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You Heard Me!

September 16, 2015 Leave a comment

I’ve been out of blogging for a while with other stuff to do but with commodities tanking and the Fed seemingly poised to raise short-term rates in the near future, and some commentators remarking that “QE risks becoming a semi-permanent feature,” I feel like the world is largely conforming to my view.  However, this is an easy feeling to have erroneously and I kind of wish I had made more official predictions in the past, even though that’s sort of a dangerous business to get into.  No doubt, if I had them, I would wish I hadn’t made them but at least then I would be humble.

So just to get myself on the record, partly for fun, and partly so that if they happen, I can point to them and say “neener, neener, I told you so” to the world, I want to take a page from my blogging hero and do an economic version of “You Heard Me.”  The premise behind this game is to make bold predictions which would make someone who hears them remark something along the lines of “wait, what did you just say?” to which you reply “you heard me!”  The point is not necessarily to nail the prediction exactly but to boldly state a general feeling about something, be it a football player or an economy.  Basically this is one prediction but I will try to add a little bit of flesh to the bones.

  1. If you watch CNBC or any show like that, in almost every discussion about the FED, someone will say “look, we know rates are going up eventually” and everyone agrees with them.  That’s wrong.  Rates are never going up again.  You heard me!

Of course, it’s possible that rates could go up a little.  Short-term rates may indeed be raised this week.  I don’t claim to know what the Fed will do in two days.  But there is a meme of “normalization” going around which is wrong.  Somehow people have gotten the idea that it is “normal” for short term rates to be something like 2-4% and this “low rate environment” must be only temporary.  It’s not.  Maybe they get rates to 1% for a while, maybe not, I don’t know (my guess is not).  But they will be doing QE again before short-term rates ever hit 2%.  By “they” I mean the FED but basically this applies to the whole world.

10 year treasury

There is the 10-year treasury rate since about 1980.  See if you can spot the “normal” level.

2. Inflation will continue to run below the FED’s target and will intermittently cause prices of commodities, stocks, real estate, etc. to nosedive requiring the FED to take action to stave off a full-on deflation.

3. QE will become the new standard policy tool.  You heard me!

The “low rate environment” is not because of temporary exogenous shocks, it is the deterministic result of our monetary system (not policy, system. You heard me!)  This system requires either: people to become continually more leveraged, governments/central banks to buy continually more stuff, or lots of people to go bankrupt.  For the last 35 years or so, we have been exhausting our ability to induce people to become continually more leveraged by continually lowering interest rates.  When we can’t do that, we need either the government (“fiscal policy) or the central bank (“quantitative easing”) to just start buying stuff.  Because we are not going to significantly lift off of the lower bound, and because remaining at the lower bound will not be sufficient to stave off a wave of defaults forever, we will eventually need to reinstate QE.  The next time, they will drop the pretext of a temporary support measure and just start adjusting it up or down every month and that will become the policy tool of choice to smooth out the path of the economy.

4. QE will tend to get bigger over time relative to the rest of the economy.  This is for the same reason described above.

5. QE will spill over into other assets, like stocks.  You heard me!

This is already going on in Japan and China.  Note that 3, 4, and 5 will tend to require bouts of 3 in order to get done because they will be viewed as “extraordinary.”  This means that they will not dare to do these things until it gets bad enough that people are jumping up and down shouting “do something!”

6.  Keynesians will constantly complain that we need more fiscal stimulus to get off the lower bound.  They will be half right.

Okay, that’s not very bold but how many years do we have to hear that line before we start to wonder if it’s not just a matter of smoothing out short-run fluctuations in the real economy?  My prediction: a lot.  You heard me!

7. Market monetarists will insist that our problems are all because central banks are too tight.  They will be about 3/4 right.

It will be true that if central banks were looser, NGDP would grow faster and inflation expectations and nominal rates would pick up.  It’s just a question of what they would have to do to “ease” further.  The MM line seems to be just talking about being looser (and I guess, to be fair, holding interest rates lower for longer) will get us back to normalcy.  The problem with this is that it still relies on the myth of “normalization.”  In order to ease more, in the long run, the FED would eventually have to do more of the things I mention above, not just change their language.  It’s true that if they just did them without waiting for recessions and financial crises to force their hand, those things might be avoided but the MMers haven’t quite come around to accepting the ultimate consequences of this.  (Bonus prediction: we won’t adopt NGDP futures targeting, even though it is a way better idea than what we are doing.)

8.  Scott Sumner will continue to make the occasional snide remark about the Central Bank buying up the whole world in order to argue that monetary policy can always get looser.  He will be 100% right.  At some point it will stop being funny….You heard me.

 

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