Notes From Underground: Back To the Sixties–Output Gaps or Phillips Curves?

The FED hounds were unmuzzled after last week’s FOMC and “The Line it Is Drawn. The Curse It is Cast.” Bob Dylan must have been anticipating the difference of opinion that is developing within the Federal Reserve bank. In a speech last night, Dallas Fed President Richard Fisher said: “There are many superb PHD theorists among the 19 members of the FOMC and support staff. There are only a handful of us–four, to be exact–who have worked as bankers or in the financial markets.” Fisher  discussed holding back from further QE based on evidence from his business contacts. The Dallas Fed President was dismissed when,”Some suggested that perhaps my corporate contacts were not sophisticated in the workings of monetary policy.” (Hat tip to Professor K.W. for sending the piece). It seems that the collegial attitude is eroding at the FED if the ivory tower is not the place of residence. Today, it was the Minneapolis Fed President Kocherlakota who delivered what I consider to be an outlandish speech.

Last year Kocherlakota was thought to be somewhat of a “hawk” as he voted NO at a few FOMC meetings because of his views on the structural nature of the unemployment problem–seems he was more dovish than assumed. In today’s speech, “Planning For Liftoff, ” Mr. Kocherlakota was reading from the Woodford Hymnal and pushing for an enhanced policy of not lifting the Fed funds rate until the targets of 5.5% unemployment and/or 21/4 % inflation were hit, but of course all the data would be smoothed over a medium term time frame so as to prevent against any short-term shocks.

President Kocherlakota openly stated that he was just pushing the Charles Evans argument further on the employment front while lowering the inflation threshold. The end result is that the Fed theoreticians are back to stressing OUTPUT GAPS as the most important variable for Fed policy and with unemployment at a headline 8.1% the Fed has plenty of time before having to worry about inflation. The slack in the jobs situation means that inflation is not a threat in the zero bound interest rate world. It seems that Dallas Fed President is correct. There is way too much theory on the Fed board and not enough bankers … and not the Wall Street type. The FED is in need of less theory and more practice.Let’s hope the “Times Will Be A Changing.”

***Following up on the BOJ move to add some liquidity, the Financial Times had an article by Ben McLannahan that the pressure on the BOJ to do something to stem the strength of the YEN, came from a meeting last month between Governor Shirakawa and the large electronic manufacturers in Osaka. The Japanese industrialists complained that the strong YEN was killing their business. It seems that the message was received as the BOJ statement noted,”The effects of financial and foreign exchange market developments  on economic activity and prices.” As I noted yesterday, the YEN closed higher after the BOJ action. It used to be that the widow maker was shorting JGBs but it now seems that the widow maker has been transferred to those deeming to short the YEN. In the world of foreign exchange as all trading it is ultimately about timing. Again, the dollar/yen 200-day moving average is 79.32. The market seems to be humming the song from Beauty and the Beast: Be Our Guest. Be Our Guest, Let Us Put You Through the Test.

***The politics of Europe are beginning to boil as the markets had just begin to calm. There is talk of Spain finally accepting the advice to go forward with asking for a BAILOUT, thus satisfying Mario Draghi and others who wish to utilize the ESM and its rules of conditionality. President Rajoy seems to accept that Spain needs the funds and the iron fist of conditionality will be softened so that Spain is not seen to be politically nurtured. There are those who are pushing Mr. Rajoy to strike while the markets are somewhat calm. Others, such as Goldman Sachs economist, Andrew Benito, raise an important point: “The more the Spanish administration indulges domestic political interests and is perceived to be taking undue advantage of external support, the more explicit conditionality is likely to be demanded. This would add to existing tensions.”

Mr. Benito seems to be warning the Spanish polity not to wave the red flag too often in front of the Bavarian Burghers. It also seems that France is getting on the political boil as President Hollande is pushing for the French Socialists to vote overwhelmingly for the austerity fiscal pact. The French President, a socialist, is being openly criticized for reneging on his election promises and not pushing a growth agenda. Hollande’s strategy seems to be that is important to be more like Germany in order to get Germany to change. Hmmm, another politician aiming for GROWTH THRU AUSTERITY IN A WORLD OF BALANCE SHEET RECESSIONS. It will be interesting to see how President Hollande extricates himself from this mess,as the political landscape has shifted from MERKOZY to MERDE.

And the French President is in it up to his neck. As the French economy continues to deteriorate, today’s PMI was a very disappointing 42.6, the political power of Mr. Hollande will weaken and the German’s will be dictating austerity terms to a beleaguered French polity. France has been off the radar screen but not for long, especially if Spain continues to drag its feet to the ESM money trough for the French are convinced that an effective bailout of Spain will forestall any market attacks on France and Italy.

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4 Responses to “Notes From Underground: Back To the Sixties–Output Gaps or Phillips Curves?”

  1. jerry thoel Says:

    YRA, Thank you as always for sorting thru the clutter to get to the real dynamics at the FED and in Europe.Your blog remains the first thing I read every morning.Buy volatility??and EURO puts???regards,THL

  2. yra Says:

    Jerry–the options are not my strength–if we think something is about to break in terms of market action and vol is cheap–ok;but maybe some other readers can opine

  3. kevinwaspi Says:

    Widow maker indeed! Shorting JGBs, shorting JPY, or fighting the Fed, each makes its own group of widows. With the Woodford Hymnal making the N.Y. Times “Best Seller List”, I fear the academics at central banks will eventually have us all on the widow list. I’m reminded of the old saw, “Markets can remain irrational longer than I can remain solvent.” Academic models will push that irrationality to the limit at the expense of free market discipline everywhere. The Fed may not believe that it can supplant market driven demand, but it continues to act as if it can. Mohamed El-Erian has been using “the new normal” for his description of current events, I’m going to claim the derivative, “the new irrational” and patiently wait for academic hubris to fall flat on its face. As Yra (thank you for the acknowledgement) has observed repeatedly, look to your technicals to guide for stress points, and tread lightly.

  4. yra Says:

    Professor–you are a reason the U of I is a premier institute–I nominate you for the Chicago Fed Presidency

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