Daily: As Fed adopts Evans Rule on way to NGDP targeting, Carney hints BoE is next
I am not going to do justice to the monumental change the Fed just instituted with the FOMC’s policy statement yesterday but I am going to take a first stab at it here in this daily with a number of articles below to follow. Here’s the crux of it.
The Fed has converted Operation Twist, which is now expiring into a program of outright purchases by the Fed, which means the Fed goes from changing the composition of its balance sheet to expanding its balance sheet. I addition, the Fed has changed the inflation target from below 2.o% to below 2.5%, meaning that the Fed is explicitly de-emphasising the inflation part of its mandate, in effect saying that it is willing to accept a higher level of inflation because it views its employment mandate as far more important. Finally, the Fed has switched from making a time-based assessment of when it will think of shifting its zero rate policy to a target-based one, targeting an unemployment rate of 6.5%.
Of all the moves the Fed made yesterday, the most important one is the move from inflation targeting to employment targeting, which is a monumental shift toward the new monetarist mantra of NGDP targeting. The Fed is making a complete paradigm shift and basically saying that the 30-year era of inflation targeting is officially over. This is big, folks. WIll it work? I don’t believe it will because the Fed does not control the jobs market. But at a minimum, it gives a green light to those who want to play risk-on trades because they know that zero rates will remain the status quo for the foreseeable future. As Cullen Roche said over at Pragmatic Capitalism, we will have to go through years of another failed monetarist experiment before we give up on employment or NGDP targeting. So this is going to be the new regime for a while.
Now, the Telegraph made it seem in one of the articles that the Fed has simply made explicit under what circumstances it will exit the zero rate policy.
The Federal Reserve has signalled it will consider raising interest rates when the US unemployment rate falls below 6.5pc, as the central bank tries to offer further clarity on when the era of cheap money will end.
This is totally wrong. It’s not about exit strategy at all. What we are seeing here is a further ratcheting up of the cult of the central bank. Basically, fiscal policy in the US is failed. The US is in the midst of gridlock and will likely choose some level of austerity beginning in 2013. And this is because policy makers on the right don’t have any faith in fiscal policy as a countercyclical policy tool. Instead, they continue to look to monetary policy. So, we are moving from a world in which ALan Greenspan can save the world through Fed liquidity and interest rate cuts to a zero rate world in which Ben Bernanke can save the world through employment and eventually NGDP targeting. And this experiment will have to fail before people move away from monetary policy as the preferred countercyclical tool for government economic policy.
I think Mark Thoma put it right when he wrote:
it’s important to recognize that these are triggers, not thresholds. A 6.5 percent unemployment trigger, for example, means that if the unemployment rate falls below this level, a new policy is necessarily triggered, meaning the policy ends. But a 6.5 percent threshold brings about a discussion and a reassessment at the Fed of the appropriate policy — but policy does not necessarily change. The Fed is instituting thresholds, not triggers, and its important to understand the difference.
This is the exact opposite of what the Telegraph was saying in its write-up. It’s not about exit strategy at all. It’s about a paradigm shift away from using inflation as a threshold in so-called inflation-targeting to using employment as a threshold in employment targeting. Ostensibly, this is one move en route to full bore NGDP targeting.
Now Fed President Charles Evans should get credit for leading the way on this ideologically within the Fed. Bloomberg BusinessWeek has a good writeup on this:
Given the slow pace of job growth, the current plan could mean that rates stay super-low past mid-2015.
This is essentially what Charles Evans, President of the Federal Reserve Bank of Chicago, has been arguing for over the last year. Dubbed the Evans Rule, the argument holds that monetary policy shouldn’t be tightened until the economy heals pasts a certain predetermined threshold. In a speech delivered in September 2011, Evans made the point that the Fed should be just as aggressive about fighting high unemployment as it is about high inflation. Said Evans:
“Imagine that inflation was running at 5 percent against our inflation objective of 2 percent. Is there a doubt that any central banker worth their salt would be reacting strongly to fight this high inflation rate? No, there isn’t any doubt. They would be acting as if their hair was on fire. We should be similarly energized about improving conditions in the labor market.”
Michael Feroli, chief U.S. economist at JPMorgan Chase (JPM), wrote after the Fed announcement: “The ‘Evans rule’ had gained increasing support on the Committee in recent months, and it was expected to be adopted eventually, but most—including us—had thought it would not be adopted until early next year. Even so, Bernanke has consistently pushed forward policy innovations faster than generally expected.” He said, “We support today’s move.”
What’s more is that Bank of Canada Governor Mark Carney who is moving over to the Bank of England in the summer said recently that he favours exactly this type of policy shift. Likely, he will move the Bank of England onto this path next. Here, the Telegraph does better reporting:
Addressing the Chartered Financial Analyst Society in Toronto, Mr Carney said that in major slumps: “To achieve a better path for the economy over time, a central bank may need to commit credibly to maintaining highly accommodative policy even after the economy and, potentially, inflation picks up.
“To ‘tie its hands’, a central bank could publicly announce precise numerical thresholds for inflation and unemployment that must be met before reducing stimulus.”
He added: “If yet further stimulus were required, the policy framework itself would likely have to be changed. For example, adopting a nominal GDP level target could in many respects be more powerful than employing thresholds under flexible inflation targeting.”
The proposals would be anathema to Sir Mervyn, who has publicly refused to abandon the inflation target or commit to long-term low rates.
So there you have it. The Fed is making a monumental policy shift away from inflation targets to employment targets, a move that puts it well on its way to NGDP targeting. The next Bank of England Governor supports these moves and will likely implement the same policy when he takes over in the UK. To me, this is further proff that monetary policy has remained the policy tool of choice for countercyclical government intervention. If and when the economy worsens, monetary policy will simply become more aggressive. Fiscal policy is viewed with suspicion, making austerity more likely in both the US and Europe.
Monetary policy over fiscal
“it’s important to recognize that these are triggers, not thresholds. A 6.5 percent unemployment trigger, for example, means that if the unemployment rate falls below this level, a new policy is necessarily triggered, meaning the policy ends. But a 6.5 percent threshold brings about a discussion and a reassessment at the Fed of the appropriate policy — but policy does not necessarily change. The Fed is instituting thresholds, not triggers, and its important to understand the difference.”
“The Fed delivered an early Christmas present to the economy by acting above expectations with not only a one-for-one conversion of Operation Twist to outright asset purchases, more than doubling the pace of balance sheet expansion, but also shifting the communications strategy to thresholds. The latter ties policy explicitly to outcomes rather than dates, which I think is the appropriate direction for policy.”
“what struck me as most important was that Bernanke emphasized that the addition of thresholds was a change in the communication of the Fed’s monetary policy, not a change in the policy itself. Indeed, I think the enhanced communication strategy is an important improvement. It increases transparency dramatically. As Bernanke noted, it is clearly more flexible in that the expectations for a change in Fed policy will fluctuate with the flow of data. In contrast, the Fed only changed the date when significant revisions in the economic forecast became evident. That said, as the statement makes clear, the Fed believes the threshold criteria are consistent with the previous date-based guidance. In this regard, policy is unchanged as the expected date of first rate hikes is unchanged.
Next, I think there will be a tendency to view the 50bp margin on inflation (the explicit statement that inflation might rise as high as 2.5% in the near term without an automatic review of the interest rate stance) as an indication the Fed is placing less weight on its inflation mandate.”
“This is essentially what Charles Evans, President of the Federal Reserve Bank of Chicago, has been arguing for over the last year. Dubbed the Evans Rule, the argument holds that monetary policy shouldn’t be tightened until the economy heals pasts a certain predetermined threshold. In a speech delivered in September 2011, Evans made the point that the Fed should be just as aggressive about fighting high unemployment as it is about high inflation. “
“More clarity was needed to for this program to fully utilize the power of expectations management.
Today the FOMC unexpectedly did just that. It tied QE3–or more accurately QE Flex since it now includes both MBS and treasury purchases–to the specific targets of 6.5% unemployment rate and 2.5% inflation. This is huge. It makes very clear to the public that the Fed will not stop until these targets are hit. “
“ots of people are talking about how today’s change in FOMC guidance is a move towards NGDP Targeting. They might be right. And while I don’t think NGDP Targeting is all bad, it’s definitely not my preferred approach. I’ve recently started to discuss something called “elastic deficit targeting”.”
“Nearly a year ago, Jeffry Frieden and I called for Conditional Inflation Targeting. Today, policy seems to have turned toward that direction.”
“QE Whatever is now officially QE4, but with an unexpected twist: Fed will hold rates steady and continue to buy until unemployment hits 6.5% and inflation remains tamed.”
“Mark Carney, the incoming Governor of the Bank of England, has suggested abandoning inflation targeting to rescue ailing economies in a speech that rewrote the central banking rulebook.”
“Three years of growth have generated a combined recovery of 15 per cent, but Estonia’s output is still around 3 per cent below pre-crisis levels.
Lithuania is in a similar position. In Latvia, where the crisis was the most dramatic with cumulative GDP drop of 20 per cent, even a fast recovery still leaves GDP around 10 per cent down on pre-crisis levels.
All three countries responded to the crisis by drastic austerity packages, including public pay and pension cuts and all saw their property markets sink as pre-2008 credit-fuelled booms collapsed in mountains of corporate and household debt.”
North America
“Perhaps the best way to understand the term Asian-American, says Eric Liu, a Chinese-American author and former adviser to Bill Clinton, is as a “classically American invention”: a manufactured identity that grants those it happens to include a level of political and cultural power they would not otherwise enjoy. Mr Liu says the various Asian subgroups in Seattle, his home town, are too small for any one to wield real power. But united as “Asian-Americans”, they are a force in civic life.”
“Retail and food-service sales increased 0.3% last month to a seasonally adjusted $412.40 billion, the Commerce Department said Thursday. Economists surveyed by Dow Jones Newswires had expected a 0.5% advance. Compared with a year earlier, overall November sales were up 3.7%.”
“In the past year — assuming a well-qualified borrower received the average 30-year conforming fixed rate on $417,000 — the savings would be $145 on the new monthly payment of $1,830 compared to one year ago when rates averaged 3.94 percent. The 15-year monthly payment of $2,812 would be a savings of $110 compared to last year’s rate of 3.21 percent.”
“The ratio of household debt-to-disposable income in Canada hit a record 164.6%, Statistics Canada reported early Thursday. It has risen steadily as consumers have taken advantage of low interest rates to buy homes.
That’s been a huge boon to Canada’s major banks, which have made billions in profits from mortgage lending. Housing represents their largest asset-class exposure, at almost 42% of total bank assets.
That poses big risks for the banks if house prices weaken or if consumers show signs they can’t pay back those debts. While housing markets in several Canadian cities have begun to ease, mortgage delinquency rates have remained low.
Still, Ms. Dickson said the environment, globally and at home, is “pretty unsettled,” given Canada’s sluggish economic growth, Europe’s sovereign debt woes and the U.S.’s looming fiscal cliff.
“The banks need to be prepared for all outcomes,” she said. “It’s something that we want the banks to be focused on. I think they do a good job of that, and that’s how people sleep at night.” She said credit-quality of loans and delinquency rates “are still extremely good.””
Technology
“The ruling from U.S. District Court in the District of Delaware was handed down on Thursday, according to Bloomberg. Apple attempted to have the case tossed out of court last month citing prior art, but Judge Sue Robinson denied the request.
MobileMedia is jointly owned by Sony, Nokia and MPEG LA. The ‘filing at the heart of the case, U.S. Patent No. 6,441,828, was originally filed by Sony in 1999 in relation to technology for a digital picture frame.”
“Former Mac evangelist Guy Kawasaki says he’s purged all iOS devices from his life.”
“One of the top executives at Apple’s chief rival, Samsung, has admitted that he uses an iPhone, iPad and Mac at home, largely due to Apple’s “sticky” ecosystem.”
” the U.K. leads international markets for mobile device adoption and usage, with mobile social networking a key driver of device sales and use. Internet shopping on mobiles is also on the rise — and the U.K. leads for online shopping generally (across all connected devices), with U.K. consumers now spending more than £1,000 per year buying stuff online.”
“According to the Korea Times, Samsung is trying to put a 6.3-inch display in the next iteration of the Galaxy Note. The Galaxy Note II, which launched relatively recently, debuted with a 5.5-inch display, already a step up from the original Note’s 5-inch screen.”
“The danger with such an outlandish device was always that the camera would take a back seat to the shiny touchscreen and the Android UI. However, Samsung has pulled off the combination with impressively fine judgement. It’s very much a competent pocket snapper with the bonus of smartphone-style internet connectivity thrown in rather than the other way around, and on that basis it just about justifies the high price.”
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