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Oh John Williams, you little tinker! One of Blondemoney’s favourite central bankers has only gone and chosen one of Blondemoney’s favourite central banking solutions. In his latest paper, San Fran Fed’s Williams suggests the option of Price Level Targeting as a way to solve the current lowflation conundrum. Yes!! Go on son!!! Blondemoney argued for this back in 2009 – for the full details check out this policy paper. The point is that with inflation targeting, bygones are bygones – we start each year at zero, looking for +2%. With price level targeting, you take into account that we went up 2% last year, so we go from a base level of 100 to 102, then another 2% takes us to 104.04 and so on; we don’t lose the inflation that’s been created, and it smoothes it out over time.

But more importantly than the toot on the BM trumpet, is why the Fed’s Williams is writing this essay, right now. Only last week he said that he thought another hike this year would be required and that he didn’t want the Fed to get behind the curve. He is not, however, being inconsistent. He is moving the debate on from details over the timing of the next hike, to the big picture framework of monetary policy overall. He argues:

1. The world has changed – The neutral rate of interest is just lower, OK?

‘The underlying determinants for these declines are related to the global supply and demand for funds, including shifting demographics, slower trend productivity and economic growth, emerging markets seeking large reserves of safe assets, and a more general global savings glut (Council of Economic Advisers 2015, International Monetary Fund 2014, Rachel and Smith 2015, Caballero, Farhi, and Gourinchas 2016). The key takeaway from these global trends is that interest rates are going to stay lower than we’ve come to expect in the past’

2. So monetary policy needs to change

‘Although targeting a low inflation rate generally has been successful at taming inflation in the past, it is not as well-suited for a low r-star era. There is simply not enough room for central banks to cut interest rates in response to an economic downturn when both natural rates and inflation are very low’

– So unconventional policy will become conventional
– Central banks could ‘pursue a somewhat higher inflation target’
– OR ‘inflation targeting could be replaced by a flexible price-level or nominal GDP targeting framework’

3. But Monetary Policy is not the only answer

‘We’ve come to the point on the path where central banks must share responsibilities. There are limits to what monetary policy can and, indeed, should do. The burden must also fall on fiscal and other policies to do their part to help create conditions conducive to economic stability’

He goes on to offer fiscal policy solutions, such as forcing countercyclical fiscal rules to automatically get governments to spend more in downturns and save in growth periods. Or to invest in research and development to boost the natural interest rate of the economy.

–> But the big picture is why he is saying this now. Jackson Hole takes place the weekend after next, and it’s clear that the Fed are now accepting their view on inflation needs to change. Yes, on one level you could take this as the simple point that if the natural rate is permanently lower, then monetary policy doesn’t need to normalise so quickly. In other words, expectations of rate hikes will be phased out and US interest rates and the US dollar will fall.

Yet the conclusion could be so much bigger than that. It suggests interest rates should barely move ever again; it suggests QE is a permanent policy tool; it suggests lower-for-longer becomes “lower-forever”. And the final hurrah: that monetary policy is pretty much impotent anyway. Fiscal policy must now do the work.

When the market tunes into this, it doesn’t just spell the end for any rally from the US Dollar: it mandates a new asset price boom. Go get yield, anywhere, at any cost. Use dollars to fund it. In fact use dollars or pounds or euros or yen because the G4 central banks just hoisted the white flag of surrender.

The central banks aren’t going to stop you, and there will be a vacuum of power from policymakers until governments pick up the fiscal baton. Exuberance just got a little bit more rational.

 

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