is at the core of the new publication on Global Monetary Conditions, which my advisory – Markets & Monetary Advisory – will start to publish in the coming months.

In this publication we in fact calculate what we term the policy-consistent M3 (or M2) growth rate for the 25-30 countries, which will be covered in the publication (see more here).

The graph below shows actual M3 growth (the blue line) in the euro zone compared with the policy-consistent M3 growth rate (the red line).


The grey bars are the a 3-year weighted moving averages of the difference between actual and policy-consistent M3 growth and as such is a measure of the monetary policy stance. Negative (positive) bars indicates that M3 growth is too slow (too fast) to ensure that the ECB will hit the 2% inflation target over the medium-term. We can here term this as the ‘money gap’.

In our new  monthly publication we will focus on four different monetary measures to put together one monetary conditions indicator (M3 growth, nominal GDP growth, interest rates and the exchange rate), but if we only focus on our measure of the policy-consistent M3 growth rate we nonetheless get great insight about monetary conditions in the euro zone.

Looking at the development in the ‘money gap’ we see that monetary conditions were broadly speaking from the euro was established in 1999 and until 2006. However, from 2006 monetary conditions clear became too easy.

That, however, change dramatically as M3 started to slow rather dramatically in early 2008 and already at the time should have been clear that soon the M3 would drop below the ECB’s reference value for M3 (and our policy-consistent M3 growth rate). Despite of this the ECB hiked its key policy rate in July 2008! This is of course was the first major policy major the ECB made in the crisis. More disastrous policy mistakes of course followed in 2011 when the ECB hiked interest rate twice!

Hence, had the ECB only focused on M3 the ECB would certainly have tightened monetary policy more aggressively in 2006 and 2007, but even more importantly it would never have hiked interest rates in 2008 and 2011. Rather judging from M3 growth relative to the ECB’s own (old) reference value or our policy-consistent M3 growth rate the ECB should have slashed interest rates aggressively in the Autumn of 2008 and in 2009 and should have initiated quantitative easing once interest rates hit zero.

Otmar Issing should be angry (but for the right reasons)

Hence, Otmar Issing is indeed right to be angry with the ECB, but he should be angry for the right reasons. Issing might point to problems of moral hazard and I certainly share these concerns, but what Otmar Issing really should be angry about is that the ECB complete have given up on taking Issing-style monetary analysis seriously as a result at least six years after 2008 monetary policy far too tight!

Unfortunately Issing seems to have given up on his own analysis as well. That is deeply regrettable.  So we can only hope that Otmar Issing will go back to proper monetary analysis of the typical ‘Calvinist preaching’, which unfortunately is so common among German policy makers – both in Frankfurt and Berlin.

If he did that he would continue to criticize the ECB for trying to distort bond market pricing and encouraging moral hazard, but he would also recognize that ECB chief Mario Draghi has been right pushing for quantitative easing and that it should be continued as long as necessary to keep M3 growth around at least 4.5-5% as this ensures that inflation will be close to ECB’s 2% inflation target.

PS I don’t think re-introducing the reference value for M3 growth would be the best policy framework for the ECB, but it certainly would be better than the present non-policy-framework and very much doubt that we would still would be talking about a euro crisis had the ECB taken the reference value serious.

Rational investors and irrational voters

It seems like there is a bit of a gap opening between prediction markets and opinion polls when it comes to the likely outcome of the US presidential elections in recent days.

Hence, the prediction market Predictit now has a 81% (19%) implied probability that Clinton (Trump) will win, while the opinion poll aggregator over at Nate Silver’s FiveThirtyEight-side has a implied probability of 88.1% (11.9%) that Clinton (Trump) will win.

If we look at the last couple of months it seems clear that the polls have been somewhat more extreme in both direction than the prediction markets.

This to me is interesting as it seems to indicate there is more “animal spirits” in the opinion polls than in the prediction markets. Or said, in another way this could be an indications that when we act as investors – betting on the outcome of presidential election – we behave more rationally than when we are voting?

Obviously opinion polls and prediction markets are not measuring the same thing. Prediction markets “predict” what the outcome will be of an election at a future date, while opinion polls measures how voters think they would vote today. That said, Nate Silver’s models try to do something in between the two.

Anyway, to me it is interesting that it seems like we are voters are much more inclined to be driven be “mood swings”, while we as investors seem a lot more cool-headed. This is of course also what we could learn from Bryan Caplan’s The Myth of the Rational Voter.

PS note that I am not here discussing whether opinion polls are better or worse than prediction markets at forecasting the outcome elections. I am discussion the different decree of rationality we have as voters and investors (or consumers for that matter).

Russia’s economy dodged a bullet, no thanks to Mr. Putin

Se my latest article at Geopolitical Intelligence Services on how a floating exchange rate have helped Russia avoid economic collapse here.

Re-visiting: “Towards a new monetary regime for Iceland”

The question of what is the best monetary policy regime for Iceland has come up in the Icelandic election campaign and particularly it has been suggested that Iceland introduce a currency board.
It is well-known that I am not a major fan of pegged exchange rates but there is also a trade-off in choosing the “optimal” monetary policy regime between on the one hand having a strongly rule-based regime and having the “correct” anchor.
I discussed these issues at a seminar in Iceland hosted by Islandsbanki back in early 2015.
See my presentation “Towards a new Monetary Regime for Iceland” here (after 15 minutes)

M&M Advisory to launch new publication on Global Monetary Conditions

Dear friends,
Within the next 1-2 months my advisory Markets & Money Advisory will be launching a new monthly publication on Global Monetary Conditions.
The purpose of the publication will not be to predict or forecast monetary policy in different countries. Rather the purpose will be to correctly measure the monetary policy stance and as well as interpret monetary developments across 25-30 countries.
This means that we will publish a monthly Monetary Condition Indicator on each of the 25-30 countries in the report. In addition, we will publish an aggregate version of the this for Global Monetary Conditions.
Overall the indicator is calibrated so that it is zero when monetary conditions are such that the central bank should be expected to hit its inflation target in 18-24 months. The global indicator will be published both in the monthly version and in a daily/real-time version.
Overall, the publication will reflect a Market Monetarist take on global monetary conditions meaning special focus will be paid to what the markets are telling us about monetary conditions as well as on monetary aggregates as well as nominal demand/nominal GDP.
The results from the indicator are very encouraging and it shows that the indicator for the Global Monetary Conditions is highly correlated with global asset prices and commodity markets as well as with the global macroeconomic developments.
In that sense the publication will be useful for both investors and traders as well as for policy makers.
We would be very interested in feedback already now. Could this be of interest to you? What would you like to see in such report?
We plan to price a 12-month subscription at around EUR 2000 with the possibility of special deals if more than one subscription is purchased or if it is part of an overall advisory agreement with Markets & Money Advisory.
The publication will be launched when we in the near future launch the new Markets & Money Advisory website.
Feel free to share.
For comments, requests and feedback feel free to drop me a mail (
Lars Christensen
CEO and owner, Markets & Money Advisory

PS Here is a sneak preview of the indicator to US monetary conditions.


Noah Smith is clueless about Monetarism

Israel Arroyo on Twitter alerted me to a new comment BloombergView by Noah Smith titled “Monetarists Are Out of Ideas”. The whole thing is complete nonsense and shows that Noah Smith has absolutely no insight into monetary theory and particularly no knowledge at all about monetarism.

In fact there is basically nothing about monetarism in the article. Most of the article is about views of the so-called Neo-Fisherians (in itself a misnomer), which has nothing to do with monetarism and none of the economists mentioned in the article are monetarist or call themself monetarists.

In fact there is only one paragraph in the article that actually mentions monetarism. Here is the whole thing:

Monetarism — broadly defined as the idea that monetary policy influences inflation and output in the standard, textbook way — is at the core of mainstream New Keynesian models, and still dominates central bank thinking. There’s evidence for it, and there’s evidence against it, but in the end, I think its prominence endures because it represents a compromise between the Keynesian interventionists and the opposing coalition of anti-interventionists. It posits that technocratic central bankers, manipulating a single price in the economy (the interest rate), are all we need. This is a minimal intervention that liquidationists can stomach and that Keynesians can grudgingly accept.

All of that is basically wrong.

Noah Smith argues that “It (monetarism) posits that technocratic central bankers, manipulating a single price in the economy (the interest rate), are all we need.”

I guess Noah Smith never read anything any monetarist ever wrote about monetary policy, but he could for example start with reading Milton Friedman’s 1967 presidential address to the American Economic Association The Role of Monetary Policy:

… the monetary authority could assure low nominal rates of interest-but to do so it would have to start out in what seems like the opposite direction, by engaging in a deflationary monetary policy. Similarly, it could assure high nominal interest rates by engaging in an inflationary policy and accepting a temporary movement in interest rates in the opposite direction. These considerations not only explain why monetary policy cannot peg interest rates; they also explain why interest rates are such a misleading indicator of whether monetary policy is “tight” or “easy.” For that, it is far better to look at the rate of change of the quantity of money.

Noah Smith should of course know that this is the monetarist position since any student of economics will be introduced to Friedman’s classic article i  Macro 101, but maybe Noah Smith skipped that class. In fact it seems like Smith completely skipped reading anything ever written on monetarism or by monetarists.

It is at the core of monetarist thinking that interest rates tell us very little about the monetary stance. Furthermore, monetarists for decades have argued that central bankers should use the money base to control the monetary stance and that central bankers should not use the “interest rate” as a monetary policy instrument. In fact monetarists argue “the” interest rate is not a instrument at all – it is an intermediate target.

So it is very clear that Noah Smith is completely clueless about what monetarism is and consequently it is very hard to take his views on whether monetarists are out of ideas serious.

In fact I would say it is hard to take anything serious Noah Smith says on monetary matters when he so clearly demonstrates that he didn’t study any monetary theory at all.



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