Thursday, September 22, 2011

The Dark Ages

At the last GOP presidential candidate debate, two candidates (Romney and Gingrich) called Ben Bernanke "inflationary," and pledged not to re-appoint him. Rick Perry has accused Bernanke of "almost treasonous" actions and said he would be treated "pretty ugly down here in Texas."  Speaker Boehner and Minority Leader Mitch McConnell wrote an open letter to Bernanke urging him not to pursue monetary stimulus as there was "no evidence" any was needed.

After the FOMC announced its new policy yesterday, the Dow fell 200 points and is down another 300 points this morning.  The dollar appreciated in value against foreign currencies, gold and oil also fell.  The yields on the 10 and 30-year Treasuries fell to new 60 year lows.  The 30 year TIPS spread, a market indicator of inflation expectations, fell below 2% for the first time.  The yield curve indeed flattened.


All of the above indicate that inflation expectations have fallen off dramatically.  Inflation expectations are at historic lows. Accordingly, NGDP growth expectations have fallen dramatically, and the Fed's announcement itself indicates the FOMC is pessimistic about growth and employment.

It's really simple:  When demand for money increases, velocity (the inverse of demand) decreases. As a result, NGDP decreases.


The Fed's job is to manage the M x V side of the equation.  Yesterday's new policy brought no new increase to M, only a reshuffling of the Fed portfolio to try and get investors to move out the curve at the margin.  As Scott Sumner reminds us, a flat yield curve represents tight money, and not loose, "inflationary" monetary policy. If the Fed was pursuing the "inflationary" policies it's accused of the yield curve would be steeper and NGDP growth would be much higher.  Anyone who tells you otherwise is ignoring at least 400 years of economic thought.  Journalists who are puzzling as to why the market is acting this way should probably order some textbooks off Amazon.

NGDP expectations matter a great deal, as David Beckworth points out:

If firms expect more income, they will invest and produce more.  If workers expect higher incomes they will spend more and have more confidence in firms, leading them to hold less cash and save more in the form of stocks and corporate bonds, boosting asset prices.  The increase in consumption and investment and production boosts employment and incomes, and the cycle continues.

My thoughts are not new or leftwing-liberal-progressive.  Milton Friedman taught them. F.A. Hayek taught them.  This "new" (but really very old) school of thought is now called market monetarism, and it is what I most identify with. Ramesh Ponnuru of the National Review has taken up the MM fight several times. Scott Sumner wrote this must-read piece for the conservative National Affairs. If you have put your currency in the hands of a central bank, then its job is to achieve monetary equilibrium and it is the only entity that can do so.

I've become cynical about the GOP's ranting against the Fed because they obviously have the most to lose (2012 election) if the Fed does its job and the economy picks up.  I've become cynical about the President because he's allowed two seats on the Board of Governors to go unfilled, along with several positions in Treasury Department and elsewhere, at a time when all hands on deck are needed (the GOP have blocked or threatened to block several nominations, but he could always recess appoint around that and chooses not to). I've become cynical about the FOMC because three members loudly voted against the FOMC's decision yesterday because they do not support "additional policy accommodation at this time." But the most valid criticism of the Fed right now is that they have not plotted any forward course; they have not told us where they want the economy to go. They have simply told us they do not like where we are headed and want to rev up the engines to prevent going there, but they've left the ship in neutral and there is no specific destination. That is defacto the same thing as moving in the wrong direction.

It feels like a Dark Age to me.

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