The global media seems endlessly fascinated by the question of whether monetary policy in the US is too easy or too tight, even as the Fed comes amazingly close to hitting its targets.  I suppose this interest can be partly justified by the size and influence of the US, which David Beckworth calls a “monetary superpower”.  Nonetheless, there should be more discussion of the fact that monetary policy in the Eurozone and Japan is way off course, and that these policy mistakes are a danger to the global economy.

Core inflation in the Eurozone is 1.0%, far below the ECB’s roughly 1.9% target:

And growth in the Eurozone is slowing as we go into 2019.

Core inflation in Japan is even further below the BOJ’s 2% target:

And growth in Japan is also slowing.

My suggestion is that both central banks consider switching to level targeting and adopt a “whatever it takes” approach to hit their targets.  These changes might require legislation, and I’m not expert on the political barriers to getting this done, which I presume are formidable.  Fortunately, these two changes might well be enough; I doubt they’d need to take any additional “concrete steps”.

PS.  Commenter LK Beland constructed a monthly series of wage income for the US, by multiplying average hourly earnings, average hours per week and payroll employment.  In some respects, this data is superior to NGDP as an indicator of the appropriateness of monetary policy. Interestingly, the graph shows even greater stability than NGDP growth, mostly hovering around 4% to 5%:

This is what I’ve been advocating as a long run policy ever since I started blogging in early 2009.  However I would have liked to have seen faster “catch-up” growth in the early years of the recovery.  Even so, this is a good sign.  If they can keep roughly 4% growth going forward then . . . . we win.

If you make policy suggestions to Europeans, they’ll tell you that they can’t do that.

Consider the problems that the ECB is having raising the core inflation rate closer to 2%.

Why not do unlimited QE? — “We can’t do that”
Why not raise the inflation target? — “We can’t do that”
Why not level targeting? — “We can’t do that”

They can’t do anything that would actually work.

Consider the problem of sluggish growth.

How about injecting dynamism into France and Italy through supply-side reforms? — “We can’t do that.”

Consider the Brexit fiasco.

How about a better Brexit, say the Norway option? — “We can’t do that.”
How about another Brexit referendum? — “We can’t do that.”

There a sense in which the naysayers are right. In politics, the law of large numbers is very powerful. Things happen for a reason. Options are not chosen because there currently is not enough support for those options.

So what is to be done? One solution is to look for alternative solutions that are politically feasible. But those do not exist. For the moment, there is no hope for Europe. There is virtually no chance that Europe will snap out of its malaise in the next three days.  They won’t do any of the things that might work.

As we look further out into the future, however, things gradually become more hopeful. The longer the malaise continues, the greater the appetite for changes that currently are not politically feasible.

The solution is not to look for alternatives to sound economic policies; there are no alternatives. Fiscal stimulus will not get Europe to 2% inflation. Rather, the solution is to keep beating our heads against the wall, day after day and year after year, until the time is right for effective solutions to be adopted. NGDP targeting plus free market reforms. That’s what I’ll keep promoting. The zeitgeist determines the policy mix; there’s nothing I can do about that. The universe is deterministic. But I can affect the zeitgeist, at least a tiny bit.

You can too.

I have a new piece at The Hill.  Here’s an excerpt:

The biggest puzzle is what the Trump administration is trying to achieve with its trade war. Is it a move to pressure the Chinese to open up their economy, thus reducing barriers to U.S. trade and investment? Maybe, but it was precisely the opening of the Chinese economy that first created the “China shock.”

Indeed, China was no threat at all to U.S. firms when its economy was closed under the leadership of Chairman Mao. An even more open China would create an even bigger shock, resulting in even more economic dislocation in the Rust Belt. Presumably, Ohio manufacturing workers who supported candidate Trump were not hoping China would buy more Hollywood films and computer software, so that America could buy more auto parts from China.

Read the whole thing.

PS.  A recent NBER paper by Zhi Wang, Shang-Jin Wei, Xinding Yu, and Kunfu Zhu reversed the finding of the famous Autor, Dorn and Hanson paper on the “China shock”.  Here is the abstract:

The United States imports intermediate inputs from China, helping downstream US firms to expand employment. Using a cross-regional reduced-form specification but differing from the existing literature, this paper (a) incorporates a supply chain perspective, (b) uses intermediate input imports rather than total imports in computing the downstream exposure, and (c) uses exporter-specific information to allocate imported inputs across US sectors. We find robust evidence that the total impact of trading with China is a positive boost to local employment and real wages. The most important factor is employment stimulation outside the manufacturing sector through the downstream channel. This overturns the received wisdom from the reduced-form literature and provides statistical support for a key mechanism hypothesized in general equilibrium spatial models.

I don’t “believe” either result.  The science of economics has not advanced to the point where it’s possible to have a high level of confidence in these sorts of empirical studies.

PPS.  Off topic, this made me smile:

Trump has moaned to donors that Powell didn’t turn out to be the cheap-money Fed guy he wanted. The president repeated the effort this week in an interview with Reuters, adding the ridiculous claim that the euro is manipulated and the more credible notion that China is massaging the yuan. (The European Central Bank rarely intervenes directly in currency markets; when the ECB does, it’s usually with the Fed.)

Where to begin:

1. Trump had a choice between Yellen and Powell.  I suggested Yellen, as she had done a very good job.  Trump’s advisors said he shouldn’t pick Yellen because she’s not a Republican.  So Trump picked Powell, even though he was slightly more hawkish than Yellen.  Trump is tribal and assumes everyone else in the world is just as corrupt as he is.  He thought Powell would be “better” because he’d want to help a Republican president.  And now Trump is shocked to find out that Powell is not his lapdog.  (Actually it’s too soon to know for sure, as Trump also wrongly assumes that higher interest rates mean tighter money.  But we can cut him some slack, as lots of other people make the same mistake.)

2. I also smiled at the notion that the ECB doesn’t intervene in the currency market.  Of course they have a 100% monopoly on the entire supply side of the euro currency market.  Yes, I understand the reporter meant “foreign exchange market” when he said “currency”.  But even that’s a bit misleading, as ECB policy does affect the forex value of the euro, and there have been ECB actions in recent years that were clearly aimed at depreciating the euro.  Ditto for the Fed and the Chinese central bank.  Still, the reporter is correct in claiming that Trump has no grounds to complain about ECB policy; I wish he had made the same point about China.

PPPS.  Another day, another two convictions of close Trump advisors.  In one case it was for for a crime that Trump ordered him to commit.  Trump’s now as deeply enmeshed in scandal as Nixon was back in 1974.  The good news for Trump is that none of this matters.  Trump’s support is in the low 40s and it will not decline at all.  There was no Nixon cult—his supporters abandoned him in droves.  But the Trump cult would support him if he murdered someone in the middle of Times Square, at least that’s what Trump himself claims.  As long as those 40% of voters stick with Trump, frightened GOP Congressmen will do the same.  Trump is safe.

Still, it will be fun watching the scandal play out—lots more to come!

PPPPS.  Focus on the blue line, as the yellow line partly reflected the worsening economy.

The term ‘contagion’ is used quite a bit in the financial press, but what does it actually mean?  There are at least three very different types of contagion, each with its own policy implications:

1.  An economic crisis in one country might reveal a weakness that was not previously apparent to the international investment community.  Thus in the late 1990s, the gradual rise of China and the strengthening US dollar was slowly weakening the position of export-oriented nations in Southeast Asia, which had fixed their currencies to the US dollar and also accumulated dollar-denominated debts.  When Thailand got into trouble in mid-1997, investors looked around and noticed similarities in places like Malaysia and Indonesia.  It wasn’t so much that Thailand directly caused problems in those countries (in the way a US recession might directly cause problems for Canada); rather it revealed weaknesses that were already there.

2.  A financial crisis in a big country might depress the global Wicksellian equilibrium real interest rate.  For example, the US housing bust and banking crisis of 2007-08 triggered a global recession.  By itself, this doesn’t necessarily cause problems in other countries.  But if the foreign country is already at the zero bound (Japan), or if the foreign central bank is too slow to cut interest rates (ECB), then a lower global equilibrium interest rate might lead to tighter money in other countries.  Here I would say that the US triggered the Great Recession, but the Fed, ECB and BOJ jointly caused the Great Recession.

Similarly, under an international gold standard, the hoarding of gold in one country can depress nominal spending in other countries.  Indeed gold hoarding by the US and France was a principal cause of the Great Depression.

3.  A financial crisis in one country can affect other nations if they are linked via a fixed exchange rate regime or a single currency.  Consider Greece, which comprises less than 2% of eurozone GDP.  Fears that Greece might have to leave the eurozone caused significant stress in other Mediterranean nations.  If one country were to exit, investors might expect this to lead to an eventual breakup of the entire eurozone.  That would trigger a banking crisis, and would also lead major debtor nations such as Italy to default on their huge public debts.  This is why a small country like Greece could have such a big impact on eurozone asset markets; investors feared that a Grexit would destroy the eurozone.

So far, Turkey looks like it fits the “reveal” template best.  The greater the extent to which Turkey is viewed as a special case reflecting local conditions, the smaller the contagion effect.  If Turkey becomes seen as emblematic of much of the developing world, then contagion is more likely.

Tyler Cowen recently linked to a John Cochrane post, discussing Larry Kotlikoff’s views on public debt sustainability.  Here’s Cochrane:

(By the way, if you’re feeling superior and taking comfort that Europe will go first off the cliff, Kotlikoff disagrees. Europe’s debts are larger, but their social programs are better funded, so their fiscal gaps are much lower than ours. The winner, it turns out, is Italy with a negative fiscal gap. Answering the obvious question, Kotlikoff offers

“What explains Italy’s negative fiscal gap? The answer is tight projected control of government- paid health expenditures plus two major pension reforms that have reduced future pension benefits by close to 40 percent.”Don’t get sick or old in Italy, but perhaps buying their bonds is not such a bad idea.)

I am a bit skeptical of that claim; so I decided to check with God, er . . . I mean I decided to check with the ultimate arbiter of truth, the asset markets:

As you can see, Italian 10-year bonds offer considerably higher yields than German, French and Dutch bonds, and even higher yields than Spanish bonds. Italy has a massive public debt (third largest in the world), an economy that has shown almost no growth since 2000, and a very dysfunctional political system (which the voters recently decided not to reform.)

I greatly respect Kotlikoff, and even more so John Cochrane.  But I respect the markets far more than any mere mortal.   So unlike Kotlikoff and Cochrane, I remain relatively pessimistic about the Italian debt situation.

PS.  I am back from 5 days in Turks and Caicos (is there a law in the Caribbean mandating nothing but Bob Marley music at resorts?), and I am starting to get caught up.

I have a new post on Bretton Woods as an example of the guardrails approach to policy, and another post commenting on the French elections.

My guardrails post is intended to address tiresome criticism of NGDP targeting by people who have never bothered to actually read what I have written on the topic. No, neither the current lack of interest in NGDP futures trading nor the risk of market manipulation pose any kind of problem for the system I am actually advocating.  (Unless you believe, “Bretton Woods could not possibly have worked because speculators would have manipulated the market.”)