The Price is wrong? Part 2: the United States

Federal Reserve Chair Jerome Powell used his speech to the KC Fed's Jackson Hole conference to signal changes to the Fed's policy approach. His speech gives a concise summary of the history of inflation targeting at the Fed, but one or two points deserve further emphasis. 

First, the Fed was late to adopt formal inflation targeting, only taking its final step in that direction under the Chairmanship of Janet Yellen, less than a decade ago. Its earlier resistance to such a move can be blamed  at least in part on Alan Greenspan. The wily and ultra-political "Maestro" never wanted to have his hands tied in any way.  The Fed's inflation focus during his term in office was very much a moving target. Believing that the CPI overstated inflation pressures, Greenspan first shifted his attention to the previously obscure Employment Cost Index. When that no longer passed muster, he switched to the even more arcane core personal consumption expenditure deflator, a GDP-related figure that has the distinct disadvantage of being a quarterly number, rather than monthly like the CPI. This is not a sound approach to making policy.  

Second, the Fed, unlike, say, the Bank of Canada, is already tasked with a dual mandate that calls on it to pay attention to both inflation and employment as it sets its policy course. It would perhaps be gratuitous to suggest here that under Greenspan, that seemed to expand to a triple mandate, with propping up the stock market becoming a central pre-occupation: the so-called "Greenspan Put". Leaving that aside, the dual mandate carries over into the changes that Chairman Powell announced this week.  Here is how Powell described those changes: 

Regarding employment: "Our revised statement says that our policy decision will be informed by our "assessments of the shortfalls of employment from its maximum level" rather than by "deviations from its maximum level" as in our previous statement. This change...reflects our view that a robust job market can be sustained without causing an outbreak of inflation.  In earlier decades when the Phillips curve was steeper, inflation tended to rise noticeably in response to a strengthening labor market. It was sometimes appropriate for the Fed to tighten monetary policy as employment rose toward its estimated maximum level in order to stave off an unwelcome rise in inflation. The change to "shortfalls" clarifies that, going forward, employment can run at or above real-time estimates of its maximum level without causing concern, unless accompanied by signs of unwanted increases in inflation or the emergence of other risks that could impede the attainment of our goals."

And regarding inflation: "our actions to achieve both sides of our dual mandate will be most effective if longer-term inflation expectations remain well anchored at 2 percent. However, if inflation runs below 2 percent following economic downturns but never moves above 2 percent even when the economy is strong, then, over time, inflation will average less than 2 percent. Households and businesses will come to expect this result, meaning that inflation expectations would tend to move below our inflation goal and pull realized inflation down. To prevent this outcome and the adverse dynamics that could ensue, our new statement indicates that we will seek to achieve inflation that averages 2 percent over time. Therefore, following periods when inflation has been running below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time."

These are subtle shifts in wording, and as we move towards the post-COVID world, it may be quite some time before they result in any noticeable changes in the Fed's actual policy stance. However, they are an important recognition by the world's most important central bank that the old assumptions about a direct trade-off between inflation and employment no longer apply. For what it may be worth -- doubtless very little! -- I was never a fan of the Phillips curve that Powell refers to here. It looks as if it is about to join the Phlogiston Theory on the scrapheap of old ideas.   

Ignore this data!

Just for the record, Statistics Canada reported this morning that Canada's real GDP fell by 11.1 percent in Q2, its worst ever quarterly showing. That equates to an annualized decline of 38.7 percent, meaning that Canada actually performed worse than the US in the quarter. This reflects the fact that Canada moved much quicker to lock down its economy as the pandemic hit.

These numbers are almost entirely unhelpful, if not outright misleading. I have been saying for some time that in current circumstances, the monthly GDP data are much more useful than the quarterly figures, and today's release shows why that's the case. StatsCan also reported this morning that real GDP grew by 6.5 percent in June, following on from a 4.8 percent rise in May. Moreover, StatsCan estimates that GDP rose a further 3 percent in July. That would still leave GDP about 6 percent below its February level, but it underscores the fact that the COVID recession really lasted just two months -- March and April -- with the economy slowly digging itself out of the hole since then.

Fans of annualization may have noted that using the "rule of 72", the June number annualizes to a growth rate of more than 100 percent! That's not going to persist, but focusing on monthly rather than quarterly GDP data will remain appropriate until at least the end of this year.

The price is wrong? Part 1, Canada

The Bank of Canada, at the behest of the Federal Government of the time, adopted its inflation targeting strategy as long ago as 1991. Since that time, monetary policy has aimed to keep inflation (measured by consumer prices) close to 2 percent, within a range of 1-3 percent as conditions warrant.  The advantage of this approach, now almost universal among major central banks, is that it provides clear guidance for markets and the general public about how the Bank will react as the inflation picture unfolds. The principal disadvantage is that it results in reduced emphasis on other important economic policy goals, such as the desirability of ensuring full employment.  

The Bank and the Federal Government renew this arrangement every five years, which means that a review is coming in 2021. The Bank has been working hard at examining possible alternatives to the existing approach, and this week Senior Deputy Governor Carolyn Wilkins was the keynote speaker (virtually, of course) at a workshop at which the Bank revealed some of its current thinking. With new Governor Tiff Macklem now in place and the COVID pandemic complicating the Bank's task, it seems clear that significant changes may be coming next year. 

It so happens that Gov. Macklem was also speaking this week, addressing (virtually) the Kansas City Fed's annual Jackson Hole gabfest. Clues about the Bank's thinking can perhaps be found in his comment that "The imperative is to step boldly beyond market transparency and engage with the public to explain how our actions serve our economy-wide objectives. This means listening to more people, understanding their perceptions — accurate or not — factoring in broader public views into our policy decisions and communicating with people on their terms, not ours."

If the Bank's objectives include transparency and simplicity, it has not always helped itself in the way it has implemented its strategy in the past. A few years ago it unveiled three arcane measures of core CPI that were supposed to be more reliable than the widely-followed headline CPI number in determining underlying price trends.  Since they were introduced,  these three series have rarely deviated by more than one or two tenths of a percentage point from the headline number. It would be little surprise if they were quietly dropped in the coming months.

The coronavirus pandemic has made the Bank's job difficult in many ways, even raising doubts about whether policymakers have the tools at their disposal to combat the economic impact of the virus, given that interest rates have been so low for so long. The pandemic is also complicating the coming decision about the future policy framework, mainly because it is reducing the faith that the public at large has in the published inflation numbers, as this article from the Financial Post explains very well.  

Ms Wilkins addressed this at some length in her keynote address: "Last year during our consultations, we heard loud and clear that the measure of inflation needed to be considered. Many people feel that inflation is higher than reported. That’s why we started working with Statistics Canada last year to look for ways to improve the CPI....This work continues now at an accelerated pace, because COVID-19 has only exacerbated this perception of higher inflation. Prices that are falling, like those around travel, are not relevant to most people; but the prices that are rising, like the cost of food, are those we encounter every week. The price of meat has risen by more than 4 percent since February—before the pandemic hit Canada. That doesn’t feel like low inflation to me or to many families, yet measured inflation is close to zero when you consider the full basket of goods and services....It’s critical that we measure inflation as accurately as possible so Canadians have confidence in our target; and we must address public perceptions in our analysis and communications."

Against this background, the Bank is staging, to quote Ms Wilkins again, "a horse race among alternative frameworks for monetary policy. These include average inflation targeting, price-level targeting, an employment-inflation dual mandate and nominal GDP growth and level targeting. Another possibility is to raise the inflation target."        

For those of us old enough to remember the bad old says of rampant inflation in the 1970s and 1980s, that last little sentence causes chills down the spine.  It's surely not there by accident and it is no surprise that higher inflation is the theme picked up in the Financial Post article linked above. Governor Macklem's desire for simplicity surely rules out nominal GDP targeting, and a dual employment-inflation mandate would instantly become a political football. That doesn't leave much on the table.

Given the lengthy recovery that is in prospect in the wake of the pandemic, even getting inflation back up to the existing target withing five years might seem like a remote possibility. Setting a goal of lifting inflation to a higher level than that, and keeping it there, looks like an unnecessary risk for the Bank to contemplate.  

The Federal Reserve has also been tinkering with its inflation targetry this week; more on this in a separate post.  

Pedantry-pourri

 Journalists work with words every day, so it's depressing to note how often they use them incorrectly.  Here are just a few example of poor English I have come across recently.

• "A new tact", to describe someone trying to change direction.  That should, of course, be "a new tack", a naval term for a change of course, going back to the age of sailing ships.

• "Unchartered waters", another corruption of a naval term. The correct usage is "uncharted waters", a reference to dangerous and unmapped areas where all manner of unknown perils might reside. By the way, "unchartered" is promptly flagged up by the spell-checker, which you'd think a journalist might notice.

• "Free reign", used to denote the liberty to choose your own course of action, is not some kind of reference to the powers of an absolute monarch. It should, of course, be "free rein", an equestrian term for giving a horse its head so as to coax it along.  

• "Amount" and "number" confused.  "Amount" is for things you measure; "number" is for things you count. So, there is "a large amount of careless journalism", but "a large number of careless journalists".

• Lastly, "fulsome". To be fair, Merriam-Webster now accepts that this can mean copious or abundant, but that's only because this sloppy usage has become commonplace in recent years. The original meaning of the word is "exaggerated", "insincere", or even "offensive". I actually quite enjoy this one, because when I read about a politician offering "a fulsome apology" for something, I know the writer is almost certainly using the word in its more recent meaning, when the older sense is so much more appropriate!    

Retail rebound

It's a milestone of sorts -- this morning Statistics Canada reported that retail sales rose 23.7 percent in June, a result which brought the data series above its February (pre-pandemic) level. It's only 1.3 percent higher, but even so, this is the first major data series to return to levels seen before the pandemic hit.

All the sub-sectors tracked by StatsCan moved higher in the month, with particularly strong gains in auto sales and clothing stores.  With inflation at a very low level, the real gain in retail sales was very close to the nominal number, at 22.9 percent.  Regionally, the strongest gain in the month was seen in Ontario, which has been much more cautious in ending its lockdowns than most other Provinces.

Even with the rebound in June, retail data for the second quarter as a whole look dire, falling 13.3 percent in nominal terms, 12.4 percent in real terms. Retailers can be forgiven if their applause for today's data is somewhat muted, as it very much remains to be seen whether the sharp declines earlier in the year (mainly in March and April) can ever be recovered, or are simply gone forever.

The unexpectedly sharp rebound in the retail sales is a tribute to the success of the Federal Government in cushioning households against the immediate economic impact of the virus lockdowns. The programs hastily rushed out back in March may not have been perfect in either design or execution, but today's data clearly show that they have had the desired effect. 

This week the Government announced that the centerpiece of its relief efforts, the Canada Emergency Response Benefit or CERB, will be extended to the end of September, at which point recipients will be transitioned over into a revised version of the pre-existing Employment Insurance (EI) scheme. This support of household incomes should ensure that retail sales can stay close to the levels seen in June, but further strong gains are unlikely until unemployment returns much closer to its per-pandemic level.   

With Chrystia Freeland now in place as Canada's new Finance Minister and Justin Trudeau looking to "reset" his government in the wake of recent scandals, attention is increasingly turning to the policies needed to guide the economy back to full recovery. Trudeau is reportedly looking at a radical restructuring, with a full slate of "green" policies, guaranteed annual income and so on. 

At the same time, voices on the right of the political spectrum are becoming increasingly anxious, and even angry, about the burden that all the emergency spending is supposedly leaving for future generations of taxpayers. It will be interesting to see how the new Federal Tory leader, to be announced this Sunday, positions himself or herself on this issue.  Imposition of fiscal austerity with the aim of avoiding a "debt crisis" will all but guarantee that the economy remains in the hole for years to come. 

Crisis upon crisis

Well, isn't this just what Canada needs right now?  With the coronavirus pandemic still far from over, with major decisions still to be made, we now have a full-fledged crisis in Justin Trudeau's Federal Government.

Last evening it emerged that Finance Minister Bill Morneau had met with Trudeau and tendered his resignation.  Morneau's departure has been mooted in the media for some time: both he and Trudeau have been caught up in a tawdry little scandal involving the well-established WE Charity*, and the way of politics is that if someone has to be sacrificed to defuse the situation, it's unlikely to be the boss. The Federal Ethics Commissioner is on the case, and it might be noted that this is the third time that Trudeau's actions have attracted attention from that quarter.

Morneau insists Trudeau did not request his resignation.  He claimed that he simply decided that this was the right time for someone else to take over.  Frankly this is about as credible as the idea that  General Eisenhower would have quit when the troops were part-way up the beaches of Normandy on D-Day. Alongside the WE scandal, there have been rampant rumours of disagreements between Morneau and his boss, whether over the huge sums that have been committed to fight the pandemic, or over Trudeau's apparent wish to use the recovery phase to force through a major "green" shift in the economy. 

A Cabinet shuffle is imminent, but it is already clear that Chrystia Freeland will take over Morneau's job.  And why not? As Deputy Prime Minister, she has already been doing a lot of Trudeau's job since last year's election; one more massive responsibility can't hurt, right? It's not that she is unqualified -- after all, she took charge of the often tricky negotiations for the replacement NAFTA treaty with the US and Mexico, so she knows her way around the economy. Still, it is becoming hard to avoid the impression that she is the only member of the Cabinet Trudeau really trusts, which can't be a good thing.  

Don't go away -- there's much more. Trudeau reportedly plans to "prorogue" (i.e. suspend) Parliament  for a month or two, to allow him time to reset the agenda. An October resumption, starting with a new Throne Speech quickly followed by a budget statement, seems to be in the works. To suspend Parliament, Trudeau has to seek the approval of the Queen's representative in Canada, the Governor General.  

That should be an interesting conversation. The G-G, former astronaut (really!) Julie Payette, has a couple of ongoing scandals of her own, involving allegedly toxic conditions in the workplace and excessive spending on her security details. Until yesterday, it seemed likely that any early meeting between Trudeau and Payette would involve his quietly suggesting her resignation, but it appears that the bus took a wrong turn and ran over Morneau instead.   

Assuming that Ms Payette accedes to the request to prorogue Parliament, Trudeau's problems will still be far from over. His government does not command a majority in the House of Commons. A vote of non-confidence at the earliest opportunity is certain and it would not be easy for Trudeau to win. A loss in that vote would trigger an election in the middle of the pandemic, so Trudeau's best hope may be that none of the opposition parties wants to take responsibility for that. The Bloc Quebecois is offering the sensible suggestion that Trudeau hand over the reins to another minister (presumably Chrystia Freeland) while the Ethics Commissioner investigates the WE scandal. 

It may yet come to that.   Stay tuned -- Canadian politics is rarely this interesting, but Trudeau's frequent blunders are changing that.  

* In brief, the government awarded a lucrative contract to WE earlier this year, without putting the business out for tender.  Trudeau and Morneau chose not to recuse themselves from this decision even though both had allowed family members to benefit financially from it. In Trudeau's case, his brother and mother had both reaped substantial fees for appearing and speaking at functions arranged by the charity.  As for Morneau, the fact that two of his daughters worked for WE did not appear to bother him at decision time, but his failure to repay WE for a family trip to Ecuador a few years ago has proved harder to shake off, although he has recently scribbled off a cheque for C$ 41,000 by way of reimbursement.     

Ontario's fiscal update

Ontario Finance Minister Rod Phillips has tabled updated estimates for the impact of the coronavirus pandemic on the Province's finances, and very scary they look. The projected shortfall for the fiscal year (April-March) is now C$ 38.5 billion, up from the original budget projection of $ 9 billion and more than double the $ 17 billion tabled back in March, when the pandemic first hit. Let's take a quick look at the numbers, and then muse a bit about what the province might do in the future.

One thing we need to get straight from the outset.  Introducing the update, Phillips told the assembled media that Ontario is in a recession.  It isn't.  A recession is normally defined as two consecutive quarters of declining GDP, and that's what Canada experienced in the first two quarters of this year.  However, as I have argued here on several occasions, at the moment it's more useful to look at monthly data. Canada and Ontario experienced unprecedentedly sharp declines in GDP in March and, especially, April, but recovery began in May and accelerated in June, and there was plenty of momentum going into Q3. The recession, painful as it was, is technically over.

That's important, because barring a second wave so serious that we all get locked down again, the Province's fiscal situation should improve through the remainder of the fiscal year, as the economy slowly heads back towards pre-pandemic levels.  If we look just below the surface of Phillips's headline deficit number, we see that he and his staff are expecting revenues $ 5.7 billion lower and spending $ 13.1 billion higher than in the March (i.e. early pandemic) fiscal update. Those numbers may be reasonable estimates: very few people were correctly anticipating the scale of the pandemic back in March, so the duration of the revenue losses and spending hikes could not be readily predicted then. 

In addition, however, Phillips is including a massive $ 9.6 billion contingency provision, against the possibility of further shocks in the months to come. The text of the release is not entirely clear, but that appears to be on top of $ 6.8 billion in contingencies that were included in the March update. This looks like very conservative budgeting indeed, which is in no way a criticism under current circumstances.

Turning to what may come next, there are worrying signs that Conservatives, whether at the Federal or Provincial level, have learned little from past crises. The candidates in the Federal Conservative leadership race that is now nearing an end have all fretted about the burden on taxpayers created by the spending initiatives launched by the Trudeau government in recent months, without in any way hinting at what they themselves might have done differently if they had been in power. And in response to questions about the Ontario fiscal situation revealed by Rod Phillips, Doug Ford stated that he was opposed to higher taxes. The clear implication, both Federally and Provincially, is that spending cuts are on the way.    

Really? We only have to go back a few years, to when Stephen Harper was Prime Minister and Jim Flaherty was Federal Finance Minister, to find an alternative approach. Harper was as fiscally conservative as they come, yet he realized that in the wake of the global financial crisis, fiscal austerity was the worst possible approach. He allowed the Federal deficit to climb to unprecedented levels a decade ago, and in so doing ensured that Canada avoided some of the worst effects of the crisis.

The economy is going to have ample slack for years to come, courtesy of the pandemic, so the risk of triggering inflation is very small.  Consequently interest rates are set to remain low, so even if you are not a fan of Modern Monetary Theory, you should be able to accept that continuing to run deficits post pandemic in order to rebuild the economy will not represent an unfair burden on generations of taxpayers. 

You don't just have to take my word for it. Here is a fascinating exchange between Keynes and some other distinguished economists of the day (early 1930s) on precisely these issues. Keynes was right, but somehow we still have to keep making these obvious points over and over again. 

 

This could get interesting

We learn via CBC that former Bank of Canada and Bank of England Governor Mark Carney has taken on a side hustle. After his spell on Threadneedle Street ended early this year, Carney was appointed as a UN special envoy on climate change and climate finance. Apparently that's not a full-time gig, because he has been providing advice to Prime Minister Justin Trudeau on how Canada should respond to the COVID-19 crisis.

Carney surely knows his way around a crisis.  He was at the helm of the Bank of Canada during the global financial meltdown, and more recently led the Bank of England's response to the Brexit vote and the subsequent chaotic negotiations -- indeed, he agreed to extend his term in London in order to ensure an experienced hand on the tiller on Brexit day itself,  at the start of this year. The fact that Carney served in both Ottawa and London under Conservative governments may be part of his appeal to Trudeau right now, possibly helping to deflect potential criticisms that the Government's pandemic response is politically driven. 

That said, Carney's re-emergence in Ottawa gives us plenty of opportunities for speculation.  For example, how does new Bank of Canada Governor Tiff Macklem feel about it?  The two men seemingly worked well together a decade ago, when Macklem was Carney's Deputy, but Carney is, to put it mildly, not bashful about expressing his views. How will Macklem respond if Carney takes to second-guessing the Bank's, or offering his opinions from the sidelines?

Then there's Finance Minister Bill Morneau to consider. Morneau has been caught up in the ongoing WE Charity scandal, which basically involves suspiciously tight connections and flows of money between a well-connected charity foundation and senior Liberal politicians, including both Morneau and Trudeau himself. Trudeau's Teflon shield seems to be deflecting much of the blame, but Morneau may not be so lucky, especially if Trudeau decides that someone has to go under the bus for appearances' sake.

Carney has long been reported as having political ambitions. Firing Morneau and installing Carney in what is effectively the number two job in the Government would be a bold and risky move, especially as Carney has no seat in Parliament.  Then again, there's a vacant seat in the Toronto area, so a hastily-arranged by-election to get Carney into the House of Commons can't be ruled out.

Lastly, Carney's acceptance of the UN special envoy role reflects a genuine interest in the climate change issue. He regularly raised the hackles of backbench Tories in London by speaking out on the issue. There are reports that Trudeau is looking to use the need to pilot the economy out of the pandemic shutdowns to launch some radical changes, which would undoubtedly focus heavily on "green" issues.  "Green Czar" Mark Carney?  Stranger things have happened. 

Making sense of the July employment numbers

Both Canada and the US released employment data for July this morning. In both countries the headline numbers looked strong, but employment remains far below pre-pandemic levels and the details of the reports provide some cause for concern.

Let's start with Canada, where the economy added 419,000 jobs in July and the unemployment rate fell by 1.4 percentage points, to stand at 10.9 percent.  Combined with the job gains in May and June, that means the economy has recovered about 1.7 million of the 3 million jobs lost in the two months after the pandemic struck.  Temporary layoffs and involuntary short-time working also fell in the month, providing further evidence of a recovery in the labour market. 

Less positively, it should be noted that 345,000 of the new jobs in the month were part time, with only 74,000 full time positions added in the month. This is logical enough, given that the job losses back in March and April were also concentrated in the part time segment. It does, however, complicate the task of determining just how quickly the overall jobs market is getting back on its feet. 

Turning to the United States, the Bureau of Labor Statistics reported that employment rose by 1.8 million in the month, lowering the unemployment rate to 10.2 percent. As something of an aside, it's hard to overlook the strenuous efforts of CNN to paint the picture as dark as possible. Note first that the gain in employment, one of the largest ever for any single month,  is described as a "sharp slowdown from June";  true, but is that really the takeaway here?  Second, the fall in the unemployment rate is rather sourly portrayed as "above the Great Recession high of 10 percent".  Just report the data, folks. 

As was the case in Canada, the bulk of the job gains represented part time positions. And as in Canada, this likely reflects the fact that the job losses in March and April were heavily concentrated in sectors such as retail and hospitality that rely heavily on such employment. It's hard to assess the validity of the comment made by an economist to CNN that "even if workers are coming back it's to jobs that pay less, and families will be worse off." That may be a small element of the overall picture, but it's likely not the dominant factor here. 

What do today's numbers tell us about the shape of the recovery? We are now reaching a point where the long-term damage to some sectors of the economy is becoming apparent.  That portion of the job losses that can be attributed to governments' intentional "suppression" may be recovered quickly, but sectors where the pandemic has triggered structural damage will see permanently lower employment. The jobs data for May, June and even July may look like the start of a V-shaped recovery, but that is unlikely to persist as we head towards the fall.

And in the meantime, the politicians seem to be doing their best to make a difficult situation even worse. The incompetent response to the pandemic in Washington is bad enough; the inability of Congress to agree on a new pandemic relief package makes things even worse. And Trump has chosen this moment to reimpose tariffs on Canadian aluminum exports, on entirely groundless "national security" grounds. Needless to say, Canada has promptly responded with a tariff threat of its own against a range of US exports. It's small potatoes compared to the US-China trade brawl, but it's just one more headwind that the economy really doesn't need right now.