MacroScope

“Reality is sticky.” That was the core of Adam Posen’s message to German policymakers on their home turf, at a recent conference in Berlin.

What did the former UK Monetary Policy Committee member mean? Quite simply, that the types of structural economic changes that Germany has been pushing on the euro zone are not only destructive but also bound to fail, at least if history is any guide.

Posen, who now heads the Peterson Institute for International Economics in Washington, argued Germany’s imposition of austerity on Europe’s battered periphery is the product of an instinctive but misguided fear of an inflation “ghost” that has haunted the country since the hyperinflationary spurt of the Weimar Republic in the 1920s and 1930s. However, Posen offers a convincing account of modern economic history that shows inflation episodes are rather rare events associated with major political and institutional meltdown — and not always around the corner.

The risks of inflation going up quickly, or in the long term, are smaller than are usually recognized in Germany. The issue is not that inflation is harmless; it certainly has its harms. The issue is, realistically, when you are facing choices, how much risk do you think there actually is of inflation occurring. I don’t want to pretend that there is some kind of exact, scientific, precise answer, but there is more of a historical record to draw on than most people acknowledge. This historical record is not often taught to German economic elites. […]

Inflation is actually quite sticky when you don’t have huge political breakdowns. Focusing on this period of the 1920’s in Germany — this horrible, horrible period — is economic solipsism instead of a good basis for current policymakers. To pretend that this source of the German hyperinflation is anything other than the political breakdown at the time is misleading; there is nothing economic that causes this situation on its own. You can say it was because the money supply grew too fast, or you can say it was because the central bank lost independence, but that is just telling you what happened technically. The cause was the breakdown of civil society, or at least of political decision-making, not the effect.

The Great Recession set the U.S. labor market so far back that there is still a long way to go before policymakers can claim victory and point to a true return to healthy conditions, a top former Fed economist said. The U.S. economy remains around 3 million jobs short of its pre-recession levels, and that’s without accounting for population growth.

“The goal line is still a long ways off,” David Stockton, former head of economic research at theU.S.central bank’s powerful Washington-based board, told an event sponsored by the Peterson Institute for International Economics. He sees the American economy improving this year, but believes the recovery will continue to have its ups and downs.

A lot of people have been quite excited about some of the recent strength in the labor market. It’s encouraging but I don’t think we’ve yet seen any clear break out and I don’t think we’re going to for a while.  […]

Ask top Federal Reserve officials about adopting a target for non-inflation adjusted growth, or nominal GDP, and they will generally wince. Proponents of the awkwardly-named NGDP-targeting approach say it would be a more powerful weapon than the central bank’s current approach in getting the U.S.economy out of a prolonged rut.

This is what Fed Chairman Ben Bernanke had to say when asked about it at a press conference in November 2011:

So the Fed’s mandate is, of course, a dual mandate. We have a mandate for both employment and for price stability, and we have a framework in place that allows us to communicate and to think about the two sides of that mandate. We talked today – or yesterday, actually – about nominal GDP as an indicator, as an information variable, as something to add to the list of variables that we think about, and it was a very interesting discussion. However, we think that within the existing framework that we have, which looks at both sides of the mandate, not just some combination of the two, we can communicate whatever we need to communicate about future monetary policy. So we are not contemplating at this date, at this time, any radical change in framework. We are going to stay within the dual mandate approach that we’ve been using until this point.

Two analyses published this week highlight how alarmed investors are about inflation in Brazil.

In the first, published on Wednesday following a poll on global stock markets, equity investors say an interest rate hike wouldn’t be a bad idea – a paradox, since stocks usually drop when borrowing costs rise. Are they keen to move to bonds? Not really; their argument is that an interest rate hike could assuage inflation fears after eight consecutive months of above-forecast price rises. A rate hike could also reduce concerns of economic mismanagement after several government attempts to intervene in key sectors such as banking and power generation.

The central bank signalled it could act later this year, but would rather wait because the recent inflation surge could be just temporary. Bond investors disagree, according to a separate analysis published today. In their view, inflation will remain above the 4.5 percent target mid-point through at least 2018, raising uncertainty about long-term investments needed to bridge the gap between Brazil’s booming demand and its clogged roads and ports.

For all the talk about imported inflation in the UK as policymakers talk down the pound and financial markets merrily give it a good beating, here’s a stark reminder that a lot of British inflation remains home-grown.

British inflation has been so sticky over the past decade that regular Bank of England pronouncements that it will come back down from wherever it is to the 2 percent target at the 2-year horizon has become something of a policy piñata in financial markets. And there is rampant speculation the government will soon modify that inflation target.

But it’s no joke to British consumers, whose wages have stagnated for years and with a plunging currency in their pocket that is down more than 8 percent so far this year. They’ve been much more frugal with their spending, and as a result the economy is on its back.

Brazil inflation jumped above expectations in February, despite a steep cut in electricity rates. It was not the first time, though; inflation has been running higher than consensus forecasts since July, considering the market view one month before the data release:

The total gap between market consensus and the actual inflation figures amounts to 1.19 percentage point – about one quarter of the inflation rate reported. Reuters polls conducted a few days before the official numbers come out have also proved wrong since July, with a total error of 0.37 point.

Why is that? Part of the difference was due to an unexpected jump in food inflation. But another part has to do with the mix of strong demand and weak supply that has dragged down the Brazilian economy over the past two years.

Worries about potential side-effects of unconventional monetary policy on financial markets are at least exaggerated, if not a near figment of the imagination.

This appears to be the conclusion of a comprehensively-argued research note by Bank of America Merrill Lynch global economist Ethan Harris.

The risk investors need to focus on is disinflation, not inflation; yet, remarkably, over the last several years critics of the Federal Reserve’s quantitative easing have “hijacked” the inflation debate, Harris says.

How about living in a fast-growing economy with tame inflation, record-low interest rates, stable exchange rate and shrinking public debt. Sounds like paradise, doesn’t it? But Brazil may be starting to realize that this is also impossible.

Inflation hit the highest monthly reading in nearly eight years in January, rising 0.86 percent from December. It also came close to the top-end of the official target, accelerating to a rise of 6.15 percent in the 12 months through January.

That conflicts with key pillars of Brazil’s want-it-all economic policy. The central bank cut interest rates ten straight times through October 2012 to a record-low of 7.25 percent, saying Brazil no longer needed one of the world’s highest borrowing costs. The government also forced a currency depreciation of around 20 percent last year, aiming at boosting exports and stopping a flurry of cheap imports.

Narayana Kocherlakota, the head of the Federal Reserve Bank of Minneapolis, has made a habit of turning economists’ heads. In September, the policymaker formerly known as a “hawk” surprised people the world over when he suddenly called on the U.S. central bank to keep interest rates ultra low for years to come. This week, Kocherlakota arguably went a step further into “dovish” territory, saying the Fed needs to ease policy even more. He wants the Fed to pledge to keep rates at rock bottom until the U.S. unemployment rate falls to at least 5.5 percent, from 7.8 percent currently – despite the fact that, just last month, the central bank decided to target 6.5 percent unemployment as its new rates threshold.

Kocherlakota’s bold policy stance is probably even more dovish – ie.  more willing to unleash whatever policies are needed to get Americans back to work – than even those of Chicago Fed President Charles Evans and Boston Fed President Eric Rosengren, until now considered the stanchest doves of the central bank”s 19 policymakers.

So in an interview on Tuesday, Reuters asked Rosengren what he thought of Kocherlakota’s plan. Here’s what he had to say:

This post was based on reporting by Leika Kihara in Tokyo

Japan has crossed the monetary rubicon: the government is actively intervening in the affairs of the central bank, pressuring it to more aggressively tackle a prolonged bout of deflation and economic stagnation. The Bank of Japan is expected to discuss raising its inflation target from the current 1 percent level during its next rate decision on January 21-22.

Overnight, a Japanese newspaper reported the finance ministry and the central bank were considering signing a policy accord that would set as a common goal not just achieving 2 percent inflation but also steady job growth.

Key Japanese policymakers played down the prospect of making the BOJ responsible for stable employment like the U.S. Federal Reserve, but said a 2 percent inflation target will be at the heart of a new policy accord with the central bank.