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Inflation: Facts & Pernicious Myths

Published by Anonymous (not verified) on Sun, 17/04/2022 - 1:15pm in

Edited: I meant to add a number of articles to the page on Inflation. Then it turned into more. I think readers will find it worth their time.

Are Major Central Banks Doing Enough to Fight Inflation?
— James K. Galbraith Project Syndicate April 14, 2022
He begins “Say what? Seriously? OK, I’ll give it a try, but promise me this is not a joke…The notion that central banks fight inflation is a pernicious myth, spread by their officers, acolytes, and by credulous reporters. Central banks raise interest rates. The blather about inflation is eyewash.”

Beware the Inflationary Bogeyman • Recent price increases in the U.S., and demands for a forceful response by the Federal Reserve, have brought back memories of the 1970s and all of the economic and political disasters of those years.
— James K. Galbraith Common Dreams, Project Syndicate – November 20, 2021

CPI, commodity charts Quite a few price increases, which the media now calls ‘inflation’ even though inflation is a continuous increase in the price level.
— Warren Mosler (@WBMosler) Mosler Economics/Modern Monetary Theory Nov 12, 2021

An MMT Perspective: Interest Rates and Inflation with Warren Mosler
— Warren Mosler (@WBMosler) Real Progressives June 26, 2021 (01:05:31)

Manhattan Project to prevent Hyper-Inflation
— J.D. Alt New Economic Perspectives March 26, 2020

Fed Flattens The Curve

Published by Anonymous (not verified) on Fri, 25/03/2022 - 2:39am in

I have been taking it easy for the past week, courtesy of dealing with a mild COVID-19 case. (It largely felt like a cold. However, some symptoms persist, and so I prefer to rest and let them clear.) During my down time, the Treasury market (along with other govvie markets) have been crushed. Fed policymakers have signalled that they want to ramp up the pace of hikes — which surprised me.

In my view, the only reason to hike 50 basis points in a meeting is if you expect that will be followed up 50 basis point hikes. I cannot guarantee that Fed policymakers agree with that assessment, but I would guess that they are lot closer to that position than they were to the idea of a one-off 50 basis point hike that was being floated. One possibility is that the Fed might alternate 50 and 25 basis point hikes. The inelegance of such a pattern suggests that they should take 12.5 basis point increments out of their monetary policy arsenal, so they can go 37.5 basis points per meeting.

If one wants to be a bond bear, I believe that the current setup has the most potential for reversing the trend in yields. I am skeptical about the effectiveness of rate hikes for slowing the economy, which implies that the faster the Fed hikes, the higher rates will end up. This is very different from the conventional belief that something will break within the economy solely because interest rates are “too high.” If we keep getting shocks raising consumer prices — very easy to see in war-strained supply chains — the length of time the Fed will be hiking will be long enough to allow a decent rise in rates. (Maybe I am complacent, Volcker-esque levels of rates do not seem to be in the cards.) My story is that the secular fall in interest rates is not telling us about r* (or whatever), rather the pace of rate cuts was very fast, while rate hikes were done slowly. As such, they never could return to previous levels across each cycle, and so the trend was down.

The main potential spanner in the works for this bond bear story is a recession/inflation roll over that hits within the next year or so. I am not pretending to be a forecaster, but it is not hard to come up with such scenarios. (Inflation rolling over might raise eyebrows, but my feeling is that Russian energy will eventually make its way into global markets. The current spike will result in some demand destruction. Grain prices will be high, but the price effects on highly processed Western diets is buffered.)

Curve Shape

Rapid rate hikes mechanically flatten the curve. In a situation where rate hikes are being front-loaded, the resulting curve is quite flat. Yield movements then tend to be largely parallel moves. It is possible that an erratic Fed could raise term premia and inject some steepening, but that seems to be a scenario that is just wishful thinking by bears.

If we look at the late 1990s, the 2-/5-year curve was trading around 25 basis points or less for almost a half decade. (The inversion around 1998 was courtesy of the Asian Crisis.) We could imagine the curve reverting to similar behaviour going forward, even without immediate risk of recession.

War Uncertainty Peaking

My reading of the situation of the Ukraine war is that the combatants will not be able to sustain the fighting at current levels indefinitely, and we should see a pause of some sort within a month or so. Fighting may resume later, but the status will be somewhat more clear than is the case right now.

As such, I do not think that it will be enough to cause the Fed to stop rate hikes, unless the erratic Russian regime does something to escalate the situation elsewhere.
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(c) Brian Romanchuk 2022

On Central Banking, Monetary Policy And Inflation (Guest Post)

Published by Anonymous (not verified) on Fri, 11/03/2022 - 1:45am in

Brian: This is a guest post by Professor Louis-Philippe Rochon of Laurentian University, who was looking for a venue to publish this piece. I have seen his presentations at some Post-Keynesian conferences, and I am happy to pass this article along.

Fact: inflation around the world is on the rise.

And as predicted, so are the calls on central banks to quickly intervene in an attempt to wrestle inflation back to some agreed-upon target level. Indeed, there exist among mainstream economists a quasi-unanimity that this is the proper policy route to follow: several increases in the rate of interest should eventually have an impact on those interest-sensitive components of aggregate demand to finally slow down economic activity in the hope that inflation will somehow float back to its target of, say, two per cent, at a minimal cost to society as a whole.

But heterodox economists know the rest of the story all too well: interest rates won't rise once or twice, but multiple times as central banks find themselves on the quest of what I called the Holy Grail: the search of that natural or neutral rate of interest, said to be up to 2.75% in both  Canada, and the United States.  This means up to possible 10 increases in interest rates.  In this respect, central banks will never give up on the notion that somehow inflation is somehow related to monetary policy, and stand ready to increase rates as high as they need to be, as only monetary policy is able to bring inflation down to target.

While this is certainly a correct interpretation of pre-crises monetary policy, does it still stand post-crises? There is some evidence that perhaps central banks have softened their inflation zeal, by adopting dual mandates, flexible inflation targeting, or acting as if they already had. Is this a softer side of monetary policy?

I don't buy it. Inflation has always been considered public enemy No. 1, as it diminishes the value of Wall Street wealth. For that reason alone, central banks, who depend on the approval of Wall Street for their legitimacy, will never let this group down. So while it may begin with a few innocuous increases in interest rates, as inflation stubbornly won't come down, rate increases will continue … well … increasing. It is pre-crises monetary policy post-crises.

And the harm is now predictable.  In fact, a  recent report by Blackrock suggests that since current inflation is mostly the result of supply-side bottlenecks, not demand, attempts at bringing inflation down to 2% via interest rates would be costly for the economy and translate into unemployment of more than 10%.

Inflation and monetary policy are indeed linked, but not for the reasons given by the mainstream, but because both are rooted in conflict.


Fact 1: While inflation does lower the value of wealth, it also reduces the value of debt, ceteris paribus, mainly carried by workers.  So inflation, itself the result of conflict, is rooted in conflict as to its causes as its consequences. While inflation does translate in lower purchasing power, workers lose far more from fighting inflation that they do from inflation itself.

Fact 2: As central banks insist on using monetary policy to lower inflation, it does so on the backs of workers, as repeated increases in rates may eventually collapse the economy, as stated above. Somehow, it is not ok to have inflation at, say, 7%, but it is ok to have unemployment at 10%? As a result, workers' income will be deeply affected.

Fact 3: As rates increase, it redistributes income from workers to rentier and bond holds.

In the end, we must be careful in using monetary policy to fight inflation.  At the root of this debate, we must ask, 'what are we trying to prevent', and whether there are other means than monetary policy to achieve this.

If it is inflation we are trying to prevent, then we must ask is how much inflation is too much? Second, what are the causes of inflation? If the causes are not coming from the demand side, then using monetary policy, which impacts the demand side of the economy, may end up doing much more harm than good.

It is time for monetary policy to help workers, to help with a better distribution of income, and to help with achieving full employment.  This requires a deep rethink of how monetary policy works, and whether it is the best tool with which to build back better, fairer and greener.

Copyright: Louis-Philippe Rochon

Full Professor of Economics, Canada

@Lprochon (Twitter user page).


March 9, 2022

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Incoming Fed Rate Hikes

Published by Anonymous (not verified) on Thu, 17/02/2022 - 4:21am in

Inflation data in the United States came in surprisingly hot, and so rate hike chatter went off the charts. I think the idea of a “surprise” inter-meeting rate hike is silly in the context of modern Federal Reserve operating procedures, but I now see more chance of an initial 50 basis point rate hike in March as an attempt to assert dominance.

Unless inflation cools a lot, the base case has to be that we are looking at 25 basis points per meeting (plus the wild card of a starting 50) for forecast horizons going out a year. The pricing I have seen is consistent with this, so this should not be a surprise to anyone. After the one year horizon, far more uncertainty creeps into inflation/growth forecasts.

Since I do not think anything of interest happened, I will mainly repeat points that are not commonly appreciated.

  • What matters most for the rate hike cycle is the terminal rate pricing. Fed members can raise their estimates for long-term policy rates in the “dot plot” in an attempt to influence market pricing, but there is no particular reason for anyone to have much confidence in the Fed’s ability to forecast where they will decide to put rates years in the future. Unless they specifically target term yields, the Fed just reacts to historical data and sets the policy rate.

  • They can muck around with Treasury buying/selling (“Quantitative Tightening”). There is considerable uncertainty about the exact effects of Federal Reserve balance sheet expansion, so I expect caution in reversing it. I am skeptical about its effects, explained in more depth below. However, it is impressive that the army of Ph.D.’s at the Fed managed to develop a policy tool that is effectively slower to react to the cycle than fiscal policy.

  • The flattening of the curve (chart above) is coinciding with the inevitable “bond market is predicting recession!” stories. My view is that we have a market segmentation issue: bears are throwing all their risk at the front, bulls are buying long tenors, and relative value players are not going to jump in front of a steamroller to pick up nickels. Forwards are converging to the discounted terminal rate, and that terminate rate will move up and down as data hit.

Blow Up the Treasury Market?

We have seen some yappy comments from some of the more outspoken Fed hawks. Roughly speaking, they are mad that the discounted terminal rate is too low. However, the only way to do that is either by raising rate expectations, or the term premium (by definition of those terms). The ability of one Fed speaker to get market participants to change their rate forecasts is debatable. So, do crazy things to destabilise the Treasury market to raise the term premium?

Although that is a strategy, it is a rather bizarre one. Over the past couple of decades, I have been reading self-congratulatory missives by neoliberal economists regarding the reforms they made to lower term premiums. Now, some hawks want to raise them? Well, that’s the kind of consistency you expect from a highly mathematical science.

The problem with discussion of term premia and things like Fed balance sheet policy is that economists use toys models that just pick some economic variables at random. Given the number of crypto-Monetarists in the profession, they look at the Fed balance sheet (“money!”) and ignore literally everything else in the bond market.

The reality is that a Treasury bond is just a source of default risk free duration (DV01 might be a better term, but whatever). Although there are some managers that might be confined to only holding Treasury securities, asset allocators rarely have such restrictions. (The exceptions are entities like trusts, and smaller central banks.) If Treasurys get too expensive versus spread product (including mortgage-backed securities, which are more of a vol risk than a credit risk), they just move their assets to those asset classes to get their DV01 there. The stock of USD duration is large, and we have to keep in mind that issuers can change the duration of issuance.

In other words, a rapid change in Fed policy could move the curve a lot in the short run, but that just will result in asset mix and issuance shifts if the curve appears stupidly priced.

Postscript: Canada Crisis Update

The safest observation I can make is that everything you might read in the American media about the convoy protests is incorrect.

  • The Emergency Act is part of a legislative overhaul of The War Measures Act that was last invoked by Trudeau Senior in the 1970s in response to separatist violence in the 1970s. The overhaul was done by the Progressive Conservative Party (yeah, the name is funny, it was that for a reason), and explicitly is subordinated to The Charter of Rights and Freedoms that were brought in by Trudeau senior in the early 1980s. (From what I recall, conservatives viewed the Charter as a liberal-commie plot at the time.) The Emergency Act had not been invoked, but the act that might be considered “martial law” was invoked by the Progressive Conservative government (at the request of Quebec) during the Oka Crisis of 1990. That crisis was a border dispute between the Mohawks and Canadian governments, with roots in treaties pre-dating Confederation. In other words, what is happening is a constitutional nothingburger that bleeding heart “conservatives” are crying about.

  • The existence of “money laundering” tells us that governments have always frozen banking assets of criminal organisations. The only thing different is that it is easier to do it more quickly (and puts more burden on the banks to enforce).

  • At the time of writing, other protests are winding down, and the authorities are signalling a roll up of the Ottawa protest. The question remains whether the “nonviolent” protest (if we ignore the intimidation, criminal charges, weapons charges, and charges of a conspiracy to commit murder) gets ugly.

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(c) Brian Romanchuk 2022

Central Bank Confusion

Published by Anonymous (not verified) on Fri, 28/01/2022 - 3:04am in

The Fed and Bank of Canada announced that they were on hold yesterday, but signalled that rate hikes are likely hitting in March. From what I have seen of chatter on Twitter and various editorial pieces, this has caused some confusion. (I am not sure what street research is saying.) This article is a grab bag discussing what I saw as common (or at least popular) points of confusion, as well as some of my editorial comments.

Editorial: Yeah, That Stochastic Calculus Really Helps

Most people are quite reasonably not concerned about economic theory disputes most of the time. But one needs to keep them in mind when keeping up with the latest events.

Whenever you are reading commentaries about central banking outlooks, you need to ask yourself: are the people in the discussions using any of the mathematical models that the literally thousands of neoclassical doctorates employed by the central banks produced? If not, what exactly was the point of them? Why is it so important that MMT have lots of mathematical models of the economy (keeping in mind that critics ignore the ones that exist) when nobody even refers to the ones that are supposed to be relevant?

Admittedly, one might not expect equity or credit analysts (or gold bugs) to keep up with DSGE modelling, but rates analysts — the primary target for rates discussions, allegedly — almost all have science/mathematical doctorates from fancy universities. If the models worked, the technical audience to use them is there. However, the only people interested in those models are those whose credentials are tied to the production of said models, which is not encouraging.

(Probably) No Need For 50 Basis Point Hikes

I do not have access to a plot of the instantaneous forward rate, but the figure above is my best bet what the shape looks like for forwards up to ten years or so. (The instantaneous forward rate is the implied path of the overnight rate from a fitted discount or zero curve.) After the ten year point, you are fitting less liquid bonds, and there are various technical effects that impact the shape of the curve. For example, you typically see a hump in the curve due to the value of convexity, which implies an inversion of some forwards. See my earlier article on the long end inversion for more details. Bonds with maturities under ten years do not have a lot of convexity, so the hump is pushed out beyond that point.

As an aside, different sources will legitimately have different instantaneous forward curves. The instantaneous forward curve is determined by taking the derivative of the discount curve, and so different choices for parameterising the zero/discount curve will result in quite different forward curves. To price an instrument with a duration longer than overnight, you take the geometric mean of the instantaneous forwards over the life of the instrument. This “integrating out” of the forward curve will mean that different fits will end up with roughly the same fair value prices of traded instruments.

The figure shows the actual instantaneous curve, along with straight line approximation. I divided the straight line approximation into three regions, labelled A to C.

  • Region A is the “on hold” period. The forwards are relatively flat, possibly with a small term premium effect.

  • Region B is the “hiking period” which features the most rapid change in the forward rate per unit of forward time. In the modern era, it’s a good bet that the “slope” of that line will be a multiple of 25 basis points / (k × six weeks), with k in the set 1, 2, …. The six weeks is the number of central bank policy meetings per year, so that is 25 basis points every k meetings.

  • Region C is the “terminal rate” period where the forward rises at a very slow pace. One possible interpretation is that the observed forward is the “terminal rate” plus a term premium.

We can then write a the fair value yield of a bond as follows:

yield = f(length of on hold period, slope of hiking period, terminal rate, term premium).

Since the term premium is just going to generate arguments, we can replace the “terminal rate” with the “adjusted terminal rate,” where the adjustment is to add the average term premium.

We can then ask: what matters for bond yields? Well, if the hiking period is two years, eight years of a 10-year bond’s lifetime has the instantaneous forward rate equalling the “term premium adjusted” terminal rate. That is 80% of the observed yield is explained by the terminal rate. The rate of initial hiking does not matter too much, all that matters is that it reaches the terminal rate relatively quickly.

At 25 bps/meeting, the policy rate is rising at 200 basis points per year. That puts us at 4% in two years, which seems be hawkish enough when compared to past history (figure above). The only conceivable reason to go to 50 bps/meeting is that the policy rate needs to be 6% or so very quickly — which seems to be a bit of a stretch.

As was pointed out by Ben Bernanke (possibly the “Gradualism” speech), the Fed Funds rate (or any overnight risk free rate) is only of limited importance for the real economy. Non-financial entities borrow and invest quite often at term rates, and if rates are rising, they will be cautious about borrowing overnight.

The real battle between bond bulls and bears is where to plant the terminal rate. At current pricing, 25 bps/meeting is enough to vaporise the bulls.

Why Not One And Done?

The idea of doing one big hike and getting it over with recurs over time. Two cycles ago, Stephen Roach floated the idea in a op ed, which was answered by the Bernanke “gradualism” speech. (Although not a Bernanke fan, I think that speech was a very good explanation of conventional central bank thinking. It also referred to “bang-bang control,” which I ran into during my doctoral student days.)

The argument against it is very straightforward. Let us assume that we follow conventional beliefs about interest rates (higher policy rates act to suppress growth and/or inflation). But if we are faced with uncertainty, the safest course of action is to move the policy rate gradually, and then change direction/go on hold when the trend in the economy is changing. “Doing it all at once” relies on a belief that we know what the terminal rate is. The current set up frees central bankers from having to forecast the terminal rate: that’s the job of rates market participants. The central bank just ratifies spot overnight pricing.

Since the effect of interest rates is determined by levels along the whole curve, a higher implied terminal rate still has an immediate effect.

“The” Interest Rate Dial Does Not Exist

I ran into some comments by someone attempting to make a big deal about the flattening that occurs during a tightening cycle. The idea is that since other rates (allegedly) matter more than the overnight rate, then the market is counter-acting the policy rate rise.

I would argue that this is a symptom of using Economics 101 models with one “interest rate.” Any modern models tell us that the yield curve is a continuum, and the only way to make sense of pricing is that yields are primarily determined by expectations.

  • The curve does not move in parallel with the overnight rate. You cannot expect X basis points in hikes to translate into an X basis point rise in yields/rates across the maturity spectrum. If you are attempting to measure the effect of interest rates on the economy (good luck), you probably need to somehow capture the levels across the curve, and not use the policy rate as a proxy.

  • Since markets are forward looking, the timing of trend changes in yields will not match the timing of changes in administered rates. Given that markets with levered players invariably overshoot in both directions, it is completely unsurprising that bond bear markets happen before the first hike, and rally once it hits. You need to look at the yield levels, and the current 10-year yield is higher than it was during most of 2021 (figure above); hence the “interest rate tightening” has started already.

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(c) Brian Romanchuk 2022

Fed Has Plenty Of Time To Decide

Published by Anonymous (not verified) on Tue, 25/01/2022 - 7:21am in


central banks

The risk asset sell off has triggered a fair mount of “what does this mean for the Fed?” takes. Since this Brian Chappatta article on Bloomberg matched a lot of my views, I will keep these comments brief. One thing that I would like to emphasise: the Fed has a lot of time before the March meeting, which is the most plausible date for a first hike. Although risk assets have been hammered over the past few trading days, six weeks is an eternity in “market time.” If equities kept plunging for the next six weeks, that would imply a very severe bear market — which probably signals that something else is wrong in the financial system and/or economy.

  • On paper, the Fed has no reason to care about stock markets. This is not the case for the credit markets. Public equity markets are used by insiders as an exit strategy, very little capital is raised. Conversely, industrial capitalism runs on debt: both public market debt (bonds, securitisations) as well as private debt (private placements, bank debt). If the funding markets dry up, even solvent firms (i.e., positive equity value) can run into liquidity issues as they need to continuously roll over debt. Central banks have no choice but to act as a lender of last resort.
  • Bank equities are probably the most obvious candidate to watch for such stresses.
  • One might easily be more cynical about Fed personnel’s attitude towards equities. American elites are obsessed with the stock market, and central bankers are part of the elite. This was probably more of an issue during the Greenspan Fed era, as there was greater confidence in the equity market being a leading indicator for the economy, as well as strong beliefs in the importance of the “wealth effect.”
  • A rout in energy prices will knock a big hole in headline inflation, which will feed into “inflation expectations” for many individuals. That reduces the urgency to hike.
  • Crypto blowing up is not only hilarious, it might reduce the demand for high end chips. This in turn could reduce some of the knock-on supply chain problems. Otherwise, the collapse of crypto and tech darlings is a non-issue for central bankers.

Although I respect the idea that some levered players are being liquidated in the “tech” area, expecting another six weeks of weak equities is quite a hurdle to jump. Luckily for me, I do not give investment advice, so forecasting whether that happens is not my problem.

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(c) Brian Romanchuk 2022

Central Bank Hawkishness

Published by Anonymous (not verified) on Fri, 17/12/2021 - 5:37am in


central banks

The Bank of England hiked today, and the Fed’s dot plot yesterday indicated that rate hikes are expected to hit in 2022. This is a quite different script than the last cycle, although it remains to be seen how many hikes happen before they stall out.

The interesting thing about the U.S. dollar rates markets is how the market shrugged the news off. Since some hikes were already priced in, this technically should not be a surprise. However, the terminal Fed Funds rate does appear low — but this perhaps fits the low rate regime seen in the last cycle.

Market pricing seems to fit a consensus scenario of inflation remaining elevated enough in the coming months to force some initial hikes. Then base effects will take their toll on the inflation rate, and so it will be harder to engineer an inflation panic, allowing the central bank to drop back to wait and see mode.

One of the major areas of inflationary problems in the United States has been in autos. I believe that the chart above captures one of the main fundamentals for the auto market: chip shortages are the key. Inventories are piling up at manufacturers, just waiting for the chips to be plugged in. Once the seasonal surge in consumer spending is past, we will be able to see whether disrupted supply chains ease.

Outside the United States, the natural gas situation in Europe is perhaps the most worrying area. Its importance in industrial processes could easily lead to knock on effects. My guess is that inflation stories might diverge more on a regional basis than has been the case in the past year.

The other major development is the stalling out of Biden’s economic agenda. This should take the edge off of aggregate demand. This is almost certainly more important than a few token rate hikes — but commentators are likely to claim that any easing of inflation was entirely the result of the Fed’s change of stance.

The debate about the effect of any rate hikes is likely to be fairly intense. From a rates market perspective, the debate matters in that if the consensus believes that 75-100 basis points is somehow enough to take the edge off of inflation, the terminal policy rate need not be much higher. The issue is how such a stance could be squared with a belief that real interest rates matter (as opposed to nominal), and real rates are still likely to be quite negative until late 2022.

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(c) Brian Romanchuk 2021