It's Wednesday and I have comments on a few items today. I haven't been able…
There has been a bit of fun in the last week, with the IMF accusing our previous conservative government (10 increasing surpluses out of 11 years in power – 1996-2007) of being the only period of profligate fiscal policy over the last 50 years. That is hysterical really because the government in question held themselves out as the exemplars of fiscal prudence and responsibility. They were, in fact, one of the most irresponsible managers of macroeconomic policy in our history, but not for the reasons that the IMF would identify. All this shows how far fetched the research that the IMF is spending millions of public dollars (donated by member governments) has become. One week they are admitting how wrong their forecasts are with millions losing their jobs as a result and the next week they are handing out medals for fiscal prudence and backhanders for wasteful spending. I was going to analyse the underlying IMF paper today because it is illustrative of why the IMF keeps making these fundamental errors. But I was sidetracked and got lost in some data and some other things. So the IMF tomorrow (maybe) and today a little walk through some trends which confirm why the IMF has a problem recruiting good economists. It all starts with their miseducation in our universities. The point is a casual look at the data shows that the mainstream of my profession hasn’t been even remotely correct in its statements over the last 4-5 years.
There was also an interesting paper published last year (September 24, 2012) – The Financial Crisis and Inflation Expectations – by the US Federal Reserve Bank of San Francisco, which explored attitudes to inflation in the US and the UK.
The paper points out the obvious:
A major financial crisis, such as that of 2008-09, can be considered a natural test of this anchoring … [of inflation expectations] …
We are now 4 years or so into the crisis and the rather (relatively) large fiscal and monetary policy shifts that were introduced back in 2008 and have not yet been reversed in many advanced nations – especially the monetary policy shifts. The central bank balance sheets are still in “non standard” monetary policy shape.
Each year that followed there were predictions of doom. Nothing happened to substantiate the predictions. The retort was that it is too early. Once growth returns, or once expectations adjust, or once upon a time … the sky would fall in.
Another year passed, the sky remained in place. Just wait, the crash is coming. Ok.
Another year, and so on.
If we asked a senior undergraduate macroeconomic class at a mainstream university or a post-graduate class what they thought was going to happen in 2008 (by NOW) based upon what they had been subjected to by way of macroeconomic theory they would tell us more or less the following. The post-grads would use fancier language reflecting the increased sophistication of the technical apparatus the lecturers use to obfuscate the reality. But the answers would be similar.
1. Interest rates would rise because the deficits had risen.
2. Inflation would rise because of the massive increase in the monetary base, which would lead (via the mythical money multiplier) to
3. Treasury bond auctions would fail as the bid-to-cover ratio fell, reflecting the increasing lack of confidence that private investors had in the solvency of the governments. Treasury bond prices would fall as a consequence.
4. There would be no increase in real GDP growth because the non-government sector would move to offset the rise in public spending. Why? The private households and firms would form the view that the rising deficits would have to be paid back via tax rises sometime soon and so they would have to start saving now (withdrawing spending) to ensure they could meet the future tax rises.
5. Public spending multipliers would thus be well below one, meaning that for every dollar spent by the government, the economy would grow in nominal terms by less than a dollar – the more extreme predictions would say be much less even suggesting a contraction of some magnitude (more than total crowding out).
6. Where nations imposed fiscal austerity, the students would have predicted that the economies would have grown faster as a result of the reverse logic pertaining to all the above points.
All these basic predictions of mainstream macroeconomic theory have not eventuated. In fact, the reverse has been happened. Various strands of evidence would tell us that. Even some of the arch proponents of all these predictions – the IMF – have admitted they made terrible mistakes with respect to their predictions (especially in relation to points 4, 5 and 6).
It is a pity that millions of ordinary folk – not those working in Washington on high pay – have become unemployed and lost their savings as a result of the IMF incompetence.
It is clear that these forecasters haven’t understood modern history – say from 1990 onwards. Even without knowing much about the way the economy operated a relatively intelligent person – that is, one who can get out of bed each morning and navigate a car or find the right bus number to reach a destination would be able to conclude that the data from say, Japan totally negated the view held by mainstream macroeconomists.
Perhaps all the doom and gloom merchants from the US don’t actually read world news. I might have mentioned this before but I recall hearing an interview on the ABC (Australia’s national public broadcaster) with a US academic who was about to visit Australia for a conference (it was the middle of May by the way – which is important to avoid any misinterpretations relating to international date lines).
At the end of the interview, he was being friendly and said “By the way, what month is is down there?”. Hilarious.
Which reminded me of a time I was in San Francisco – at the height of the – Bosnian Genocide – at Srebrenica and Zepa in 1995. A major world event by any standards which received front page coverage in most of the World’s newspapers. On the day the information seeped out to the world, the largest daily in San Francisco covered a front page headline story like “cat rescued from tree by police officer in Oakland” and the massacre was a small column on page 5 or something.
While on the theme of having fun, here is a couple of minutes of amusement from Break.Com.
Apparently, that is not fair because the US is a big important place and people are more interested in domestic issues. Okay, a couple of years ago, the Newsweek Magazine gave 1000 Americans the official US Citizenship Test – “29 percent couldn’t name the vice president”.
According to this summary (May 20, 2011) – How Dumb Are We?:
Seventy-three percent couldn’t correctly say why we fought the Cold War. Forty-four percent were unable to define the Bill of Rights. And 6 percent couldn’t even circle Independence Day on a calendar.
It seems though that intelligent Americans know their second amendment – at least I have heard gun owners talking about that a bit lately.
Previous research shows that only “58 percent of Americans” quizzed could say who the Taliban were, despite the US leading “the charge in Afghanistan”.
And the ignorance appears to spill over into matters relating to the federal budget. As the article – How Dumb Are We? reports:
… poll after poll shows that voters have no clue what the budget actually looks like. A 2010 World Public Opinion survey found that Americans want to tackle deficits by cutting foreign aid from what they believe is the current level (27 percent of the budget) to a more prudent 13 percent. The real number is under 1 percent. A Jan. 25 CNN poll, meanwhile, discovered that even though 71 percent of voters want smaller government, vast majorities oppose cuts to Medicare (81 percent), Social Security (78 percent), and Medicaid (70 percent). Instead, they prefer to slash waste-a category that, in their fantasy world, seems to include 50 percent of spending, according to a 2009 Gallup poll.
So knowing that Japan has run relatively large deficits for 23 or so years now, has the highest public debt ratio – more than 3 times the so-called insolvency threshold (as in Rogoff and Reinhart’s myth making), close to zero interest rates, high bid-to-cover ratios at public debt tenders, and fights deflation – might be a stretch.
But for those who are still reading, here are some charts I captured from the latest edition of – Monetary Trends January 2013 – which is published by the Economic Research division of the US Federal Reserve Bank of St. Louis.
This is a great publication as it gives a very good overview of all monetary data pertaining to the US, which then can prompt more in-depth analysis.
I was thinking that this month, the US starts to look more like Japan every day except that its unemployment rate is much higher.
Consider these trends. The first graph shows one of the alleged culprits that was going to bring the downfall – the annual change in the monetary base. Extraordinary leap in 2008 and again in 2011 (quantitative easing). Should spell higher inflation and certainly higher inflationary expectations.
And what about this graph which shows the “Federal Debt Held by Federal Reserve Banks as Percent of Gross Domestic Product” (seasonally adjusted) as published by the US Federal Reserve Bank of St. Louis – FRED2 database. This trend led to wild claims that the central bank was “monetisation”.
Remember the infamous – Secret Video – which caught Mitt Romney out hating about 50 per cent of his fellow citizens.
Here was one response by Mitt Romney during that meeting last year when he was asked by an audience member about the impending bankruptcy of the US:
… as soon as the Fed stops buying all the debt that we’re issuing-which they’ve been doing, the Fed’s buying like three-quarters of the debt that America issues. He said, once that’s over, he said we’re going to have a failed Treasury auction, interest rates are going to have to go up. We’re living in this borrowed fantasy world, where the government keeps on borrowing money. You know, we borrow this extra trillion a year, we wonder who’s loaning us the trillion? The Chinese aren’t loaning us anymore. The Russians aren’t loaning it to us anymore. So who’s giving us the trillion? And the answer is we’re just making it up. The Federal Reserve is just taking it and saying, “Here, we’re giving it.” It’s just made up money, and this does not augur well for our economic future.
The bid-to-cover ratios (concerning his “failed Treasury auction” claims) are now running above four (Source). In that article we read that the early December Treasury auction “(i)nvestors bid for more than four times the amount of two- year notes” on offer “matching a record high”. The result is that yields are low and staying low.
Last September, the New York Times ran an article – http://www.nytimes.com/2012/09/22/business/economy/as-the-us-borrows-who-lends.html and said:
What would happen if China decided to start selling Treasury bonds? And what would happen if the Fed’s appetite for government bonds were to be quenched?
Not much, it appears.
The story contains theoretical errors (that private bond markets could push up rates against the central bank’s will) but the trends reported are correct and make the sort of rabid fantasies that Mitt Romney attempted to capitalise on politically last year seem laughable.
Along the lines of Who is Kofi Annan? Answer: Coffee is a drink! I better be careful though, because I might have said that CofFEE was a – Research Centre – I have something to do with!
Anyway, back to the evidence trail.
The next graph shows the movements in interest rates. Flat and low and pointing downwards. There is really nothing complicated here. The central bank controls the short-term interest rates (not the market) and, in turn, conditions the longer-term rates. The central bank can control interest rates to be whatever they desire.
The next graph shows movements in CPI inflation and 1-year-ahead CPI inflation expectations. The inflationary expectations measures are “the quarterly Federal Reserve Bank of Philadelphia Survey of Professional Forecasters” and the “monthly University of Michigan Survey Research Center’s Surveys of Consumers”.
It is hard to conclude anything other than they are all flat or falling.
The FRBSF article cited above “examines how household inflation expectations have evolved since the beginning of the financial crisis in the United States and the United Kingdom”. I will deal with the UK another day.
They use the monthly University of Michigan survey which “asks a random sample of approximately 500 households what changes they expect in key macroeconomic variables, such as inflation, interest rates, and unemployment. Respondents are asked their inflation expectations over the next 12 months, and 5 to 10 years out”. It is a well-known time series of inflationary expectations.
This graph is from that article. The conclusion is that while there was some volatility in “year-ahead” expectations (reflecting in part oil price swings), by “the end of the sample, year-ahead inflation expectations are significantly lower than the levels registered in late 2008.”
Longer-term inflationary expectations have “stayed in a relatively narrow range around 3%”.
The overall conclusion:
… even such a severe shock as the financial crisis did not significantly change U.S. household long-run inflation expectations. It’s worth recalling that, for most of the period of this study, the United States had no formal inflation target.
The President of the US Federal Reserve Bank of St. Louis, James Bullard was very clear that quantitative easing would lead to elevated inflationary expectations. His position was broadly in line with what Monetarists think.
The policy change was largely priced into the markets ahead of the November FOMC meeting, as financial markets are forward-looking. The financial market effects of QE2 were entirely conventional. In particular, real interest rates declined, expected inflation increased, the dollar depreciated and equity prices rose.
Well the evidence doesn’t support the claim that inflationary expectations rose.
As I said earlier – none of the data is consistent with what our students would tell us. Which means one thing really – it is quite simple. They are being taught a model that fails in every way to embrace what happens in the real world.
All of the evidence provided above is consistent with Modern Monetary Theory (MMT).
If you trace back through our earlier academic literature since the 1990s and then the more recent “popularised” versions via our blogs you will find a consistent story and a close correspondence with the fact, which I think no other macroeconomic approach can lay claim to over such a long period of time.
As I said at the outset, I was going to write about the latest IMF claims about prudent and profligate fiscal positions today but generally got sidetracked in my blog time by a request from a journalist for some commentary on recent data trends.
And that is where I went after that.
That is enough for today!
(c) Copyright 2013 Bill Mitchell. All Rights Reserved.