Bullard goes neo-Fisherian

It's always easy to be a member of the peanut gallery, hurling criticisms at people who are trying to do their jobs- be they chefs, musicians, sportsmen, or policymakers.  Macro Man is aware of this, and while he believes in all of his general criticisms of the Fed and other central banks, he will concede that sometimes a few of his barbs may be a trifle unfair.  On other occasions, however, decorum prevents him from saying what he really thinks, such is the breathtaking absurdity of what is on display.   On those occasions, as the saying goes, the jokes just write themselves. 

The latest example of this comes from the man that we used to call "Hollywood" at Macro Man's old shop, a Fed president who loves the spotlight like no other.   Step forward James Bullard, president of the St. Louis Fed!  The irony is that Mr. Bullard is an intelligent man who likes to explore interesting ideas on the margins of policy-making orthodoxy.  There's clearly a role for someone to push the bounds of conventional wisdom, particularly given the unusual circumstances in which monetary policymakers find themselves these days.

However, given the prominent role that communication and forward guidance play in monetary policy, particularly for the Fed, is it really too much to ask for a little consistency?   Consider the following timeline:

February 24:   Bullard airs concerns over the level of inflation expectations and breakevens, continuing a line of thought that he first articulated in mid-January.  In such circumstances, he deemed it "unwise" to continue normalizing rates.  What made the timing of these comments so unusual is that the research department of his own St. Louis Fed put out a piece that very day highlighting the absurdity of current breakeven pricing. 

March 16:  The Fed delivers an unambiguously dovish policy release, with both the dots and inflation forecasts marked down despite a pronounced rise in spot inflation.

March 18:  Bullard gives a speech in Frankfurt acknowledging a view that the Fed's policy goals have been met and that it would be prudent to put rates up a bit higher.  WTF?  A mere three weeks after moaning about inflation expectations, Bullard has taken a page out of Macro Man's book and is experimenting with neo-Fisherism.

This, for the uninitiated, is the theory that the private sector sets the real interest rate, which is of course the difference between the nominal rate and inflation.  Thus, if we take the real rate as a given, keeping policy rates low actually generates lower levels of expected inflation.

This is what makes Bullard so frustrating.   His presentation is really very interesting, though Macro Man will admit a bias given that his thinking has been in line with the conclusions for some time now.  Still, the timing, just two days after a dovish Fed announcement and just three weeks after his own concerns about inflation expectations, is just a flat out head scratcher.   Bullard gives the impression of being an intellectual magpie, flitting from shiny new ideas to shiny new idea.  That's great from an economics professor or even a market commentator....but less so from a voting monetary policy-maker.

In any event, and somewhat ironically, reader A.R. had emailed Macro Man the day before Bullard's presentation hit the tape inquiring about what appears to be a strong historical neo-Fisherian relationship between inflation and policy rates.  The chart below plots the 1 year change in inflation (ie. the difference between CPI inflation today and that of 12 months ago, as opposed to the change in prices today versus twelve months ago, which itself is CPI inflation) and the 1 year change in Fed funds.  As you can see, the relationship has generally been very strong, though has broken down during periods of ZIRP.


The relationship also appears quite strong in the UK...


Of course, just because these charts show a strong relationship does not mean that there is a strong neo-Fisherian relationship here.  After all, policy rates move in response to perceived shifts in inflation, both current and expected.  Indeed, you could argue that the two lines in the charts above are so correlated because they are responding to the same stimuli, most notably the rate of economic growth relative to trend.

Still, there is something intuitively appealing to the idea that perma-ZIRP sends a signal that encourages a downward shift in inflation expectations.   After all, the if the central bank economic experts are telling you that there is no inflation and that your money no longer earns any interest, why should you expect any inflation moving forwards?

Ultimately, the problem with just about any economic model is that you can demonstrate just about anything if you try hard enough.  After all, it was once "proven" that listening to "When I'm Sixty-Four" makes you younger!  Perhaps that's the root of the frustration that policy critics feel.  ZIRP and negative interest rates are close to, if not within, the event horizon of a monetary black hole, yet many policymakers are behaving as if classical economics will work as normal, when any first year physics student could tell you that things get mighty strange in and around black holes.

If policymakers were a bit more open to alternatives to the same old, same old, we all might be a bit better off.
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CJ
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March 21, 2016 at 8:06 AM ×

My other major gripe with ZIRP is that in depriving savers of interest income, they are reducing consumption today as consumers make up for lost interest income by saving a higher proportion of their wages. As a simplistic example let's say I used to make $100 in wages and an additional $5 in interest income for a total of $105. Let's say of that $105 in total income I spent $90 and saved $15. Under ZIRP, my new total income would be $100 in wages and $1 in interest income for a total of $101. In order to save the same $15 for retirement or other longer-term expected expenses, I now must reduce my consumption to $86--a reduction of $4. Obviously there are holes in this framework, mainly that it assumes expected retirement needs are relatively stable in a deflation environment, but I think the point is that rates going from 5% to 2% is very quite likely stimultive b/c the +ve impact to borrowers likely outweighs the negative effect on savers, whereas rates going from 2%-0% is probably a net negative b/c it is far more penal on savers than it is stimulative for borrowers. This could be one reason behind the relationship between policy rates and inflation expectations.

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theta
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March 21, 2016 at 9:08 AM ×

How do neo-Fisher models account for fiscal policy? It seems completely absent from this model. CB sets nominal rates, private sector sets real rates, we calculate inflation from that. But I would say that the missing ingredient, a key one in fact is (expansive) fiscal policy. This drove wage inflation in the 70s, and is relatively absent today, leaving more room to monetary policy.

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Anonymous
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March 21, 2016 at 9:39 AM ×

ECB and China on the wires. EU equities shooting up, US equities rising on Globex. Central Banks are gonna bleed the shorts...

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washedup
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March 21, 2016 at 10:06 AM ×

CJ - I was thinking the same thing - also OER (admittedly a bigger factor in CPI than PCE) has been negatively correlated with non shelter costs in recent years, suggesting a substitution effect where low interest rates drive housing prices and rental prices up, reducing discretionary spend on other items.
For all the talk of trying to achieve a dual mandate, the Fed has been more successful bringing nominal leverage down through asset appreciation than by inflating away debt - I do think its a multi-stage game though, and the next stage will likely be the latter, of course with no guarantees of success.
MM that IFF data on China in your comment to the last post supports the debt substitution idea - not much fanfare to it either, which suggests the domestic credit markets in China aren't exactly 'seized up' - btw has anyone else noticed the newfound verbosity of PBoC? Clearly some western central banker reminded them that class participation is 50% of the credits.

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Macro Man
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March 21, 2016 at 10:34 AM ×

@ theta, see here for more on neo-Fisherism, including a bit on the role of fiscal policy. TL;DR version is that hard neo-Fisherian theory doesn't require fiscal policy, but soft neo-Fisherian theory sees a role for supportive fiscal policy as part of the process.

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Anonymous
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March 21, 2016 at 12:39 PM ×

Nico mate dont bother - that just encourages them.

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March 21, 2016 at 1:21 PM ×

Run a causality test and settle which causes which.

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JMT
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March 21, 2016 at 1:46 PM ×

I completely agree with MM's commentary here regarding the efficacy of continued ZIRP. or near-ZIRP, policy, with its debilitating effect on inflation expectations. My comment here is to counter the 'condescension' put towards Bullard.
Over the recent years, as a prop FI trader, my rather rudimentary analysis and monitoring of all Fed officials and their commentaries, has told me that Bullard has been the most accurate in his statements about where actual policy is heading (excluding the Chairperson). We all know about the 'dots' and can assign a name to many of the forecasts. With Bullard however, his comments have often vacillated but in hindsight have proven quite prescient.
The conclusion I came to some time ago is that Bullard wears a second 'hat' beyond his role as a Fed president. I believe that many of his comments are more than just an 'opinion' and that he is the Fed outlet to the markets in an era where there is no apparent heir to the John Berry, Greg Ip, Jon Hilsenrath, 'perceived' leaks. I have found it has been beneficial to listen when he speaks. His 02/24/16 comments just emphasizes my point, and his recent speech in Frankfurt, so close to hearing the 'dovish' Janet last Wednesday, I think is also important. It tells me that the Fed have already decided, excluding any new extraneous events, to tighten at either the 04/27 or 06/15 meetings (06/15 being the more obvious) and that the front end of the curve is offering many cheap opportunities to take advantage of this. (IMHO, it was no coincidence that of all the FOMC members, the voice we heard on 10/16/14 live on CNBC was Bullard.)

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Anonymous
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March 21, 2016 at 2:41 PM ×

Poor US data (Homes Sales etc) but huge bids in ES. Big money not letting US equities break the bottom of their up-trend. Conclusion: more upside to come in coming days... looks a certainty that we'll see new all-time highs in US equities in the near future...

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DownWithTheBeanCounters
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March 21, 2016 at 3:08 PM ×

Not that prices are always "right" and mindful that there are other global factors driving demand, but, if the neo-Fisherian world view held we would have expected the 5yr-5yr to behave better and the yc to steepen no?

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DownWithTheBeanCounters
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March 21, 2016 at 3:10 PM ×

(oops hit send too soon) steepen post hike and flatten post dovish meeting.

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Anonymous
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March 21, 2016 at 3:16 PM × This comment has been removed by a blog administrator.
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Macro Man
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March 21, 2016 at 3:36 PM ×

I am sorry to say that there is going to have to be a zero tolerance policy towards trolls henceforth.


@ JMT, I have no issue with Bullard going off of the intellectual reservation, and generally find his presentations to be interesting and informative. However, I do find it problematic the way that Bullard courts press attention. I certainly don't believe that this is some sort of coordinated secret squirrel role, and I don't think it's appropriate to host CNBC in the foyer of the St Louis Fed on the morning of payrolls, as he did a few years ago. Moreover, if the FOMC wanted to indicate that April and/or June are live and/or likely, wouldn't the statement and yellen's p[resser have been a more appropriate channel than a Regional president's speech in Munich?

All that being said, I do agree that he represents a decent glimpse into which way the tide is flowing and it's worth considering his views as a leading indicator of possible tilts. William is a known "hawk", but he sounded ready to go this morning.

@Down, if you think of asset markets and inflation expctations as partially global phenomona, the price action is easily explained via NIRP et al.

In any event, I don;t think anyone (outside of the Fed, unfort) takes 5y5y as an indicator of much of anything but market liquidity premium.

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Nico
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March 21, 2016 at 4:05 PM × This comment has been removed by a blog administrator.
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washedup
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March 21, 2016 at 4:26 PM ×

wow MM - feel bad for you having to mop up this garbage - want us to investigate a way to automate it?

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Anonymous
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March 21, 2016 at 4:36 PM ×

Literally cash under mattress

http://www.bloomberg.com/news/articles/2016-03-16/munich-re-rebels-against-ecb-with-plan-to-store-cash-in-vaults

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Anonymous
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March 21, 2016 at 5:30 PM ×

Awash in bankrupt toilet paper -> Wall Street's Pile of Unwanted Treasuries Exposes Market Cracks

http://bloom.bg/1Mw0BiW

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Anonymous
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March 21, 2016 at 6:29 PM ×

BOJ's Nakaso Says It Is Technically Possible To Go Further Into Negative Territory With Rates

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Leftback
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March 21, 2016 at 6:56 PM ×

Theta asked: "How do neo-Fisher models account for fiscal policy? It seems completely absent from this model."

Quite. This is b/c Washington has been asleep at the wheel since 2009 with respect to fiscal policy, Europe is in Fauxsterity, all of this while lowflation and the output gap are screaming that fiscal policy is the appropriate channel through which to act.

W.r.t. Bullard, I have always assumed that he is the Designated Swing Guy, who has license to swing from both sides of the plate. As the FOMC "Switch Hitter" (is that right?), he is sent out to deflate bubbleicious rallies with a slightly hawkish tone, or to reflate at the bottom of deep sell-offs with renewed dovishness. His flip-flopping atttracts media attention, makes the market gyrate in an interesting way for a few days and allows other members of the FOMC to remain steadfastly rooted in their ├╝ber-dovish (Kocherlakota, Rosengren), mildly dovish (Brainerd, Yellen) or more hawkish (Fisher, Mester) positions.

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Leftback
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March 21, 2016 at 7:05 PM ×

Add to the above, Williams and Lockhart statements today, as usual mildly hawkish and you have most of the landscape.

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Hotairmail
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March 21, 2016 at 7:14 PM ×

I don't think this is just to do with rates signalling inflation levels although no doubt it has a role. I can think of at least 2 other more important effects. Firstly, aside from economic cycle fluctuations we have also had a significant drift down from about 1980. It is no coincidence to my mind that this drift down has coincided with a large increase in overall debt levels and money supply. As debts rise the mechanism for transmitting monetary policy (bank rate) has become very much more sensitive to both the overall levels of rates and the increments with which they are changed.

The second mechanism I think has been investment in production being made profitable with cheap money.

Of course, this has also coincided with the globalisation of labour and free capital flows that has allowed rates to be kept low in response to measured inflation.

Combined, the intent has always been to keep the game going with easy money which has benefited leveraged asset holders and their banks, but a failure to take any sort of medicine you would think would cause some problems to the capitalist system but who knows when.





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JMT
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March 21, 2016 at 7:39 PM ×

Thanks for the follow up response MM. Some additional comments...
I think the official FOMC statement and presser last week, and therefore 'policy', were to reassure that the Fed acknowledges market/global sentiment and to emphasize that we will not see four hikes in 2016, although with the dots still suggesting possibly two hikes. Bullard's speech, the location of which is immaterial in the modern information age, I doubt was to project 'official policy' but based on past similar situations, I believe, should not be downplayed. I pay attention to his speeches the way I used to watch out for the 'Thursday evening' WSJ the week prior to an FOMC meeting, making note of the speech content and look for trading opportunities accordingly.
(My focus on Bullard was really emphasized after the 2013 Jackson Hole conference. He gave an 'official' speech there then countered some of his own comments two days later in TV interviews, suggesting it was too early for the Fed to start tapering QE. Going into that Sep FOMC meeting the market consensus was clearly expecting the start of the Taper and was caught offside, the FOMC statement released worded almost exactly as Bullard had 'suggested'. And, since this period, Jon Hilsenrath's role appears to have been significantly diminished, with the Fed being its own news outlet.) (Of course this view of Bullard's role could absolutely be completely wrong, and maybe it is just that he likes being in front of the camera!)

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Leftback
admin
March 21, 2016 at 8:25 PM ×

Ignore the RISING BULLARD at your peril. These can do a spot of damage to the portfolio and bring tears to the eyes:

Rising Bollard #1
Rising Bollard #2

Look, it is a slow day here..... :-)

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Leftback
admin
March 21, 2016 at 8:31 PM ×

Even the BBC knows about the RISING BULLARD:

BBC Wally Reviews Rising Bollard Hazard"

Makes you wonder whether the British are an entire nation of wallies, really? Innit.

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