San Francisco Fed president John Williams has been yapping about the need for interest rate hikes, 4% inflation targets, and Fed-set GDP growth targets.
Williams is bullish on jobs. He also says the US economy is at “full strength” but inflation needs to be higher now so we can cut rates later.
His speech to the Hayek Group in Reno Nevada was called Whither Inflation Targeting? Here are some excerpts:
Good evening; it’s a pleasure to be here to discuss the economy and monetary policy with the Hayek Group. I’ll start with a quick overview of the U.S. economic outlook and what it means for monetary policy. Spoiler alert: The punch line is that the economy has climbed back to full strength, and it therefore makes sense to move monetary policy gradually back to normal. That brings me to the second topic of my talk: What is “normal” monetary policy?
Our goal is not to have an unemployment rate of zero. Instead, it’s to be near the “natural rate” of unemployment: That’s the rate we can expect in a healthy economy. It’s impossible to know exactly what that number is, but economists generally put it between 4¾ and 5 percent today.1 With the unemployment rate at 4.9 percent, we’re right on target.
Turning to the other side of the ledger, the Fed’s monetary policy committee—the Federal Open Market Committee, or FOMC for short—has set a long-run goal of 2 percent inflation. Inflation has been running persistently below that goal for several years.
We’re not quite at our target yet, but the combination of fading transitory factors and a strong economy should help us get back to our 2 percent goal in the next year or two.
To sum up, I remain confident about the road we are on.
What it Means for Interest Rates
So, what does this mean for interest rates? In the context of a strong economy with good momentum, it makes sense to get back to a pace of gradual rate increases, preferably sooner rather than later. Let me be clear: In arguing for an increase in interest rates, I’m not trying to stall the economic expansion. It’s just the opposite: My aim is to keep it on a sound footing so it can be sustained for a long time.
History teaches us that an economy that runs too hot for too long can generate imbalances, potentially leading to excessive inflation, asset market bubbles, and ultimately economic correction and recession. A gradual process of raising rates reduces the risks of such an outcome.
What is Normal Monetary Policy?
New realities pose significant challenges for the conduct of monetary policy in the United States and elsewhere. Foremost is the significant decline in the natural rate of interest, or r* (r-star), over the past quarter-century to historically low levels.
The daunting challenge for central banks is how to deliver stable inflation in a low r-star world. This conundrum shares some characteristics and common roots with the theory of secular stagnation; in both scenarios, interest rates, growth, and inflation are persistently low.
How Low Can Rates Stay?
In a recent paper, Kathryn Holston, Thomas Laubach, and I estimated the inflation-adjusted natural rate for four major economies: the United States, Canada, the euro area, and the United Kingdom. In 1990, estimates ranged from about 2½ to 3½ percent. By 2007, on the eve of the global financial crisis, these had all declined to between 2 and 2½ percent. By 2015, all four estimates had dropped sharply, to 1½ percent for Canada and the United Kingdom, nearly zero for the United States, and below zero for the euro area.
The critical implication of a lower natural rate of interest is that conventional monetary policy has less room to stimulate the economy during an economic downturn, owing to a lower bound on how low interest rates can go. This will necessitate a greater reliance on unconventional tools like central bank balance sheets, forward guidance, and potentially even negative policy rates.
In this new normal, recessions will tend to be longer and deeper, recoveries slower, and the risks of unacceptably low inflation and the ultimate loss of the nominal anchor will be higher. We have already gotten a first taste of the effects of a low r-star, with uncomfortably low inflation and growth despite very low interest rates. Unfortunately, if the status quo endures, the future is likely to hold more of the same—with the possibility of even more severe challenges to maintaining price stability and full employment.
Low R-Star and Strategies for Mitigation
There are actions that central banks and governments can undertake to avoid this fate. These include fiscal and other policies aimed at raising the natural interest rate, as well as alternative monetary, fiscal, and other policies that are more likely to succeed in maintaining a strong economy and stable inflation in the face of a low natural rate.
Although inflation targeting central banks that aimed for a low inflation rate generally have been successful at stabilizing inflation in the past, such an approach is not as well-suited for a low r-star era. There simply may not be enough room for central banks to cut interest rates in response to an economic downturn when both natural rates and inflation are very low.
The most direct attack on low r-star would be for central banks to pursue a somewhat higher inflation target. This would imply a higher average level of interest rates and thereby give monetary policy more room to maneuver. The logic of this approach argues that a 1 percentage point increase in the inflation target would offset the deleterious effects of an equal-sized decline in r-star.
A second alternative would be to replace the inflation target with a flexible price-level or nominal GDP target, where the central bank targets a steadily growing level of prices or nominal GDP, rather than the rate of inflation.
Because they provide a clear metric by which to judge whether the economy is above or below the stipulated goal, they may help improve the systematic conduct of policy and its communication and public understanding, especially when interest rates are constrained by the lower bound.
Of course, like a higher inflation target, these approaches also have potential disadvantages that must be carefully scrutinized when considering their relative costs and benefits.
Time is not on our side. We have witnessed the extreme difficulties of achieving price stability and full employment with a low r-star. I firmly believe that now is the time for experts and policymakers around the world to actively study and assess the pros and cons of alternative proposals, so that we are better prepared for the challenges related to persistently low natural real rates of interest.
Down the Rabbit Hole Synopsis
- Williams says the “economy is at full strength”. I point out the last four quarters of real GDP are 2.0%, 0.9%, 0.8%, and 1.1%. Is that full strength?
- Williams admits “It’s impossible to know exactly the natural rate of employment” but he is content to guess.
- Williams does not admit it’s impossible to know the “natural interest rate” and he wildly guesses at that.
- Williams seeks to defeat the natural interest rate because he knows it needs to be higher. Natural just is not good enough.
- Williams proposes a higher interest rate target of 3% to 4%. Purportedly, just having a higher target will perform magic wonders. I ask a simple question to Williams, the Bank of Japan, and the ECB: “If you cannot hit a 2% target how the hell can you hit 4%?”
- Williams says because we need higher inflation, we need to hike now so the economy does not overheat.
- Williams also wants to hike now so we can cut rates later. That implies we cannot get to 4%! Alternatively, it implies Williams would cut rates to avoid recession even if inflation was at 4%. The logical conclusion is 8% inflation would be the next target.
- Williams mentioned debt deflation. Lovely. The chief sponsor of debt deflation is central bank wizardly. They do not count asset bubble inflation in their measures.
Counterproductive Policies
The hubris of Williams is amazing. He claims to be able to figure out the “natural rate of interest”, which he cannot do, then he believes he is smart enough to know by what degree the Fed should circumvent it.
Williams mentions bubbles but cannot see the massive bubbles in front of his face.
Price Deflation Should be Welcome
There is no credible evidence that people put off buying something because prices are falling. Those who need a coat, a computer, or a car will buy one. If your computer or toaster goes out, you throw it away and buy another. If your gas tank needs filling, you fill it. If prices are low enough, impulse buying goes up, not down.
Inflation expectation theory widely believed by central bankers is total nonsense.
Asset Deflation Not CPI Deflation!
It’s asset deflation not CPI deflation that central banks ought to fear. Even the BIS agrees with that statement. For discussion please see Historical Perspective on CPI Deflations: How Damaging are They?
Economic Challenge to Keynesians
Of all the widely believed but patently false economic beliefs is the absurd notion that falling consumer prices are bad for the economy and something must be done about them.
I have commented on this many times and have been vindicated not only by sound economic theory but also by actual historical examples.
My January 20, 2015 post Deflation Bonanza! (And the Fool’s Mission to Stop It) has a good synopsis.
And my Challenge to Keynesians “Prove Rising Prices Provide an Overall Economic Benefit” has gone unanswered.
In their attempts to fight routine consumer price deflation, central bankers create very destructive asset bubbles that eventually collapse, setting off what they should fear – asset bubble deflations following a buildup of bank credit on inflated assets.
Risks of Low Inflation
Williams worries about “low inflation”.
The only risk associated with falling consumer prices is the 100% likelihood that central bankers will attempt to do something ridiculous in response!
The convoluted thinking of San Francisco Fed president John Williams is a prime example.
Mike “Mish” Shedlock
Hi Mish,
All I can say is what utter drivel these people talk – I doubt they could hold down a real job!
Regards
Lundi
I heard a solid argument that in today’s low interest rate world people have come to realize that they need to save more in order to retire (especially those close to retirement), so rather than reducing interest rate to spur spending it has the opposite effect in that it has forced people to save more as they are not getting enough returns in their retirement nest egg to live on, they need 2-3 times as much saved.
Also people that already retired have less fixed income returns to spend. In a time that baby boomers are at retirement age its no wonder low interest rate policy is doing nothing to increase inflation.
I also agree that deflation does not stop people spending, to suggest such a thing is pure idocy, either that or they have something to gain themselves and this is their excuse/lie.
They should think about asking Congress to do away with all holidays. Every holiday has a sale, a sale means lower consumer prices. So in fact all holidays are bad for the nations economy.
Who would of thought that Christmas would turn out to a be a total national disaster. I mean I go from store to store and see sales, lower prices, why do these stores hate America? Why would shoppers go to these places and buy things on sale? I pity them as you must as well for they fail to see the harm they do.
Holidays and Walmart’s low prices, the real problems of our times.
What we really need is deflation now so that shoppers can fill their carts at the store. Inflation is nothing but a bank loan bailout. We need someone on the people’s side, not just bankers.
Deflation is a blessing for shoppers.
I was expecting something on these lines… some say raise, immediately some others will come saying no, and then they meet and stay put. Why not simply STFU and do nothing when that is what you are going to do anyway.
Hawk or dove does not depict them correctly. Pigs would!
I don’t want to be the resident contrarian here, but wouldn’t high inflation solve our problems? With high inflation, nominal GDP grows while nominal debt stays the same. Since our problems are caused by too much debt to GDP in the private sector, inflation is the easiest way to make this go away. Imagine if we had a nominal inflationary period that resulted in our nominal GDP quintupling: our private debt to GDP would be 40% and we’d have a post WWII style economic boom.
The only problem is that savings would be destroyed, but there is no free lunch. Do you want to lose the savings from hyperinflation or do you want to lose everything because of a depression?
The experts are morons but I think they are on to something here.
What do you guys think about a Steve Keen-ian solution of sending every American a check for 10k, paid for by just printing the money? We’d have hyperinflation for a few years but when the dust settled we’d be in much better shape.
“Since our problems are caused by too much debt to GDP in the private sector, inflation is the easiest way to make this go away.”
It is. Not coincidentally, it’s also the easiest way to destroy the middle class, as well.
Completely depends on how the inflation is created. Grow middle class wages so that they can afford the higher prices and the middle class is strengthened.
Oh wow, now I get it! Just grow middle class wages…..why didn’t Janet think of that?!? Presto! Problem solved! Thank the Lord for the deep-thinking angels walking in our midst. Maybe a minimum wage increase to $30/hour…..would that do it?
No, a solid plan for reindustrialization and promoting labor unionization would. That’s how it worked in the 40’s – ’70s.
What happened in the 40’s? I forget. Something happened. I’ll look it up. If it worked for us in the 40’s, maybe we can try it again?
What kind of world consists of economic actors that respond to having their debt written down for them by fiat, by not taking on more debt? The REASON debt-to-gdp is so high, is specifically BECAUSE of persistent pursuit of inflationary policies aimed at making taking on debt less risky and more profitable. Anything from mortgage interest deductions to GM bailouts to bailouts of German banks via robbing German taxpayers and routing the loot through Greece. Like Mish likes to say, the cure cannot be the same as the disease.
Also, you don’t “lose everything because of depression” by getting the government out of the counterfeiting game. Buildings and factories don’t just fall down. Nor does corn stop growing. Nor do programmers lose their ability to write code. All that happens, is a redistribution of ownership of so called ‘assets.’ From those who borrowed too much, to those who didn’t. Wooohoo what a disaster. Not. From the pow of the banksters, government and other worthless leeches, it will certainly cut into their ability to leech. Which is, of course, the key concern of the “policy community.” But honestly, is that really such a problem for anyone but them?
“What do you guys think about a Steve Keen-ian solution of sending every American a check for 10k, paid for by just printing the money? We’d have hyperinflation for a few years but when the dust settled we’d be in much better shape.”
Moronic
And anyone advocating this utterly clueless.
Otis – “The only problem is that savings would be destroyed, but there is no free lunch.”
Oh, yes, apparently there is. Debtors and asset holders HAVE been enjoying a free lunch.
Creating inflation is what these guys have been trying to do. But it is not happening. Probably the relevant question to ask is why?
Now let us take Steve Keen’s solution of 10k. What if the end result is the same? Increase to 20k?
Why does everyone think that we need to create inflation or deflation. Let it crash and burn if you will. Some one will build something from the rubble. That is free market. Any other thing in any form is meddling. Do we need more of it. It has been 30 years since 1987 and I for one look forward to a market without manipulation.
But it won’t crash and burn. What will happen is what is happening. People and businesses will pay down debt. Some will be slowly written off. Demand will stay low. Businesses won’t invest. Attitudes about growth. capitalism and the role of government will change and move to the left. And this will go on for decades.
As a buy and hold investor it’s a discomforting thought,
I agree, crash and burn is the only correct way the market knows to deal with wholesale mal-investment. It’s the right way to proceed and progress. It is also what the central politburo are fighting against to keep their banking owners in the manner to which they’ve become luxuriously accustomed.
The only way to purge three decades of manipulation, falsification and latterly, outright counterfeiting fraud, pumped directly into the banks coffers at everyone else’s expense, alongside being handed indirectly to housing and stock market speculators riding on their coat tails, is for them to step back, stop delaying the inevitable, do nothing and let the market sort this unholy mess out.
KPL and John: yes, they need to quit manipulating. Talk about picking winners and losers! Unbelievable how people are all for MORE manipulation, as long as it helps them.
They just do not get it. The problem is disposable income, jobs, wages. Tough to create inflation when people just cannot afford to buy stuff as they did in the past. Higher taxes at the local, state and federal levels, Obamacare, and zero interest rates are the problem.
They can target whatever they like, but people have to be able to afford it otherwise they will not, even if that means using credit.
John Williams appears to be the perfect poster-boy for why the Fed should be put out of business. His insightful ramblings include mutually exclusive goals. Raise rates and raise the inflation target? The goal should be stable currency and nothing more.
Drop the weenie half measures.
Just pull a Jekyll Island II and authorize all of us to monetize used toilet paper as money.
That would get this shit show rolling butt fast.
Inflation is a tool to remove wealth from those who have earned it and hand it to those who have borrowed it. It might improve the economy if the borrowers have invested the money more wisely.than the earners would have. Some recent history shows bankers investing in mortgages that will not be paid back. Share buybacks at the highest stock prices ever. Occupation efforts in middle east and Afganistan. New weapons systems to fight WW3 with Russia. I predict none of these will produce any benefit to the future.
Printing money for inflation and spending the proceeds as we have been is the way to convert a world power to an unimportant backwater country wallowing in decay.
So what happens to real estate when you have a mass of mortgage debt fixed at say 3.5% when the inflation rate is now 4%+?
If you’re the one with the fixed debt. I suggest giggling.
“but economists generally put it between 4¾ and 5 percent today.1 With the unemployment rate at 4.9 percent, we’re right on target.”
A completely arbitrary measure for ‘unemployment.” Measured sufficiently different in different countries, and different decades, to yield a number differing by more than +-1/4. Yet, “we’re right on target.”….. This clown isn’t just clueless. He is literally a straight up unintelligent human being.
Since Central Banks ought not to exist, I’m not really sure debating what they ought to fear makes much sense. But asset price deflation is no less a blessing than consumer price deflation. In fact, the demarcation line between the two is, like with most classifications employed by the empiricist clowns claiming to practice something they call “economics”, is pretty much entirely arbitrary. When a Facebook employee gets a new computer to surf the web and watch porn on, it’s an “asset.” When Zuckerberg bought a laptop to write Facebook on, it was a consumer good……. Build a house, and it’s an “asset.” Build it well enough so it doesn’t sink if you drop it in the ocean or drag it around America behind a truck, and it’s a “consumer good.”…. Contemporary “economics” at it’s finest and most coherent.
What is arguably a negative, is a decrease in the total, economy wide, value of all “assets.” But so is a decrease in the total value of all “consumer goods.” As all either measurement really means, is a smaller economy.
But for any given, individual anything; whether it’s labeled an “asset” or a “consumer good”, the cheaper it gets, the more of it people can afford. Hence, the wealthier the population is. A society where everyone can afford 10 apples is wealthier than one where everyone can only afford one, But so is the case of 10 houses vs 1. And 10 Google sized companies vs 1. Man, in the latter case, said society may even be able to afford paying for Obamacare for a few years before costs got too high……
” He is literally a straight up unintelligent human being.”
Yes.
And ANY talk of the UE rate is incomplete without discussing the participation rate.
reeses pieces
John Williams?
A special breed of CLUELESS.
I’ve been following him closely since he gave his first speech as SF FRB president (2011) … it was a humdinger for cluelessness. Anyone who follows FOMC closely knows enough clues given beforehand for policy moves. The old “buy the rumor sell the news” … well, williams never seems to have heard of it:
…
“That brings us back to the question of why commodity prices have risen so much. Some commentators have suggested that the Fed itself has contributed to the run-up by keeping in place excessive monetary stimulus.
…
Economists at the San Francisco Fed recently looked at how commodity prices reacted when the Fed announced new policy actions to stimulate the economy. If Fed policies were responsible for the commodity price boom, then we should have seen those prices jump when the Fed announced more monetary stimulus. In fact, the researchers found that, if anything, commodity prices fell after new policy announcements and were not pushed higher by news about Fed policy.7”
http://www.frbsf.org/our-district/press/presidents-speeches/williams-speeches/2011/may/williams-price-stability-global-economy/
“There is no credible evidence that people put off buying something because prices are falling. Those who need a coat, a computer, or a car will buy one. If your computer or toaster goes out, you throw it away and buy another. If your gas tank needs filling, you fill it. If prices are low enough, impulse buying goes up, not down.”
This is exactly correct. In fact, inflation causes the behavior alteration in many, perhaps most, people. If restaurant prices get too high, we eat at home. If meat gets too expensive, we eat pasta. If the coat I want costs too much, I look for a cheaper one. Many go to Goodwill and such.
In fact, there is only ONE area where falling prices causes people to put off buying, and that is in assets. Almost everyone is too scared to buy stocks after the market crashes. In 2009 and 2010, houses in many cities went begging as no one wanted to touch them having been burned in the prior years.
Time to give responsible prudent savers and those who put their excess capital into self-liquidating debt a few days in the sun, rather than treating them like chumps. Let’s begin by having a rip-snorting auto-da-fe, with central bankers as the guests of honor.
IMO, a must read piece on inequality…
http://www.nakedcapitalism.com/2016/09/bill-mowers-we-the-plutocrats-s-we-the-people-saving-the-sou-l-of-democracy.html
I for one am surprised that the elite can cause their own destruction by not doing the right thing. It may take time (may be a long time) but we will get a ‘let them eat cake’ moment. It is a given!
People can’t help themselves, whether elite or not. You do what makes you think your successful until it just doesn’t work anymore. Hopefully your not left hanging on the business end of a rope when it’s all done.
We need US dollar #2. Debt on #1 is huge, but we can start all over again with a new and improved US dollar.
“San Francisco Fed president John Williams has been yapping about the need for… 4% inflation targets”
If they can’t hit 2%, how can they hit 4%?
“Our goal is not to have an unemployment rate of zero. Instead, it’s to be near the “natural rate” of unemployment”
There is no “natural rate” of employment. Employment is cyclical. In a recession, it rapidly rises, then declines over time to the cycle low when the next recession arrives.
Raise rates now so that we can lower them in the future???? Was this really a grown man speaking? These maroons are destroying our economy. First they lower rates to the negative range, destroying the savings of millions. Then they say we “need” 4% inflation, further mangling our purchasing power. Where do these morons come from?
The US is in a recession, which would be obvious except for the understatement of inflation and the very inadequate GDP Deflator…..but the bigger the lie, the better for those in government.
“Unfortunately, if the status quo endures, the future is likely to hold more of the same”
Wow, ain’t THAT the truth?!?
Here’s a solution, wait for the next big BIS meeting, bomb the f’ing bejesus out of the banksters bunker, nationalized all central banks, wipe out world debt.. and start over.
Oh yeah invest in rope…