{"id":12269,"date":"2010-11-10T17:13:21","date_gmt":"2010-11-10T06:13:21","guid":{"rendered":"https:\/\/billmitchell.org\/blog\/?p=12269"},"modified":"2010-11-10T17:13:21","modified_gmt":"2010-11-10T06:13:21","slug":"when-does-no-evidence-mean-no-evidence","status":"publish","type":"post","link":"https:\/\/billmitchell.org\/blog\/?p=12269","title":{"rendered":"When does no evidence mean no evidence?"},"content":{"rendered":"

\t\t\t\tI keep reading that the inflationary expectations genie is about to jump out of the bottle and far from being benign and supportive will wreak havoc on real wealth. I also keep reading that the gold price is rising because of these increasingly robust fears of future inflation. It is one of those themes that get trotted out to alert us to the dangers of government intervention in the economy. It takes about one sentence to get to Zimbabwe and usually Weimar then gets dropped in. I know the characters that perpetuate this sort of stuff have had their minds poisoned by their undergraduate macroeconomics indoctrination but we do become adults eventually and should be able to question everything. If I am doubt I work out the logic of a problem and then confront the logic with some real world data to see if the logic at least is consistent with what actually happens. I am no empiricist but I don’t buy the idea that if the facts refute the theory then the facts must be wrong. Today I went off looking for those pesky inflationary expectations. I found them … looking forlorn. Just another ruse!
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\nFormer US Treasury secretary Robert Rubin wrote an Op-Ed in the Financial Times (November 1, 2010) – How America can withstand the headwinds<\/a>. It contains many errors and his judgement of economic trends remains very poor.<\/p>\n

Rubin was a senior member (then Chairman) of Citigroup after his political career ended. He left just before its near collapse amidst criticism of his performance. In 2001, he used a mate in the US Treasury Department to try to put pressure on the bond-rating agencies to avoid downgrading Enron’ debt which was a debtor of Citigroup. In January 2009, he was named by Marketwatch<\/a> as one of the “10 most unethical people in business”.<\/p>\n

So an all-rounder really. Please read my blog – Being shamed and disgraced is not enough<\/a> – for more discussion of Rubin and who he keeps company with (Alan, Larry!).<\/p>\n

The headwinds he identifies include:<\/p>\n

\n… high unemployment and low job growth; both a decline in fiscal demand and unsustainably high federal deficits; excess capacity; business uncertainty; weak consumer financial conditions; and much else.\n<\/p><\/blockquote>\n

He concludes these headwinds are so strong that “the probabilities are much greater that growth will be slow and bumpy, and unemployment high, for an extended period”.<\/p>\n

That will happen if people like him continue to perpetuate the myth that the US federal deficit is unsustainably high. In relation to what? Answer: there is no application to expressions like “unsustainably high” when dealing with a federal budget outcome when at the same time you note the other headwinds which are all deflationary.<\/p>\n

A budget outcome is only effectively unsustainable if it pushes nominal aggregate demand beyond the capacity of the economy to absorb that spending in real terms (that is, beyond the capacity to increase real output). The budget of a sovereign government is never unsustainable in narrow financial terms. A sovereign government can run whatever deficit it chooses from a perspective of financial viability. It might be unwise to push the economy into inflation but it can always do that.<\/p>\n

So I found this assessment curious and decided to read on. I regret doing so.<\/p>\n

Rubin then juxtaposed what could be a constructive further fiscal stimulus – one that supports small business etc and has a “real, trusted and enacted long-term structural deficit reduction” to a “major new stimulus” that could be “counterproductive” because:<\/p>\n

\nIt could seriously increase business uncertainty about future economic conditions and policy, or change market psychology unexpectedly and dramatically, causing serious market disruptions. Or, even if a major new stimulus worked initially, it could fail to generate lasting momentum due to the headwinds, leaving us worse off than we would have been, with more debt but no greater gross domestic product … And a large, new round of quantitative easing has real risks: undermining confidence in the Fed’s ultimate refusal to monetise our debt; undesirably heightened inflationary expectations more broadly, now or later, or actual inflation; and competitive devaluations and trade restrictions.\n<\/p><\/blockquote>\n

So this uncertainty argument again – the type of argument that is repeatedly being use to underpin the deficit terrorist attack on fiscal policy.<\/p>\n

Fiscal austerity is being justified by empirically-failed notions of Ricardian Equivalence which alleges that the withdrawal of government spending will be more than replaced by consumer and investment spending.<\/p>\n

The claim is that consumers and firms are what the mainstream macroeconomists call Ricardian agents Private spending is currently extremely flat at present because according to the crackpot mainstream economists (Rubin is one of them) all private agents are so fearful of the budget deficits that they are saving up to ensure they can meet the future tax hikes that they think will be required to pay back the deficits.<\/p>\n

The theoretical models used to derive these results are from La-la land which then means we are not surprised that their main predictions have regularly failed when real world events have given the theory a chance to shine. <\/p>\n

On the existence of Ricardian households and firms please read my blogs – Its simple – more public spending is required<\/a> and Even the most simple facts contradict the neo-liberal arguments<\/a> and Pushing the fantasy barrow<\/a> – for more discussion.<\/p>\n

There is a contradictory thread running through the mainstream narrative at present which is also present in Rubin’s quote above. Ricardian agents also employ rational expectations (RATEX). This literature evolved to challenge the notion that fiscal policy could be effective in stimulating (or reducing) real activity.<\/p>\n

RATEX theory argues that people (you and me) “know” the true economic model that generates actual outcomes. Accordingly, they anticipate everything the central bank or treasury is going to do and render it neutral in real terms but lethal in nominal terms. In other words, the government cannot increase real output with a fiscal or monetary stimulus but will always cause inflation.<\/p>\n

Please read my blog – The myth of rational expectations<\/a> – for more discussion on this point.<\/p>\n

The rise of RATEX led to a re-prioritisation of policy targets – towards inflation control and away from broader goals like full employment and real output growth. Indeed, whereas previously unemployment had been a central policy target, it became a policy tool in the fight against inflation under this new approach to monetary policy.<\/p>\n

So if any of this was a reliable indicator of the way people behave we should expect rising inflationary expectations (noted as a current policy danger by Rubin). In which case, why would people postpone consumption if they thought everything was going to become more expensive? There is no mainstream literature covering the apparent contradiction between the Ricardian consumers who are terrified of budget deficits and postpone consumption to save in order to service the future (higher – allegedly) tax rates (to pay the deficit back!) and the same RATEX consumers who believe the deficits will be inflationary.<\/p>\n

The fact is that this is all nonsense!<\/p>\n

In terms of Rubin’s article, it is clear that most of the headwinds he mentions are currently deflationary in nature and placing huge constraints on US economic growth. The unemployed would love to spend some more on gaining quality housing and\/or better access to services but they won’t because they have no income.<\/p>\n

Remember the golden rule: spending equals income and income generates more spending. All of which creates jobs.<\/p>\n

Within this deflationary environment we keep hearing about the inflation threat. Rubin also buys into the erroneous position that the increase in base money is likely to lead to “undesirably heightened inflationary expectations”. So we better have a look for some reliable evidence of these heightened inflationary expectations.<\/p>\n

The rest of the article is US-Hurrah-Hurrah sort of stuff – who could be listening to that nonsense any more and “working together one and all” sort of motherhood statements that get us nowhere. Whenever I hear that sort of talk I am immediately on alert for which business lobby is trying to screw the government and the workers while being there for “one and for all”.<\/p>\n

Reuters journalist Felix Salmon had a lovely short analysis<\/a> of the Rubin article (November 2, 2010):<\/p>\n

\nThe op-ed, which is written in borderline-unreadable technocratese, has a simple structure: there are headwinds in the economy. What should we do about them? Spending more might be problematic. Expansionary monetary policy likewise. So what should be done? The administration should be more business-friendly. And it should put together a “serious fiscal plan”.\n<\/p><\/blockquote>\n

I loved that assessment! The rest of Salmon’s discussion of Rubin’s arguments is also classic. For example, “Does Rubin really think it probable that the announcement of extra government spending would cause some kind of crazy market crash?” and “Rubin seems to be asking us to give up investment today on the grounds that it might cause business uncertainty tomorrow” etc.<\/p>\n

Anyway, with all this talk of growing inflationary pressures I thought I better go hunting for them. Two sources of data can help us. Time series that capture price expectations and bond market data which allows us to construct the yield curve.<\/p>\n

Inflationary expectations<\/strong><\/p>\n

The balance sheet of the US Federal Reserve has grown amazingly over the last few years. We are all familiar by now with the following graph derived from data available from the Cleveland Federal Reserve Bank<\/a>.<\/p>\n

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<\/div>\n

The mainstream macroeconomics textbooks are replete with discussions about base money or the central bank liabilities – which are held as reserves by banks and currency by the public. They claim that the ultimate money supplied is a multiple of the central bank liabilities. Please read my blogs – Money multiplier and other myths<\/a> and Money multiplier – missing feared dead<\/a> – for more discussion of this fairy tale.<\/p>\n

Blanchard who is now IMF chief economist wrote a textbook that is representative of the genre. He said in his first edition that:<\/p>\n

\nThe central bank controls central bank money … an increase in central bank money leads, because of the money multiplier, to a more than one-for-one increase in the money supply …\n<\/p><\/blockquote>\n

The mainstream prediction is that the expansion of the Federal Reserve’s balance sheet (depicted above) will be inflationary because it has<\/strong> to mean a rapid expansion in the money supply. The Federal Reserve Board’s actions are equivalent in the mainstream models as “printing money” which makes it tantamount to their analysis of seignorage (when they “monetise” a budget deficit).<\/p>\n

The question is how long does it take for our Ricardian\/RATEX agents to build inflationary expectations given this sort of balance sheet expansion? Answer: the mainstream have no idea – they just assert that it happens. A rational agent should immediately adjust their expectations upwards.<\/p>\n

Given the cliff-like nature of the Federal Reserve’s balance sheet expansion if any of this was true then there should be signs of inflationary expectations rising by now.<\/p>\n

So we should be able to see this in the data given that the cliff was climbed more than two years ago and the Federal Reserve has shown no sign of reducing its balance sheet (exactly the opposite).<\/p>\n

Data? The Cleveland Fed Estimates of Inflation Expectations<\/a> data are a good source of data.<\/p>\n

The following graph is drawn from that database and shows a time-series of inflationary expectations for a 10-year horizon. That is, the observations at each point in time reflect what the expected inflation rate would be in 10 years time from that observation.<\/p>\n

\"\"<\/a><\/p>\n

<\/div>\n

So inflationary expectations continue to fall. Central banks claim they are interested in longer-term trends and that monetary policy today determines future inflation.<\/p>\n

The Cleveland Federal Reserve Bank’s summary of their latest data release (graphed above) says:<\/p>\n

\n… this suggests that the Federal Reserve still has credibility in keeping inflation low and that the massive increase in its balance sheet and the accompanying increase in banking system reserves has not served to unanchor the public’s expectations of inflation.\n<\/p><\/blockquote>\n

So where does Rubin get his idea that policy risks triggering “undesirably heightened inflationary expectations” from? Answer: Not the real world!<\/p>\n

The next graph presents the US data in a different way. It shows for five different observations (the last being October 2010) what the structure of inflationary expectations was at that point in time from 1-year ahead predictions to 30-years ahead.<\/p>\n

The data shows categorically that inflationary expectations across all forecast-horizons have fallen over the last few years as the Federal Reserve has been pumping up its balance sheet and the US Treasury pumping out its net spending. Even expected inflation 30-years out is lower now.<\/p>\n

When does no evidence mean no evidence?<\/p>\n

\"\"<\/a><\/p>\n

<\/div>\n

Australia? We are after all being touted as the one-in-a-hundred year (mining) boom economy at present and the central bank (RBA) is hiking rates because it thinks there is an inflation threat emerging. Well the latest evidence from the RBA – Other Price Indicators – Table G4<\/a> doesn’t support that line of reasoning.<\/p>\n

The two series shown are the “Consumers’ inflation expectations” (Melbourne Institute median expected inflation rate for the year ahead) and the “NAB survey” of price expectations (National Australia Bank Quarterly Business Survey) – average expected increase in the price of final products in the next three months. These often-used data suggests that inflationary expectations in our “growth” economy are also moderating.<\/p>\n

\"\"<\/a><\/p>\n

<\/div>\n

The yield curve says it ain’t so!<\/strong><\/p>\n

And what is the US Treasury Yield Curve telling us?<\/p>\n

The yield curve is a graphical depiction of the term-structure of risk-free interest rates and plots the maturity of the government bond on the horizontal axis against the respective yields (return) on the vertical axis. We can use the term maturity and term interchangeably. So a 10-year Treasury bond matures in 10 years and in the meantime delivers some return (yield) to the bond-holder.<\/p>\n

Please read my blog – Time to outlaw the credit rating agencies<\/a> for more explanation of yield curves and Operation twist – then and now<\/a> – for a brief a video presentation.<\/p>\n

To understand the next point here are some essential yield concepts in fixed-income investments that are used in the markets. The yield indicates the money that will be returned from the investment and is usually expressed in percentage terms. There are several concepts of yield that can be defined.<\/p>\n