A Sunday morning read on monetary macroeconomics and the lessons from the Great Reflation (no subscription needed.)

The question is, how did central banks get it so long during the great reflation? A short thread.

moneyinsideout.exantedata.com/p/lessons-from… Focusing on the fiscal-monetary aspects of global inflation (overlooking the energy shock and Brexit) the OECD recently noted "evidence that money growth and inflation have been closely linked recently."

bis.org/publ/bisbull67…

Is the New Keynesian model fit for purposes? I wonder…

One of the fun things about following central banks is understanding reaction functions in the context of evolving data and their in-house models—macro forecasts that inform the policy discussions and rate setting. And the workhorse for such policymaking has become the so-called New Keynesian (NK) model—the optimising agent model (“intertemporal IS curve”), with sticky prices (“Calvo pricing”) and a policy rule (“Taylor rule”).

Who cares about the Volcker experience?

Well, studying the 1970s is all the rage these days, and policymakers are rightly framing the current challenge against the backdrop then.

Consider the energy shock today (in Europe.) The chart below shows crude from early 1971. And it lines up favourably compared with gas prices in Europe today. Admittedly, European Gas has moderated since August.

It is natural that policymakers look back to the experience then for inspiration. Here is the Bundesbank's Nagel: bundesbank.de/en/press/speec…

Is the UK experiencing a balance of payments crisis?

There is some chatter about this given the deteriorating fiscal position and sterling weakness.

Indeed, the @FT’s @alphaville point us to Deutsche Bank note that a “sudden stop” is not a mere tail risk.

A thread... Certainly, there is a lack of reflection on the UK’s BOP, so it’s an important point, but I’m not sure the chatter about an EM-style sudden stop is particularly enlightening.

@DuncanWeldon correctly creates context here. But let me to be pedantic...

duncanweldon.substack.com/p/whats-in-the…

Of course, the ECB has an inflation problem, as demonstrated this week by @Isabel_Schnabel.

But it is also becoming clear that there is another inflation problem at the ECB. That's an inflation forecasting problem. Indeed, is inflation forecasting dead? Give me 2 mins... The problem is that the ECB staff's quarterly star-gazing exercises, also known as their macroeconomic projections, are are often stale within weeks of publication—or maybe even before they are published.

Draghi's speech announcing the ECB will do "whatever it takes" to preserve the euro came 10 years ago this week.

Having picked up on the pessimistic mood amongst investors, Draghi rose to deliver his own perspective. After noting that the Eurozone was like a bumblebee—able to fly despite apparently defying the laws of physics—he noted that the ECB would do enough to preserve the euro “and believe me, it will be enough.”

But how ought this intervention be viewed today? And what comes next?

Money supply in the United States: Thoughts

M2 is the sum of two items: M1 and other (smaller) items. M1 is currency, demand deposits plus other liquid deposits (various deposits at credit unions, thrift institutions, savings deposits, including money market deposit accounts.) The additional items to make up M2 being small denomination time deposits (<$100k ex. retirement balances) and retail money market funds.

The chart above shows M1, M2 and commercial bank deposits. Commercial banks being domestically chartered and “foreign-related institutions."

The FT has a curious story about the ECB contemplating blocking the earnings banks are set to make on the TLTRO3s taken out during the pandemic and set to mature by end-2023.

ft.com/content/5ce8f4… The issue is that despite the favourable terms of borrowing maturing, the banks are still set to make a bumper gain on holding these TLTRO3s to maturing.

This was the subject of this substack a week ago (paywall, sorry). Indeed, the VLTROs in 2013...

moneyinsideout.exantedata.com/p/why-dont-eur…

This is true, but the ECB will be willing to hide behind semantics to deny this. What is most interesting about the story in Reuters today is that it reveals that one of the key concerns is "who will pay."

https://twitter.com/MacroAlf/status/1541686839806935042

In this case, if (say) Germany were to sell Bunds to recycle into BTPs, given the sharp move in yields in recent months, they would make mark-to-market losses on their portfolio.

Why does this matter? Well...

Over the past 6 months, service sector inflation has accelerated across major economies, meaning that inflation can no longer be considered a traded good phenomenon.

Some observations. Indeed, there are signs that the traded goods inflation cycle has peaked, that non-energy industrial goods/durables are rolling over. But at about 9%YoY, such traded good inflation is still at a very high level (driven by the US in particular).

Does the Bank of England have a communication problem?

As with @notayesmansecon, i would appreciate it is the BOE would publish all speeches on their website, so we can keep up with all remarks by policymakers from source and not through the press.

https://twitter.com/notayesmansecon/status/1539162062521352192?s=20&t=ESW4JzXuhg_kSlyDaj7cDg

But there is something more going on. Communication in general is lacking of late. Let’s count the speeches published on the Bank website by MPC members since 2017. What do we find?

First, a few caveats. What's published there is not all public remarks—such as testimony to TSC.

Last week’s Bank of England meeting leaves much to chew over.

Since BOE has been a leader in the normalization (in terms of APF tapering, QT, and rate hikes) the fact the MPC is now split on further rate hikes is or significance.

If the Bank blinks, will others follow? Curiously, the MPC is itself split.

The 25bps hike was a 6-3 split decision, with 3 external members voting for a 50bps move.

But on forward guidance for rates, “some ... judged ... that such guidance [on hikes] was not appropriate at this juncture.”

What's to stop the Big Dollar?

As the year began, the question of where the dollar was headed remained an open one—as it always is, of course. One way of framing the issue is below, which shows the deviation of US household net worth-to-GDP from the 6-year moving average. While the chart is admittedly carefully constructed, on only five occasions since the end of Bretton Woods has the dollar real exchange rate deviated from the changing fortunes of HH net worth.

What's going on with quantitative tightening?

Tracking the balance sheets of major central banks shows a contraction of about USD0.5 trillion since February measured in *current* dollars. This is not a sign of true b/s contraction, however. This is mainly due to USD strength... ...and strength against JPY in particular. Indeed, the USD value of JGBs held by the Bank of Japan (BOJ) fell from USD4.6 trillion in February to about USD4.2 trillion today despite continued net purchases. As such, BOJ accounts for most of the overall balance sheet adjustment.

What happened to the Taylor Rule?

That's another way to frame the discussion by Blanchard last week about @ojblanchard1 's expression of concern last week about the negative real interest rate.

piie.com/blogs/realtime… Indeed, the Taylor and similar rules were dominant in the 1990s and 2000s, until post-GFC when the policy rate was constrained by the ZLB on rates, bringing balance sheet management into play.

But if these rules were in use in the past year, they would imply the fed fund rate...

Where are the Central Bank of Russia reserves kept? Well, a decent chunk are held as deposits with central banks, the BIS, or the IMF. Indeed, the deposit share of reserves increased sharply in 2018 when they were forced to sell US Treasuries...

@M_C_Klein The increase in deposits was coincident with the reported increase in the share of euros on CBR balance sheet, which is at least suggestive that these Treasuries were moved into deposits at European banks or at the Eurosystem...

Thanks to @KPatricio1 for exploring the legal aspects of the IMF’s Stand-By Arrangement with Argentina from 2018. In joint work, we explore the legal aspects of the Fund’s arrangements, and argue in this case the program represents an ultra vires act.

thegeneraltheorist.com/2022/01/10/the… The legal argument might be summarized, from my amateur, non-legal viewpoint, simply: the Fund (staff, management, and the Board) has the legal responsibility to ensure, in their lending arrangements, adequate safeguards are in place in the discharge of global taxpayer money.

As @danielmunevar has pointed out, yesterday the IMF dropped an Ex Post Evaluation (EPE) of the Argentina SBA from 2018. Such an EPE is expected for exceptional access cases, and Daniel has been doing God’s work in pulling out some of the key points from that document. THREAD. But there is more to be said, and I will say some of it here.

Indeed, I recently worked my way through the original document from 2018 (Country Report No 18/219) and happen to be apprised of the detail of the program as it began life.

https://twitter.com/danielmunevar/status/1473982657465827328?s=20

Like Lieutenant Colonel Kilgore in Apocalypse Now, the experienced hands of the macroeconomic fraternity are today sat crouched, surveying the post-pandemic horizon, sniffing the soil: “I love the smell of inflation in the morning.” And how!

They remember better that we, youthful then in their nappies, groping to understand the emerging inflation narrative then.

Why not grope again?

ft.com/content/dc3bed…

Brexit versus Covid and regional BOP.

Something I have been pondering about UK is the fact that Brexit and Covid happened more-or-less simultaneously, and how these two offset.

Regional BOP are not always available and in a reasonably “optimal” currency area not necessary However, both Brexit and Covid represented BOP shocks to the regions of England and the UK, and it is possible that they at least partially or completely “wash out”.

A summary of the wealth gains in the United States during the pandemic.

While more than 2/3rd went to the top 10% of the wealth distribution or top 20% of income distribution.

moneyinsideout.exantedata.com/p/distribution… It is still important for consumption and labour supply choices that in percent of end-2019 net worth some of the most disadvantaged groups made the largest gains.