EclectEcon

Inflation: a Long-Term Outlook

Earlier this month, I wrote a post predicting that we will experience inflation in the 2-3 year long-term. This prediction was based solely on the expectation that central banks will be forced to monetize the massive deficits being created by gubmnts at all levels. Furthermore, even if these are short-term huge increases in deficits, they won't just go away. They are enormous additions to gubmnt debts and will have to be dealt with somehow even if gubmnt deficits return to pre-pandemic levels in the next year or so.

The trouble is, if I'm right and if others agree with me, then long-term interest rates should be higher than they are, and TIPS (inflation-protected bonds) rates should reflect higher inflation expectations. Given that neither the long-term bond rates nor the TIPS yields reflect an expectation of strong inflation, clearly others don't agree with me.

So was I wrong? Am I wrong to hold onto these beliefs?

As a part of a webinar* that I attended yesterday, presented by Dennis Lockhart and David Altig, both affiliated with the Atlanta FED, the question of long-term inflation was addressed.

They mentioned the exploding balance sheet of the FED. They pointed out that although an exploding balance sheet would normally go along with rapid inflation, in this case the velocity of money has shrunk considerably as people are holding onto money, not spending, etc. They continued,

• The FED balance sheets have been growing rapidly and will likely continue to do so, at least in the short run
• Aggregate Demand and Aggregate Supply curves are both shifting to the left, and without much implication about what will happen to overall price levels. When both curves shift to the left, we know output will fall, as it has, but we can't predict much about the overall price level without knowing more about the relative shifts.
• There will be some (or considerable, they weren't sure) structural shifting in the makeup of AD .
• Most of the growth in the FED balance sheet has been in very short-term paper. The FED has mostly been buying up short-term debt, Treasury Bills, and lending money very short-term through re-purchase agreements with major banks. Unlike the financial crisis of 2008, the commercial banking system seems pretty solid and solvent, but providing sufficient liquidity has been the aim of the FED.
• As countries emerge from the pandemic, the FED will gradually scale back its creation of reserves, and the balance sheets will shrink slowly, roughly in sync with the emergence from the pandemic. 

Two issues where they didn't really face the questions I have:

1. The gubmnt debt is growing rapidly. The FED can't let all the short-term paper expire; they'll have to monetize the debt. This is a potentially serious problem. All that increased debt created by governments at all levels simply won't go away. And as the FED monetizes that debt, there will be inflationary pressures. One possible out might be to increase the interest rate the FED pays on reserves, but neither of them mentioned that possibility.
2. (and this one really bothered me) They argued that the Fed massively increased the balance sheet in dealing with the 2008 banking crisis and we didn't have inflation. My reaction would have been (if it had been a Zoom) don't be myopic:

• • That was when the Fed started paying interest on reserves. The Fed created reserves and the commercial banks saved them. The extra reserves didn't lead to much of an increase in the money supply as a result.
  • They both seemed to think we'll emerge from this depression as quickly as possible as soon as we know we have a vaccine and/or treatments. If so, can the FED shed all those short-term securities just as quickly? 
  • How quickly we can emerge from it will depend on how serious the structural re-alignment will be and has been.

Put differently (or the same way I started), I don't think gubmnts are going to reduce their deficits or debts by cutting spending or increasing taxes much; Central Banks are going to monetize these increases in debt for the most part:

How can Central Banks monetize such extreme increases in gubmnt debt without creating inflationary pressures eventually?

And if I'm right, why aren't markets reflecting higher inflationary expectations?

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*I'm grateful to the Global Interdependence Center for inviting me to participate in their sponsored webinar, "College of Central Bankers presentation: Assessing the Monetary Policy Response"

 

Masks: Pluses and Minuses

I wear a mask every time I leave our condo building, and I go out for walks maybe four or five times a week. Over the past month and a half, I have had some thoughts about the pros and cons of wearing a mask.

Pluses:

• For others: A mask will trap some or most of the virus as I exhale or if I cough or sneeze, thus reducing the likelihood that I will transmit the virus if I have it (I don't think I do, but who knows?).
• For me: A mask will trap some, but almost surely not all, of the potential droplets or aerosols containing the virus if I'm near someone who has the virus. When I go walking, I wear a mask made from a T-shirt  (see this and this) into which I insert a triple layer of paper towels and a double layer of facial tissue. It's a good, tight fit, and I expect it's at least as good as many surgical masks. The very few times I have gone shopping and the one time I had to go to a clinic I wore an N95 mask. I know my wearing a mask won't stop all the viruses all the time, but it will most likely reduce the probability of my being hit by a cloud of virions, and the evidence I've seen suggests that is good.
• Face: Wearing a mask keeps me from touching my face. Unkind friends also point out that it keeps them from having to see my face.
• Signaling: When I'm walking, people see that I'm wearing a mask. They tend to give me a wide berth. I don't know why for sure, but I think some do because they can see that I am concerned and they want to honour that; another reason might be because a mask signals that maybe I have Covid19 and they want to avoid it if I might transmit it. Either way, the signal seems to lead to some distancing behaviour on the part of others.
• Virtue Signaling: It's a different type of signaling. It says to the world, "Look at me. I want to save lives." I don't know, honestly, if I regard this as a plus or a minus because it seems too much like the Pharisees of the New Testament, but I'll marginally call it a plus.

Minuses:

• Hydration: It's really hard to keep hydrated if you're wearing a mask. So I don't, even though I know hydration is generally a good idea. Instead I drink a lot before I leave home.
• Itchiness: People generally don't realize how often they touch their faces until they wear a mask. I often find I'd like to scratch my cheek or nose but can't because I'm wearing a mask.
• Glasses: The masks I wear do not have exhale vents, and so some of my exhaling seems to find its way up to my glasses. On cooler (and colder) days, my glasses fog up, which probably means there's too much leakage, but I can't imagine there isn't leakage around most masks. Fortunately, my eyesight is good enough, I can just take off my glasses when I'm wearing a mask.
• Nuisance: It's a pain, putting on a mask. For me, it's probably more of a pain because I have to refit my layers of filter each time, tie the mask on properly, untie it when I get home, throw out the filter, and put the masks in the washing machine. We put the N95s on the balcony in the sun to disinfect because otherwise we can't reuse them, and we have only one apiece.
• Recognition: Friends in our condo building don't recognize me: I wear a hat, no glasses, and a mask covering most of my face. It's only a little amusing; I see it as a negative more than a plus.
• Smiling [added after the original post] It's hard for people you meet on the trail to know whether you're smiling. I try to avoid people, but there are times when you meet someone; you both take opposite sides of the trail or sidewalk and try to leave at least 10' between you. I'd like to smile (and in fact I do) but I'm not sure they can tell, and so I nod or wave or try to indicate friendliness or kinship or something.

On balance for me, in our situation, the pros strongly outweigh the cons, and I'll keep wearing a mask for quite some time when I leave our building. We distance assiduously, wash frequently, and use hand sanitizers a lot; and our building does not permit any visitors, but there are enough people living here who are at risk that I want to be careful not to bring the virus here. Other nearby buildings have had Covid19 cases, but we've been careful and lucky here... so far.

I know I could reduce the risks even more by not going out for walks at all, by hiring others to do our shopping, etc. But in the great realm of trade-offs and risks, these are the few chances I'm willing to take. I'm just super cautious when I take those risks. But if some stores in this area require customers to wear masks before going in, those are the stores that will get my business.

My BMI Went Up Again

A number of years ago, I realized my sons were taller than I was. I asked if they'd been growing (in their 30s!), but it turned out I had begun shrinking. And so, as a lark, I started a "Shrink Chart" on a door jamb to measure how much I shrink. The top line in the photo was my height about 7-8 years ago, the bottom line was today. The difference between the top line and the bottom line is about two inches, and that's after I had already begun shrinking.

Even though I've lost some weight, my BMI went up!

[note: yes, I take meds and supplements to strengthen my bones, and yes I do back exercises too (probably not enough).]

The Meaning of Life -- Perspectives Matter

It snowed this morning!

And so I was able to do some snowstomp art.

I call this piece, "The Meaning of Life".

Let me explain my interpretation of the work and why I titled it The Meaning of Life:

If you look at the artwork from right to left, it looks as if the circles are being forced smaller and smaller with fewer lines and less body. That is how life looks sometimes. We're born with all sorts of possibilities but as life goes on, we're trained and shaped and forced into various conformities. The extra possibilities are compressed, shaved, and removed as we slowly feel ourselves shrinking into only one or two of the many options with which we began.

But if you look at it from left to right, you see emergence: we grow, we learn, we acquire new skills, we expand our horizons, we explore new possibilities.

Perspectives matter.

Update:

The meaning of life is so elusive. Here's the artwork just an hour and a half later:

 

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My previous snow stomp art:

        The Meaning of Life (this post)

        Peter Cottontail Visits the Condo

        Fight CV19 and STAY HOME

        Skool Daze

        I Think It Might Rain

        The Penrose Triangle

        Snowflakes (done with my granddaughters)

       Tobogganing Through the Trees   

        Kilroy Was Here

       Happy St. Patrick's Day, 2019

       Spring is Sprung

       You Wanted Spring? 

       Too Cold to Build a Snowman 

       Simply a-MAZE-ing 

       Let There Be Music

      Ommadawn 

      The First Robin of Spring? 

      Be My Valentine, 2018

      Curling AND the Super Bowl

      I'm No Escher... 

      Hark! the Herald Angel Sings

      Nativity Scene, 2017

      Planning an Escape

      Caught in the Net

Surf's Up 

Diagonally Warped in a Parallel Universe, Part 2

      Diagonally Warped in a Parallel Universe

      Pikachu

      Happy New Year, 2017

      O Tannenbaum

      Nativity Scene

Special Weather Statement

Think Tropics

Qubix

Valentine, 2016

Paisley'd Circles

Happy New Year, 2016

The House of the Rising Sun

Easter Eggs

A weak pattern in the blowing snow.

The same pattern after some melting

New Year's Champagne

Tiptoe Through the Tulips

Happy Valentine's Day

Cabaret

A Christmas Tree (my first effort)

 

How Can I Predict Inflation in the Face of Such a HUGE Drop in Consumer Spending?

Apparently consumer spending declined in March by nearly 8%, by far the largest drop in recent history.

How can I predict inflation when there has been such a drop in demand?

One big reason is that inflation arises when there is too much money chasing too few goods, and the recent drops in GDP have been monumental.

Here's more of an explanation for my predictions:

The drop in consumer spending provides an impressive graph, to be sure! From it, alone, it looks as if a lack of consumer (and undoubtedly business) demand will keep the lid on spending pressures, at least in the short run. 

 

The argument coming from me and other monetarists [channeling Milton Friedman, I hope] is that there's been a massive reduction in output, as well, and it won't get back to 2019 levels for a long time; at the same time there has been and will continue to be a massive injection of spending power (the money supply) as central banks monetize the rapidly growing gubmnt debt. Unless the extra money supply is soaked up somehow as we come out of the depression, it'll create inflationary pressures. 

 

Consider the old quantity equation of money: MV=PQ, where

M is the money supply

V is the number of times each dollar turns over during the year in spending for final goods and services.

When interest rates are low, this number also tends to be low because the cost in terms of foregone interest income tends to be minor. When interest rates are high, people move money into earning assets more quickly and the 'Velocity' of money tends to rise.

P is the overall price level

Q is the rate of real output [i.e. Real GDP]

 

The equation is a tautology, with V being the variable that makes it true by definition.

 

But it's clear that V is pretty low right now (people fleeing to cash for security, hence not turning money over so rapidly; also because interest rates are low). So current increases in M are not having much impact on P despite a falling Q. 

 

As the economy emerges from the depression, Q will grow back to 2019 levels, but V will also grow. And M will be much higher than the 2019 levels, meaning P will have to grow. 

 

When and how much?

As Friedman is famous for having said, "It's a long and variable lag."

 

 

Crustless Quiche

 

Here's our latest version of crustless quiche. The custard mixture is amazingly light even though we don't whip it. I expect the cream (or half & half) really help. Delicious!

The recipe is at the end of this post.

The recipe we have put together says to whisk (very lightly) 4 large eggs, two cups of half and half, some salt and pepper to taste (I'm guessing we used about a tbsp of salt and a tsp of pepper, but it's hard to tell since we just put them in without measuring), and then stir in 1 and 1/2 tbspns of melted butter.

Spray or grease or butter the bottom of a large pie plate.

Cut up two decent-sized slices of ham into smallish cubes. Many recipes say to use cut up cooked bacon, but I prefer using ham because it's a whole lot easier.

Next, cut up half a large green pepper into small pieces and put them in the pie plate on top of the ham.

Cut up 1/4 of a large onion and add it to the pan. We don't precook any of these cubed things (of course the ham is already pre-cooked).

Put a bunch of cheese slices on top of the chopped mixed. We like jalapeno-havarti. We pretty much cover the entire pie plate. We used three slices here:

Notice that we put the pie plate on a cookie sheet to catch any spillovers in case we overfill the pie plate.

Add the liquid mixture.

Oops, we had too much, so we didn't put it all in.

Put a tonne of Tex-Mex shredded cheese on top of all that. I'm guessing that in all we used roughly 1/4 of a package. Ms. Eclectic says it might have been more than that.

What did we do with the rest of the "custard"? We put it in two large ramekins along with cheese.

We baked everything at 350 for 45 minutes and then took out the ramekins. They were wonderful!

They remind me in looks of the quiche bites from Tim Hortons, but these tasted infintely better!

We baked the big quiche for another 15 minutes until it was golden brown on top didn't jiggle in the middle.

Once again, here's the final product (included twice for the sake of Facebook to get the final product to show in the preview (I hope).

Here's the recipe (quantities are approximate):

Ingredients:

Whisk these to make the custard. Keep it in a separate bowl until ham and veggies are in the pie plate:

• • 4 really large eggs
  • 2 cups of half and half
  • 1 tablespoon of salt
  • 1 teaspoon of pepper
  • 1 and 1/2 tablespoons of melted butter

Put these on the bottom of a greased/sprayed/buttered pie plate in any order:

• • 2 thick slices of ham, cubed
  • 1/2 green pepper, cubed
  • 1/4 onion, cubed (we often use cut up green onions)

Put the cheese slices on top of the cubes:

• • 3 slices of jalapeno havarti cheese (we used two more for the ramekins)

Pour the custard over the mixture.

Add the shredded cheeses

• • 1/2 cup or more shredded Tex-Mex cheese

Bake at 350F for about an hour or so.

Let cool and set for about 20 minutes.

Addendum:

During the isolation, I find we use a lot of things from the fridge, either because I just bought them and we don't want them to go bad or take up too much space, or because they're about to go off and we want to use them up. One thing for sure, we're throwing out much less 'bad' food these days than we did before isolation. So we call the quiches we make now "Isolation Quiches".

Tiff Macklem, the New Governor of the Bank of Canada

The Globe and Mail has reported that Tiff Macklem has been appointed Governor of The Bank of Canada as of June 2nd . This is great news!

Tiff Macklem (Western Ph.D. 1989) Named as Future Governor of the Bank of Canada

Tiff Macklem (Western Economics Ph.D. 1989) has been named the new Bank of Canada Governor by Finance Minister Bill Morneau. Macklem, former Senior Deputy Governor and Chief Operating Officer at the Bank of Canada, was appointed Dean of the Rotman School of Management at the University of Toronto in May 2014. Macklem has remained closely involved in nearly all of the Bank's major initiatives. He will replace Stephen Poloz (Western Economics M.A 1979, Ph.D. 1982)... 

Tiff was a teaching assistant for me waaayyy back, probably in 1979 or so. He was a kind and diligent student then, and I was both pleased and not surprised when he became Deputy Governor of the Bank of Canada in 2004.

About ten or eleven years ago, we met up again when he was on campus to talk about his role at the Bank of Canada and at the Ministry of Finance during the financial crisis of 2007-8. He was great then, and I'm sure he will be great again.

This new job won't be easy for him.

During the regime of Stephen Poloz, the world and Canadian economies were slowly emerging from The Great Recession. Steering monetary policy was comparatively easy over the past seven years (until this past January), as economic growth continued, inflation rates were kept low, and the unemployment rate dropped to levels not seen in decades (see this).

However, as I have posted before, Tiff Macklem will have to deal with what most economists expect to be a serious world-wide and continent-wide recession. Furthermore, he will have to control (i.e. fight against) intense pressure from the government to monetize all the newly created debt we are seeing.

The government is borrowing now to pay for all their new programmes (in addition to all their previous deficit spending of the past few years), but who can they borrow from? They can't just wade into the money markets and drain all the liquidity from those markets; and foreign investors won't want all of the newly issued Canadian debt. So, as has happened before (see 1977-82), the Bank of Canada will be obliged to step forward to buy up a HUGE percentage of the newly issued government debt.

The government will be injecting billions of spending dollars into the spending stream but their borrowing won't be from the public and won't drain off much of that extra liquidity created by the spending (and transfer payments). Borrowing from the private sector through the money markets would help ameliorate the inflationary pressures, but if the government tries to borrow enough to cover all their increasing deficits from the private sector, it will drive up interest rates and crowd out what little private investment there is right now.

What can Tiff Macklem do in this situation? He's between a rock and a hard place.

If he refuses to monetize the debt, he'll be in the midst of a major clash with the government, reminiscent of The Coyne Affair of 1961. If he does continue to monetize the debt, he'll be in danger of setting off more rapid inflation than would be politically tolerable, once again hurting people who are currently locked into fixed nominal contracts and creating uncertain expectations for the future.

One option I would like at least to see on the table is for the Bank of Canada to pursue nominal GDP targeting, advocated lucidly by Scott Sumner (who blogs at EconLog and The Money Illusion). From the Wikipaedia article about Sumner,

Nominal GDP targeting[edit]

Sumner contends that inflation is "measured inaccurately and does not discriminate between demand versus supply shocks" and that "Inflation often changes with a lag...but nominal GDP growth falls very, very quickly, so it'll give you a more timely signal stimulus is needed".^[10] He argued that monetary policy can offset fiscal austerity policies such as those pursued by the British government in the wake of the 2007 economic crisis.^[10]

Selling that policy, or even trying to do this as a matter of unannounced policy, will be difficult, though. Politicians will continue to want to spend more and more and more, and voters will resent both higher taxes and higher rates of inflation. Macklem has his work cut out for him.

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As an aside, the continuing influence of PhDs from The University of Western Ontario on monetary policy both in the Bank of Canada, and elsewhere (e.g. the C.D. Howe Institute and the Fraser Institute) is a reflection on the high quality of education provided for students at UWO in monetary economics back in the 1980s. Canadian monetary policy has been highly regarded by all leading policy makers and financial economists around the world for having done an admirable job with monetary policy.

Professors David Laidler and Michael Parkin, in particular, played major roles in teaching and training students like Stephen Poloz (current governor of the Bank), Tiff Macklem, and Timothy Lane (senior deputy governor of the Bank). These students were fortunate to have studied with such scholars before the rational expectations, manufactured-data-general-equilibrium models dominated the field. Canadians are fortunate, too.

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My recent posts about the upcoming recession, inflation, etc.:

https://www.eclectecon.net/2020/04/covid19-despondency.html

https://www.eclectecon.net/2020/04/grocery-prices.html

 

 

Contest!!! What's the oldest thing you have found in your freezer or pantry during the covid19 isolation?

After I posted a photo to Facebook of some half-year-old ground beef we found in our freezer, others began commenting that they, too, had come across treasures in their freezers that were considerably more past their expiration dates. So here's the contest:

Contest #1:

Post a photo, either in the blog comments or on Facebook, commenting on this post, with a photo of something old from your freezer. The oldest item for which a photo is posted will win a signed copy of one of my novels, either 2605 or Murder at the Office Christmas Party. E.g., here's some not-so-old ground beef:

Contest #2:

Post a photo, either in the blog comments or on Facebook, commenting on this post, with a photo of something old from your pantry (I have a box of tea from 2009, for example). The oldest item for which a photo is posted will win a signed copy of one of those two novels, as well.

General:

• Contest ends 10am EDT, June 1.
• The photo must show the "best before" date on the box, can, or package. It's probably a good idea if the photo also shows what the product is, too.
• Each winner gets their choice of novel.
• I'll add the novel, Susan's Story to the prize list if I receive the author's copies in time.
• Anything dated before 1975 is automatically excluded.
• I reserve the right to alter the rules if people find loopholes. 8-).