[Steve_American]

Here I quote and post the 1st part of Bill's blog for today, 9/7/21, with a few of my comments.
To see the graph in the subject/title you need to go to this link
http://bilbo.economicoutlook.net/blog/?p=48257

As the mainstream paradigm breaks down.

On September 2, 2021, the Head of the BIS (Bank of International Settlements) Monetary and Economic Department, Claudio Borio gave an address – "Back to the future: intellectual challenges for monetary policy" = at the University of Melbourne. The Bank of International Settlements is owned by 63 central banks and provides various functions “to support central banks’ pursuit of monetary and financial stability through international cooperation”. His speech covers a range of topics in relation to the conduct of monetary policy but its importance is that it marks a clear line between the way the mainstream conceive of the role and effectiveness of the central bank and the view taken by Modern Monetary Theory (MMT) economists. I discuss those issues in this blog post.

First, note that Claudio Borio openly admits: that

"… the loss of policy headroom is not technical in nature … as central banks purchase a growing amount of assets, they risk being perceived as eroding the basis of a market economy."

In other words, all this talk about the need for fiscal rules, and other constraints on government (treasury or central bank) are really not financial (“technical”) but, rather, issues of ideology.

If you think the “market economy” is the ultimate arbiter, then, of course, intervention into those processes will be seen as sub-optimal.

I do not hold the outcomes of an unfettered market economy as being the desirable benchmark upon which we assess government policy.

Quite the opposite in fact.

Other Issues arising from Claudio Borio’s Speech:

1. “inflation has proved rather insensitive to monetary policy easing, thereby thwarting central banks’ efforts to push it up to target post-GFC.”

2. “in its recent review, the Federal Reserve downplayed the role of an unobservable equilibrium rate of unemployment in setting policy” – meaning that the US central bank has effectively abandoned the NAIRU mentality that has ruled monetary policy for several decades and sustained elevated and very wasteful levels of labour underutilisation.

It (NAIRU) was all in vain folks.

And in this paper from June 1987 (which was actually written in 1985) – "The NAIRU, Structural Imbalance and the Macroeconomic Equilibrium Unemployment Rate" – I provided a comprehensive framework and empirical evidence as to why it would be in vain.

34 years later it is, according to Claudo Borio a “well known factor”. [Bill's 'it' in this sentence confuses me.]

Takes time to catch on, eh?

3. “inflation expectations may be rather backward-looking or at least unresponsive to policy announcements” – all the academic papers that claimed that monetary policy had to pursue inflation targetting and fiscal policy should be submissive to that agenda because that was the way inflationary expectations would remain anchored – what do they say now?

4. That the economic cycle is now driven by the “financial cycle” – which means excessive credit and private debt accumulation as financial market regulation and oversight was weakened.

Claudio Borio says:

"There is no question that a key reason for the rise in the financial cycle has been financial liberalisation."

And if you go back to the 1980s, when the mainstream New Keynesian macroeconomists were falling over each other to extol the virtues of financial market deregulation as the path to financial stability, and setting us up for decades of financial instability and crisis, you have to wonder how they can still retain their highly-paid, protected jobs and keep getting the public platform.

5. To all the inflation-mavens, who have run out of credibility claiming government deficits would send them broke, and now hang onto the only thing left – inflation scaremongering, Claudio Borio noted:

"It is hard to believe that the inflation process could remain immune to the entry of 1.6 billion lower-paid workers in the global economy, as the former Soviet bloc, China and emerging market economies opened up."

Add to that the relentless labour market deregulation and anti-union attacks in advanced countries, which have made “the wage-price spirals of the past (“second-round effects”) less likely”.

This is a point I have been making for ages – "you need propagating mechanisms for inflation to become entrench after an initial shock."

At present, the global supply chains are in chaos.

I was told last week from a friend who uses large bulk freighters as part of his company’s business that the freight prices are rising steeply, in part, because there is huge congestion in China’s system of ports as a result of the Delta Covid strain causing long delays in port clearance.

And, the short-term price spikes are evident.

But to become entrenched as an accelerating inflation, the real income struggle between labour and capital has to be ignited.

That propogation will not be forthcoming any time soon.

The Volcker Shock
Claudio Borio invokes the “Volcker’s efforts” in the 1980s as evidence that:

"… central banks worldwide succeeded in taming inflation."

This is one of those dubious claims that persist in history.

The Volcker Shock was like treating a mild headache with a morphine overdose.

It should not be used to demonstrate the ‘effectiveness’ of monetary policy in disciplining price pressures.

Here is a plot of the University of Michigan Inflationary Expectations data from January 1978 to July 2021 and the Federal Reserve Funds Rate for the same period. [Actually, I can't post the graph, you'll have to go to the link.]

You can see that there is not a close correspondence between the time series behaviour of the two series.

Just to satisfy my curiosity, I spent a little while running Vector Autoregressions and Granger causality tests on the data with various lags. Cutting through the jargon, these econometric procedures are standard ways to investigate the associations across time at various lags of the variables.

While the work was nascent, experience tells me that there was no causality running from the federal funds rate to price expectations, although it did work the other way. The interrelationship is thus complex and one cannot infer that monetary policy (adjusting the funds rate) disciplines inflationary expectations.

History tells us that in all the nations I have studied, it was the large recessions (1981-82, 1991 depending on country) that expelled the persistently high inflationary expectations (as a result of the OPEC oil hikes) from the economies.

Those episodes were not exclusively brought on by monetary policy adjustments.

You might say that Volcker knew that if he hiked the funds rate, he would choke off borrowing and that would create a recession, which would discipline expectations.

The problem was that the Monetarist causality he had in mind did not prove to be realised.

He thought he could control the broad money supply by controlling the base money (reserves plus currency) – making it harder for banks to acquire, which would push up rates in the financial markets and squeeze borrowing.

Interest rates went into a sharply upward spiral and borrowing was reduced.

But as a result of the higher rates, there was a dramatic increase in capital inflow in pursuit of dollar-denominated financial assets, which pushed the exchange rate up from the Autumn of 1980 to November 1982 (by around 40 per cent against the major currencies).

This severely undermined US exports and the recession.

Unemployment started to escalate sharply.

The inflation that was in train at the time was the result of oil price hikes in 1979 (quadrupling) and this caused recessions everywhere. The cost pressures were working their way through to other commodities (food, housing, etc) and so by the time Volcker set about wrecking prosperity, the inflation dynamic was already waning.

Further, I am often surprised when people introduce the so-called Volcker Shock as evidence that monetary policy should be the primary macroeconomic counter-stabilisation tool.

Within normal limits of interest rate movements, adjusting interest rates has very little impact at all on the real economy.

The fact that Volcker was prepared to push the overnight rate so high (around 20 per cent) and precipitate a widespread financial crisis, which then pushed thousands of firms into bankruptcy and forced unemployment to rise above 10 per cent in order to kill inflation that was already dissipating is not something to be recommended.

Extolling the virtues of a policy tool that only really achieves the stated aims by invoking a massive crisis, when the target is hardly a worry is not very clever.

One can cure a headache by taking massive overdose of morphine. But the patient dies!

[The graph Bill spoke of js many lines above is HERE, after many lines of his comments.]
[There is also more to the post.]

[late]

NAIRU sucks, take anything Milton says with a pound of salt.

[JohnRawls]

Here I quote and post the 1st part of Bill's blog for today, 9/7/21, with a few of my comments.
To see the graph in the subject/title you need to go to this link
http://bilbo.economicoutlook.net/blog/?p=48257

As the mainstream paradigm breaks down.

On September 2, 2021, the Head of the BIS (Bank of International Settlements) Monetary and Economic Department, Claudio Borio gave an address – "Back to the future: intellectual challenges for monetary policy" = at the University of Melbourne. The Bank of International Settlements is owned by 63 central banks and provides various functions “to support central banks’ pursuit of monetary and financial stability through international cooperation”. His speech covers a range of topics in relation to the conduct of monetary policy but its importance is that it marks a clear line between the way the mainstream conceive of the role and effectiveness of the central bank and the view taken by Modern Monetary Theory (MMT) economists. I discuss those issues in this blog post.

First, note that Claudio Borio openly admits: that

"… the loss of policy headroom is not technical in nature … as central banks purchase a growing amount of assets, they risk being perceived as eroding the basis of a market economy."

In other words, all this talk about the need for fiscal rules, and other constraints on government (treasury or central bank) are really not financial (“technical”) but, rather, issues of ideology.

If you think the “market economy” is the ultimate arbiter, then, of course, intervention into those processes will be seen as sub-optimal.

I do not hold the outcomes of an unfettered market economy as being the desirable benchmark upon which we assess government policy.

Quite the opposite in fact.

Other Issues arising from Claudio Borio’s Speech:

1. “inflation has proved rather insensitive to monetary policy easing, thereby thwarting central banks’ efforts to push it up to target post-GFC.”

2. “in its recent review, the Federal Reserve downplayed the role of an unobservable equilibrium rate of unemployment in setting policy” – meaning that the US central bank has effectively abandoned the NAIRU mentality that has ruled monetary policy for several decades and sustained elevated and very wasteful levels of labour underutilisation.

It (NAIRU) was all in vain folks.

And in this paper from June 1987 (which was actually written in 1985) – "The NAIRU, Structural Imbalance and the Macroeconomic Equilibrium Unemployment Rate" – I provided a comprehensive framework and empirical evidence as to why it would be in vain.

34 years later it is, according to Claudo Borio a “well known factor”. [Bill's 'it' in this sentence confuses me.]

Takes time to catch on, eh?

3. “inflation expectations may be rather backward-looking or at least unresponsive to policy announcements” – all the academic papers that claimed that monetary policy had to pursue inflation targetting and fiscal policy should be submissive to that agenda because that was the way inflationary expectations would remain anchored – what do they say now?

4. That the economic cycle is now driven by the “financial cycle” – which means excessive credit and private debt accumulation as financial market regulation and oversight was weakened.

Claudio Borio says:

"There is no question that a key reason for the rise in the financial cycle has been financial liberalisation."

And if you go back to the 1980s, when the mainstream New Keynesian macroeconomists were falling over each other to extol the virtues of financial market deregulation as the path to financial stability, and setting us up for decades of financial instability and crisis, you have to wonder how they can still retain their highly-paid, protected jobs and keep getting the public platform.

5. To all the inflation-mavens, who have run out of credibility claiming government deficits would send them broke, and now hang onto the only thing left – inflation scaremongering, Claudio Borio noted:

"It is hard to believe that the inflation process could remain immune to the entry of 1.6 billion lower-paid workers in the global economy, as the former Soviet bloc, China and emerging market economies opened up."

Add to that the relentless labour market deregulation and anti-union attacks in advanced countries, which have made “the wage-price spirals of the past (“second-round effects”) less likely”.

This is a point I have been making for ages – "you need propagating mechanisms for inflation to become entrench after an initial shock."

At present, the global supply chains are in chaos.

I was told last week from a friend who uses large bulk freighters as part of his company’s business that the freight prices are rising steeply, in part, because there is huge congestion in China’s system of ports as a result of the Delta Covid strain causing long delays in port clearance.

And, the short-term price spikes are evident.

But to become entrenched as an accelerating inflation, the real income struggle between labour and capital has to be ignited.

That propogation will not be forthcoming any time soon.

The Volcker Shock
Claudio Borio invokes the “Volcker’s efforts” in the 1980s as evidence that:

"… central banks worldwide succeeded in taming inflation."

This is one of those dubious claims that persist in history.

The Volcker Shock was like treating a mild headache with a morphine overdose.

It should not be used to demonstrate the ‘effectiveness’ of monetary policy in disciplining price pressures.

Here is a plot of the University of Michigan Inflationary Expectations data from January 1978 to July 2021 and the Federal Reserve Funds Rate for the same period. [Actually, I can't post the graph, you'll have to go to the link.]

You can see that there is not a close correspondence between the time series behaviour of the two series.

Just to satisfy my curiosity, I spent a little while running Vector Autoregressions and Granger causality tests on the data with various lags. Cutting through the jargon, these econometric procedures are standard ways to investigate the associations across time at various lags of the variables.

While the work was nascent, experience tells me that there was no causality running from the federal funds rate to price expectations, although it did work the other way. The interrelationship is thus complex and one cannot infer that monetary policy (adjusting the funds rate) disciplines inflationary expectations.

History tells us that in all the nations I have studied, it was the large recessions (1981-82, 1991 depending on country) that expelled the persistently high inflationary expectations (as a result of the OPEC oil hikes) from the economies.

Those episodes were not exclusively brought on by monetary policy adjustments.

You might say that Volcker knew that if he hiked the funds rate, he would choke off borrowing and that would create a recession, which would discipline expectations.

The problem was that the Monetarist causality he had in mind did not prove to be realised.

He thought he could control the broad money supply by controlling the base money (reserves plus currency) – making it harder for banks to acquire, which would push up rates in the financial markets and squeeze borrowing.

Interest rates went into a sharply upward spiral and borrowing was reduced.

But as a result of the higher rates, there was a dramatic increase in capital inflow in pursuit of dollar-denominated financial assets, which pushed the exchange rate up from the Autumn of 1980 to November 1982 (by around 40 per cent against the major currencies).

This severely undermined US exports and the recession.

Unemployment started to escalate sharply.

The inflation that was in train at the time was the result of oil price hikes in 1979 (quadrupling) and this caused recessions everywhere. The cost pressures were working their way through to other commodities (food, housing, etc) and so by the time Volcker set about wrecking prosperity, the inflation dynamic was already waning.

Further, I am often surprised when people introduce the so-called Volcker Shock as evidence that monetary policy should be the primary macroeconomic counter-stabilisation tool.

Within normal limits of interest rate movements, adjusting interest rates has very little impact at all on the real economy.

The fact that Volcker was prepared to push the overnight rate so high (around 20 per cent) and precipitate a widespread financial crisis, which then pushed thousands of firms into bankruptcy and forced unemployment to rise above 10 per cent in order to kill inflation that was already dissipating is not something to be recommended.

Extolling the virtues of a policy tool that only really achieves the stated aims by invoking a massive crisis, when the target is hardly a worry is not very clever.

One can cure a headache by taking massive overdose of morphine. But the patient dies!

[The graph Bill spoke of many lines above is HERE, after many lines of his comments.]
[There is also more to the post.]

Less text, simpler video: