It Can't Die of Old Age If It's Not a 'Recovery' To Begin With

It Can't Die of Old Age If It's Not a 'Recovery' To Begin With
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On her last day as Chairman, Janet Yellen allowed CBS News reporter Rita Braver to follow her around saying goodbye and reminiscing. It was February 1, 2018, by every mainstream account a good time to be sailing off into the sunset. Federal Reserve officials like Yellen had been waiting a very long time for everything to pay off. Last February, more than any other time over the last decade, they finally believed they had done it.

Yellen was obviously disappointed at not being re-appointed following her one term. She thought it a matter of politics, having been a lifelong Democrat. Jay Powell was a Republican and well-liked among influential people within the Republican President’s orbit.

On the merits, her track record, the outgoing Chairman was less restrained than usual. Ms. Yellen positively gushed about the economy under her tested eye. “I believe that since I've become Chair, several million jobs have been created, [something] on the order of ten million.” Ten point two, to be exact.

No one ever asks, is ten million good? It sounds good, which is why these numbers are so frequently deployed. One thing we know for sure, it wasn’t Ben Bernanke’s record during his first term. From February 2006 through January 2010, the US economy lost more than 5.6 million jobs. Yet, he was given a second chance.

If there is dissatisfaction over Yellen’s performance it isn’t obvious why. Something seems wrong. Reducing ten million to percentage terms the incomplete picture clears up. During the late nineties, the apex of the Federal Reserve when Alan Greenspan was the indubitable, unassailable maestro, in the four years between January 1996 and January 2000 the US economy gained 12.7 million – with a population one-fifth smaller.

Naturally, then, everyone turns toward time. You see, this is approaching the longest expansion on record. Thus, it’s not just those ten million that corroborates success, it is ten million plus time.

Rita Braver marveled at it, asking Janet Yellen if after nine years this economic progress could continue. After all, some say the cycle is getting long in the tooth. Yellen emphatically replied:

“Yes, it can keep going.  Recoveries don't die of old age.”

Especially when they aren’t recoveries.

It has become a matter of acceptance; orthodox Economics having declared the business cycle an error and an unnecessary one. An entire scheme has been created, championed vigorously by Janet Yellen as well as her husband, Nobel Laureate George Akerlof, so as to “fill in the troughs without shaving off the peaks.”

That was a phrase first used by Economists Brad De Long and Larry Summers in a joint paper published all the way back in September 1988. The purpose of their examination, one which has been widely celebrated, was to push back against anti-Keynesian doctrine.

Robert Lucas and Thomas Sargent, among others, had in the seventies shown that recessions were uninteresting over the long run. Because each contraction was always followed by symmetric recovery (Milton Friedman’s “plucking model”) there could be no advantage gained to recession-fighting policies. The net costs for all the ups and downs was zero; you end up in the same place you started.

The business cycle wasn’t fun especially on the way down, but in time what mattered was only economic potential.

That wasn’t something fiscal or monetary policy could affect; and certainly not in predictable fashion. Rather, according to Lucas as well as Friedman, there was as much danger in trying to “fill in the troughs” as not.

This was called the natural rate hypothesis, using Knut Wicksell’s framework of interest rates to suggest a measure for economic potential. What any intentional policy of recession combat might do is push the economy temporarily above or below it without a clearly defined mandate for doing so. Summers and De Long summarized this opposition:

“The view that the business cycle consists of repeated transient lapses from potential output is a major piece of the ‘Keynesian’ view: there is often room for improvement, and good policy aims to fill in troughs without shaving off peaks. This Keynesian view stands in opposition to the ‘natural rate’ view: that the business cycle is due to expectational errors that alternately push the economy above and below its sustainable growth path. This natural rate view implies, even in its variants most hospitable to Keynesian concerns, that the scope for macroeconomic policy to affect welfare is small.”

The authors then go through an exhaustive series of statistical calculations that purport to show how reducing the severity of recession can lead to better long run outcomes. Why accept the downturn if you aren’t going to give up anything on the upswing?

“The lack of a transitory component in output since WWII—the finding that the canonical shock to production is persistent in a univariate context—tells U.S. [sic] that performance has been good and that the shocks that used to produce the business cycle have been damped by a robust economic structure or by skillfully conducted policy.”

What could have been this other “robust economic structure?” They don’t say. Either way, the authors chose instead to believe how Economics coming of age in the postwar era did a reasonably good, statistically significant job of interference. “These conclusions suggest the likelihood that successful efforts to manage demand might well have increased average output and reduced average unemployment during the post-WWII period.”

And this was written in 1988, before the Great “Moderation” which would then be used as evidence for Summers and De Long’s theory.

Akerlof and Yellen famously agreed. Perhaps her second-most widely cited paper, written in July 2004, the future Federal Reserve Chairman began it by profusely praising Keynes:

“In 1936 Keynes’s General Theory explained how fiscal and monetary policy could be used to end depressions. Since that time no developed country has ever seen a downturn on the scale of the 1930s. The General Theory was not just a how-to book on the avoidance of depressions. It was an argument for stabilization policy itself.”

Sure enough, Yellen and Akerlof use the Great “Moderation” as evidence for this neo-Keynesian framework. “…the volatility of output and unemployment in the United States and numerous European countries has declined considerably since the 1980s—a phenomenon that has been dubbed the Great Moderation.”

Perhaps revisions are in order?

The funny thing is, both the natural rate people as well as the Summers/De Long trough-ers are stuck in the same place. According to the former, the natural rate has fallen so low it may be hampering the usual anticipated effects of those who are following the latter. That’s why you constantly hear about ten million jobs cherry picked along arbitrary timeframes (just as I did using those particular four years at the end of nineties).

When did this happen? Two thousand eight, to be precise.

The proper way to evaluate economic performance is peak to peak. Thus, we are not interested in just what went on during Janet Yellen’s transitory tenure, rather what did Bernanke/Yellen/Powell actually achieve, loosely speaking, using the same overall policy framework. Yellen might have been a Democrat, self-described, but as Federal Reserve Chairman she was indistinguishable from her predecessor in every way that mattered (and her successor, too).

According to the Bureau of Labor Statistics’ Establishment Survey, employment peaked in January 2008 at 138.4 million payrolls. As of the latest data, for January 2019, there is estimated to be 150.6 million payrolls. That’s a net gain of just 12.2 million, an absolutely atrocious long run record that seems to be importantly consistent with the idea behind a low perhaps negative natural rate.

Yellen can claim that at least things went right during her one term, but she was Bernanke’s Vice Chair for his whole second term as well as San Francisco branch President during the crisis and immediate aftermath. The Great “Recession” and aftermath was obviously asymmetric. Policies intended to “fill in the troughs” didn’t.

As a matter of academics, what seems to have happened is tragic comedy. Economists desperate to resurrect Keynes after the messy disaster of the Great Inflation used the Great “Moderation” to “prove” that effective stabilization was an ideal goal. And not just a goal, that they were already good at it. As with everything in econometrics, this statistics-based paradigm, it doesn’t appear as if they stopped to consider whether the Great “Moderation” was itself an outlier and what might have made it so.

Worse, these people developed their so-called toolkit, the intended means for stabilization, during these same two decades. The primary vehicle was Alan Greenspan raising or lowering the federal funds rate a quarter-point here or there predicated on his finger in the wind. To them, and their recency-biased statistics, monetary policy of this nature was extremely effective at maybe even eliminating the business cycle altogether.

The funny thing is, Akerlof and Yellen’s 2004 paper come to the conclusion that Lucas was wrong in his calculations showing recessions don’t impose costs on the long run. “We are beginning to identify losses from business cycle volatility that, while not huge, are still not to be sneezed at.” These small losses can accumulate, and in the non-linear world in which we live they add up considerably over time (as Summers and De Long suggested).

In realizing this, and arguing for activist policies, Yellen cautioned:

“Since the gains from stabilization policy depend largely on the nature of the inflation process—whether it is linear or nonlinear and whether it is accelerationist or not—we suggest policymakers should be cautious about embracing inflation forecasts derived from theoretical models embodying overly strong priors…Indeed, the success of the Federal Reserve in the late 1990s in reducing unemployment and inflation simultaneously was arguably a consequence both of the Fed’s commitment to dual policy goals and its empirically oriented and open-minded approach toward forecasting inflation.”

Ouch. There’s a lot more to what the authors are saying here, to oversimplify, one key finding was in how stabilization policy must begin by recognizing its own limitations. This was very easy to do during the Great “Moderation” when it didn’t really seem to matter; that is, no matter what Greenspan’s Fed did it appeared to work. Therefore, understanding actually why it worked out this way wasn’t really important.

There were almost no troughs and very high peaks, so “open-minded approach toward forecasting inflation.” It couldn’t have been more closed-minded.

In fact, more than anything what the last year since Yellen’s involuntary retirement has been about is inflation. Everything has been staked on this one factor, the final proof that validates the ten million claim.

If consumer prices accelerate, then it means that this is the best the economy could ever have hoped to achieve. It wouldn’t matter that ten million in four years is lackluster by every historical standard, according to economic potential indicated by the quickening pace of the CPI there was no way for it to have been better. The problem in this situation isn’t stabilization policies, meaning Economics and Economists, it is you and me.

Should inflation not accelerate, however, then flip that last sentence around. You begin to understand why policymakers around the world had become so emotional over 2017’s minor global improvement.

The verdict is in. It was actually determined long before now, meaning there was no chance Economists had this right. Flat curves at low nominal levels declared all throughout the past few years that the economy was still going nowhere.

What’s changed recently is how Federal Reserve officials now agree. Janet Yellen left at the beginning of February 2018 with the world thinking she had done it. In January 2019, those she left behind still can’t say what’s been done. They don’t come right out and admit it, they would never do such a thing, but this is pretty damning nonetheless:

“Some participants noted that some factors, such as the decline in oil prices, slower growth and softer inflation abroad, or appreciation of the dollar last year, had held down some recent inflation readings and may continue to do so this year. In addition, many participants commented that upward pressures on inflation appeared to be more muted than they appeared to be last year despite strengthening labor market conditions and rising input costs for some industries.”

The above is taken from the meeting minutes of the last FOMC gathering, released this week, so I’ll translate them: we appear to have been wrong about that whole boom/overheating agenda.

The upper bound for federal funds is presently set at 250 bps. According to current orthodox thinking, that’s still below the neutral interest rate and should therefore be slightly accommodative. Some suggest it is way too high already and along with so-called QT the cause of our growing global predicament.

In reality, it’s neither. Federal funds as a market is irrelevant. The federal funds rate is even more so. These people have no idea what they are talking about, but they’ve built up a seemingly impressive infrastructure that makes it appear like they do.

When in doubt, should the public start to question conditions in Plain English, write something like Summers and De Long: “We read this as a sign that the metaphor of ‘hysteresis’ as applied to economies should be understood as asserting not that there are no tendencies after demand shocks for the self-regulating mechanisms of the economy to push unemployment down and output back to trend levels.” Or from Akerlof and Yellen: “What evidence we do have from these two different types of sources, however, favors the hypothesis that once inflation is low, downward nominal wage rigidity mutes and truncates the pass-through of inflationary expectations.”

It’s all gibberish. Useless prattle.

Another Nobel Laureate, Ronald Coase, in his 1991 acceptance speech observed:

“The concentration on the determination of prices has led to a narrowing of focus which has had as a result the neglect of other aspects of the economic system…This neglect of other aspects of the system has been made easier by another feature of modern economic theory – the growing abstraction of the analysis, which does not seem to call for a detailed knowledge of the actual economic system or, at any rate, has managed to proceed without it.”

What we are left with is Janet Yellen’s lackluster ten million; actually, eleven years and twelve point two million. If ever there was a time an eight-figure number could be really bad, this is it. She told CBS’s reporter how “recoveries don’t die of old age.” That’s right, they are killed by Economists who are so bad at their jobs, these stabilization policies they’ve used have managed to stabilize the global economy in its trough.

We don’t have to worry about the peaks anymore because there aren’t any.  The reason inflation never worked out as had been expected is quite simply they don’t know what to expect of reality. “Something” else happened instead, and, as the latest economic statistics around the world confirm, that something is almost certainly going to add an increasingly uncomfortable amount to the already decade-long stretch.

This was no Great “Recession” just as there was no Great “Moderation.” If Economists had listened to Ronald Coase, they might’ve discovered its true secret. There once was a eurodollar system build up. And now there isn’t. Pretty simple stuff after all. 

Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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