Sunday, December 7, 2008

Policymakers got it wrong too

What happened on December 1, 2008? The National Bureau of Economic Research (NBER) announced that the U.S. entered its 22nd recession since the turn of the century in December 2007. Global economies are also in recession - Eurozone, U.K., Japan - driven by the U.S. financial storm and record inflation rates.

The NBER announcement sparked many bloggers to look back on who called the recession and who did not. Here is a short list of examples:
  • Boom2Bust compiled a list of memorable no recession calls
  • Econbrowser revisits its indicator index and gives props to Calculated Risk for adding recession bars to their charts back in March 2008.
  • Barkley Rosser argues he was not wrong on the recession call but the USD call.
What I think is a little more telling is how policymakers - except Bernanke - did not see this coming. Bernanke started to cut pre-emptively – back in September 2007, and before the recession started – in response to the crash of the sub-prime mortgage market. But some economies were less fortunate.

The chart (click to enlarge) illustrates daily policy rates for key central banks – Federal Reserve Bank (Fed), Bank of Japan (BoJ), European Central Bank (ECB), Bank of England (BoE), and the Bank of Canada (BoC) - spanning the dates 01/03/2000 to 12/05/2008. During the 2001 U.S. recession, global central banks cut policy rates in concert. However in 2008 and amid rising inflation, the Fed cut first in Sep. 2007, followed by the BoC and the BoE in Dec. 2007, and lastly the ECB and BoJ cut in Oct. 08.

The biggest no-recession folly is Trichet’s no-U.S.-recession-spreads-to-Eurozone-call. Here is an excerpt from the Internaional Herald Tribune on February 14, 2008:

”The European Central Bank president Jean-Claude Trichet said Thursday that his counterparts in the United States and Britain had cut interest rates based on a "very different" economic outlook to the one in the euro area, signaling he is in no rush to follow suit.”

The President of the Eurozone – the central banker for 15 economies - seriously underestimated the global implications of the U.S. financial crisis. Trichet likely agreed with the German Finance Minister Peer Steinbr├╝ck, This crisis originated in the US and is mainly hitting the US,” he said. Oh how wrong they were because the G7 economies have all experienced the same outlook (ex post) - contracting economic growth in 2008 (see chart above).

Bernanke got it right: in spite of record inflation, 5.4%, Bernanke said this at the Fed meeting in Jackson Hole on August 22, 2008:

”Although we have seen improved functioning in some markets, the financial storm that reached gale force some weeks before our last meeting here in Jackson Hole has not yet subsided, and its effects on the broader economy are becoming apparent in the form of softening economic activity and rising unemployment. Add to this mix a jump in inflation, in part the product of a global commodity boom, and the result has been one of the most challenging economic and policy environments in memory.”

Ex post, economists will likely say that Bernanke’s mistake was not easing further or not starting his policy of quantitative easing earlier.

Inflation surged and is likely one of the direct causes of the 2008/2009 recession. However, global policy makers (ex the Fed) put too much weight on the inflation pressures and not enough weight on the U.S. financial storm. Inflation targeting is not an inflexible rule. The ECB, the BoE, and the BoC could have been more aggressive in their policy rate cuts.

You all know that I likey Bernanke. The U.S. would be a lot worse off if Trichet were our central banker rather than Ben Bernanke.

Rebecca Wilder


  1. Rebecca says: "Inflation ... is likely one of the direct causes of the 2008/2009 recession."

    On Recessions

    Inflation cannot cause a recession.

    Under Central Bank Controlled Paper Money Systems, only a negative change in the relation of Money in Circulation (notes and coins) to Functional Credit Growth causes a recession.

    In short, when money becomes more Inefficient, do recessions happen.

    On Inflation
    Inflation is a process undertaken on purpose by a central bank in an attempt to increase the Efficiency of Money.

    The goal of Central Bankers using inflation is to increase the growth of Commerical Credit for NEW OUTPUT of manufactured, mined and farmed goods.

    When this happens, we call this growth Economic Expansion.

    Under Central Bank systems, Central Bankers use Inflation to cheapen the price of money hoping to expand Capital Opportunties through cash renting for manufacturing and production (mining, farming) purposes.

    Inflation happens when those in power (Central Bankers) want to increase internal trade (Home Economy) through these: increased number of opened contracts, increased rate of cash payment for transaction settlement.

    A wanted increase in Commercial Credit relative to Money is the wanted EFFECT of inflation.

    Should inflation work, more New Issues of Preferred Stock, Commerical Paper and other investment instruments arise to attract Money.

    Should inflation work, more folks gain goods and jobs as manufacturers, farmers, miners hire workers.

    When Inflation Fails
    Prices reflect clearing of what is available and wanted for sale with how much cash and credit exists in the hands of buyers.

    When Central Bankers undertake inflation, such that more Money in Circulation grows faster than the Dispersion of Credit, money gets concentrated into fewer hands.

    Such concentrated money bids up prices of things in existence against things yet to be manufactured.

    The end result is a fast rise in street prices of existing things.

  2. To be sure, rising food and energy prices caused the CPI to rise, causing inflation without any interference by the central bank (printing money). In Q3 2007 and Q1 2008, real consumption growth slowed, while nominal consumption growth remained strong, implying that consumers reacted to rising prices – reducing spending on non food and energy goods in alongside surging food and gas prices. This is the idea behind stagflation – the real economy contracts because a nominal variable (in this case the price of food and gas – driven by oil and natural gas) surges.


  3. On CPI
    CPI (Consumer Price Index) gives anyone a meaningless measure.

    There is no such thing as a Monolithic Price, one number, that captures all price data -- only what bogus economists tell you.

    CPI gives the basis for a fake analytical framework.

    You can tell any story that you want to tell, simply by changing what want included into the CPI.

    On Consumption, Real, Imaginary
    There's no such thing as "nominal" consumption.

    All consumption is real.

    Price Paid = Units of a Thing x Units of Money

    If you increase the Units of Money, the Price Paid rises yet, consumption (Units of a Thing) does not go up.

    Measuring Inflation
    Since Inflation is a process undertaken on purpose by a central bank in an attempt to increase the Efficiency of Money, the rate of inflation is the rate of accretion of new cash (notes and coins) into circulation plus accretion of new credit (30 day balances).

    The Prices Paid for things shall rise if the amount of things available for sale does not grow in proportion to growth of spendable money (cash plus credit).

    On Oil Prices
    Oil and money are commodities, one in the earth -- oil -- and the other made by man -- (paper) money.

    Men swap commodities. Some call this swap an exchange. In truth, men swap rights, one right for another right. With oil and money, men swap the right of owning oil for the right of owning money.

    All swaps must have one commodity exchanged for another.

    When one thing gets calculated in terms of another, we call this a ratio.

    The result of the ratio, we call it a value. When we use money as one commodity in the swap, we give another name to the word value -- PRICE.

    The ratio of one commodity (oil) to another (money) expresses a value, which we call a price (of oil).

    A rise in price means a change in the ratio has happened calculated at one time from being calculated at another time.

    Only two ways can achieve a price rise:

    [1] money rising quicker than oil
    [2] oil falling quicker than money

    Each year, a RECORD AMOUNT of oil gets pumped. Since the price (the value) of the ratio is rising, only one cause can be true -- a RISE IN MONEY quicker than a rise in oil.

    Sellers sell to the highest bidder. When folks have more money bidding for a near fixed amount of oil (slightly growing in amount year-to-year), prices rise.

    Oil prices shot to the moon because of the Global Glut of Money.

    What caused the Global Glut of Money?

    Money is the highest form of Credit and Credit is another word for Debt. Credit and Debt are other names for Capital.

    As credit (=debt, =capital) grows for bad products that nobody wants, a collapse of trust follows. Deals get broken and folks walk away paying on debt.

    Yet, the money created for this debt stays in the pockets of some folks.

    It is the default on credit (=debt, =capital) that causes problems. This increases money at a rate quicker than credit for good products, good invention.

    When credit (debt) defaults rise, the paper money and coins issued go into the pockets of winners.

    These winners begin to bid up prices on existing things, typically commodities of energy, metals, food.

    Why? Simply, these winners cannot find worthy investments to make, which would turn their notes and coins into capital paying a return.

    Money flows into oil futures games because those with money cannot find other games worthy to play.


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