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At the height of the financial crisis a decade ago, economists and policymakers underestimated the depth and severity of the recession that would follow. I argue in a paper released today by the Brookings Papers on Economic Activity (BPEA) that remedying this failure demands a more thorough inclusion of credit-market factors in models and forecasts…

Today the Business Secretary, Alok Sharma, has written in The Daily Telegraph about the support on offer from the government for businesses, saying that it should be enough to enable firms to avoid laying off staff during the outbreak.

The words the future of conflict triggers shiny images of technology overtaking the battlefield and an extreme revolution in military affairs. But how real is the hype about the disruption to defence and what will this mean for the soldier on the ground? In this panel we bring together three experts to consider the real face of the future of conflict. Flt. Lt. Dr James Kuht, RAF Doctor and Founder of the Reimagining Defence podcast, Lt. Col Al Brown, Chief of the Staff General Scholar and Visiting Fellow at Pembroke College, Oxford and Graham Fairclough, former Chief of Staff for the UK's Chief of Defence Intelligence in London and currently Chief of Staff for Rebellion Defence to share their experiences and vision for harnessing the exponential growth in technologies for defence, its potential uses and misuses, and the implications for the battlefield.

David Bailey

Our guest for this episode is David Bailey, Senior Lecturer in Political Science and International Studies, at University of Birmingham. David is joining us to talk about his forthcoming book with Rowman & Littlefield, Protest Movements and Parties of the Left.

As we've been arguing on this show for the last few weeks, there is no doubt at this stage that the left is 'back'. Arriving admittedly a decade or two later than Latin America's "Pink Tide", the left has made electoral gains recently, both in Europe, and in the US. Yet it is also clear that the left is not used to having this kind of potential. To the contrary, suffering through its long period of post-Cold War defeat, it has been content to engage in a lot of internal squabbling, and become comfortable avoiding the tough question of how it might engage ordinary people with its ideas. David Bailey's book is a very interesting intervention, in this sense. Without necessarily taking a side in the debates he examines (to what extent should the left embrace the state? Should we pursue reform, or revolution?), he surveys the history of some of the more prominent moments and modes of leftist protest and struggle. What is interesting, however, is he choses to do this in an optimistic way. Refusing the left's traditional mournful stance on its history, and deliberately trying to focus on the things the movements got right, Bailey is out to capture the spark of revolutionary disruption in each of his case studies, where the impossible was somehow, suddenly, made possible.

I got to see an advance copy of the book recently, and more than anything I was kind of pleasantly surprised by his open-minded stance on left strategy, finding those sparks of disruption everywhere, from the early days of 1917 Bolshevik Revolution, to the anarchist movements of the Spanish Civil War, and even in post-war parliamentary reformism. The civil rights movements get a look in here, and there are chapters on the New Left, the history of feminism, and the rise of environmentalism. And those interested in more recent history will find the last chapters quite interesting I think, looking at the Occupy movement and, more interestingly, the influence of 'Left Populist' struggles Latin America on the rise of what Bailey calls 'left pragmatism' in Europe and North America, embodied of course in parties like Syriza and Podemos, but even more recently in figures like Jeremy Corbyn and Bernie Sanders.

By now, it should be obvious to just about everyone that goods whose availability we once took for granted are in short supply. Blame COVID-19 lockdowns affecting countries where these goods are being produced, a breakdown in air/sea/land transport logistics, and so on. The pre-COVID-19 world was built on distributing manufacturing facilities where things could be made most efficiently, assuming fairly inexpensive shipping even across vast distances. Is that world now gone? We'll have to wait and see if and when the pandemic subsides. In the meantime, here's another not-quite-amusing example for those encountering these shortages: A few days ago, I noticed that my supplies for the exercise supplement creatine monohydrate were running low. I experienced sticker shock while scanning current selling prices. Briefly, what creatine does is replenish the body's supply of adenosine triphosphate (ATP), which fuels muscle contractions such as while performing resistance training. It turns out that most of creatine's precursors come from (surprise!) China. As many of you are probably aware, China has taken a zero tolerance approach to confronting COVID-19 outbreaks. With production centers and major port cities not immune to these recurrent lockdowns, creatine supplies have taken a hit. Here is a detailed and enlightening discussion of the ongoing creatine shortage from the Natural Products Insider:Strict export regulations and regional COVID-related limitations are
slowing China-originating supply chains for two top sports nutrition
energy ingredients, caffeine and creatine. Outside of China, suppliers
and manufacturers are clamoring to beef up inventories of these
increasingly hard-to-find materials but face steeply rising prices for
whatever supply they can secure [...] Similarly, the price of creatine has risen from its consistent $4 per kilo to between $10 and $14/kg.There is more good detail: More unique to the sports nutrition industry is creatine, which
factors into energy production in the body and is popular with core
market users, namely bodybuilders and athletes looking to boost muscle,
performance and recovery. "There is a worldwide creatine shortage," confirmed Jeff Golini,
Ph.D., executive scientist for All American Pharmaceutical, who
confirmed all the raw material to manufacture creatine comes out of
China, meaning this shortage impacts all forms of creatine, from
monohydrate to hydrochloride (HCl).

Thus, while suppliers such as AlzChem Trostberg GmBh (Creapure) and
All American Pharmaceutical (Kre-Alkalyn) make their ingredients in
Germany and Montana, respectively, their starter materials come out of
China, placing even these suppliers in the impact zone. What's behind the shortage is not quite clear and asking different
"insiders" results in varying answers, including lots of guesswork and
perspectives.

Vitajoy sells both caffeine and creatine, and Crane said as far as he
can tell the shortage is related to the pandemic. His sources suggested
COVID-related issues in the northern area of China, where most creatine
factories reside, caused production facility closures. "I believe that
is what might have started the ball rolling," he reasoned. "From there
it was reported that there were some starting material issues and,
before you knew it, any availability in creatine was gone."

Worse yet, the US-China trade conflict seems to be worsening availability:  Golini attributed the shortage to changing world politics, including
the recent U.S. presidential administration transition, and the ongoing
global power struggle involving trade. "China now is saying we have a
shortage of everything in order to re-control the world market, create
demand and raise pricing," he said. "From creatine to resins to make
plastics to pipe to erythritol to you name it."

"Creatine is $14/kg if you can find it," Kneller lamented. Crane noted pricing went from around $4 to more than $8/kg in a
matter of months. "We feel like we might be seeing some daylight
regarding supply in the coming months, but it's hard to pinpoint exactly
when," he reasoned. Golini sees a longer struggle. "This shortage for creatine—as a
matter of fact, there is none [available]—will continue this entire
year, and you will see pricing go through the roof," he warned.Then there are the aforementioned regional shutdowns for COVID-19 containment--including areas crucial for creatine supply chains. These include Wuhan itself:

Creatine producers appear
concentrated in the northeastern province of Hebei, near the Yellow Sea
separating China from both Koreas and Japan [...] In January 2021, Chinese officials locked down the city of Shijiazhuang,
the capital Hebei, and other areas of the province due to a COVID
outbreak. Hebei Hangwang Import and Export Trading Co. Ltd., Sure
Chemical Co. Ltd. Shijiazhuang and other creatine producers are located
in this city. However, this restriction was lifted March 25, leaving only the city of Wuhan, Hebei, still under a lockdown that was lifted April 7. According to Made in China, several creatine suppliers are located in Wuhan, where COVID was first detected in China.

The bottom line is supply chain disruptions have become more common
and rolling over the past several years due, among several reasons, to
trade wars and the pandemic. Many supplement companies have grown to
accept this fact, take steps to be better prepared and hope situations
improve. "We expect global supply chain disruptions to follow COVID," Titlow
summarized. "The better COVID is managed (e.g. vaccines), the better the
supply chain."There's even an amusing video online about bodybuilders regarding the creatine shortage as a harrowing event of enormous proportions. These are not quite the best of times for global supply chains; that much is clear.

     

I was invited recently to take part on a panel discussion
on Modernizing Liquidity Provision as part of a conference hosted jointly by CATO and the Mercatus Center entitled A Fed for Next Time: Ideas for a Crisis-Ready Central Bank.  My post today is basically a transcript of the presentation I gave in my session. I'd like to thank George Selgin and David Beckworth for inviting me to speak on why the Fed should create a standing repo facility, an idea that Jane Ihrig and I promoted early last year in a pair of St. Louis Fed blog posts here and here.

In those posts, Jane I argued that the Fed should create a standing repo facility that would be prepared to lend against U.S. Treasury securities and possibly other high quality liquid assets (HQLAs). We distinguished the facility we had in mind from the discount window in two key respects. First, unlike the window, it would restrict collateral to consist only of HQLA; and second, it would grant access to non-depository institutions, in particular, to dealers and possibly even to all the counterparties that are presently permitted to access the Fed's ON RRP facility.

At the time, we motivated the facility as a way for the Fed to conduct monetary policy in a manner consistent with the FOMC's preferred operating framework of ample reserves together with its 2014 Policy Normalization Principles and Plans which stated, among other things, the desire to hold "no more securities than necessary to implement monetary policy efficiently and effectively."

Jane and I speculated that a significant source of the demand for reserves over other HQLAs came from the Global Systemically Important Bank's (G-SIB's) perceived need for resolution liquidity. We reasoned that these G-SIBs might be more inclined to hold higher-yielding HQLAs over reserves if it was known beforehand that the former could be readily converted into reserves on demand at a standing facility at pre-specified terms. At the same time, the facility would provide a ceiling on repo rates and eliminate the need to estimate the so-called "minimally ample" level of reserves. That is, the facility would automatically flush the system with the reserves it needed as reserve supply and demand conditions varied because of adjustments in the Treasury General Account or other economic factors. Finally, we doubted whether the facility would lead to any significant amount of disintermediation as some people feared. In our view, it would serve mainly to cap the terms of trade in a number of over-the-counter (OTC) repo transactions involving Treasury debt.

The title of this session is "Modernizing Liquidity Provision." We're here today, of course, because of the massive Fed-Treasury interventions in response to the COVID-19 pandemic. Jane and I didn't tout the standing repo facility as a crisis tool because we figured that in a crisis, investors were unlikely to have much difficulty in finding buyers of U.S. Treasury securities. Since the 2008-09 financial crisis, we've grown accustomed to the idea of USTs serving as a flight-to-safety vehicle. And, indeed, this seems to have been the case as the present crisis initially unfolded. Bond yields began to drop sharply in Februrary and then again following the Fed's rate cut on March 5, with the 10-year hitting a low of 54bp on March 9.

But then something happened that I don't think anyone was expecting (certainly, I was not). In particular, after March 9, there's clear evidence of selling pressure stemming from what looked like a repo run on treasury securities. That is, for a variety of reasons there was an enhanced demand for cash which, in this instance, led to sales of U.S. Treasuries, depressing their value as collateral--effectively evaporating a significant portion of the supply of safe assets--which led to margin calls, which led to further selling pressure, and so on.

When the Fed cut its policy rate to 10bp on March 16, bond yields continued to rise, with the 10-year hitting almost 120bp on March 18. Bond yields came down only after the Fed intervened first with its discretionary repo operations and then with $1.5T of outright purchases of securities. This episode reminds us again that cash is king in a crisis and that U.S. Treasury securities are not always considered cash-equivalent in a crisis.

A natural question to ask here is whether disruptions like this constitute a policy problem. After all, it's not like bond traders are unfamiliar with the notion of interest rate volatility. When I glance at the data, the absolute size of this volatility seems more or less stable since the mid 1980s. However, because interest rate levels are so much lower today, a 50bp move is quantitatively more significant in relative terms. This wouldn't be much of a problem, in my view, if treasury securities served merely as pure saving instruments. But for better or worse, the UST has evolved over time to become an important form of wholesale money. In particular, it is used widely as collateral in the repo market (the so-called shadow bank sector). Its value as collateral stems in large part from its perceived safety and liquidity. And most of the time, the U.S. Treasury market is liquid. Except for when it isn't, of course. And so the question is, when it isn't liquid, does it matter and, if so, should something be done about it?

My views on this questions are informed by both by theory and from what I know of the history of the U.S. Treasury market (e.g., Garbade 2016). Theory tells us that in a fiat money system, there's no fundamental difference between account entries at the Federal Reserve and (say) at Treasury Direct. They are both electronic ledgers containing interest-bearing accounts. There are legal differences, of course. Only depository institutions have access to Fed accounts, whereas treasury securities can be held much more widely. Treasury securities are more complicated objects because they differ from each other in terms of coupon, time left to maturity, and possibly other characteristics. For this reason, treasury securities, as with most bonds, trade in decentralized over-the-counter markets instead of centralized exchanges.

While OTC markets may have their advantages (they evidently displaced the centralized exchange of bonds in the 1920s), their decentralized structure can be problematic. When investors become fearful, bond dealers and other traders may become unwilling or unable to execute trades, so that meaningful price information is lost. Safe assets may trade at significant discounts or premia, not for any fundamental reason, but simply because liquidity (market participation/communications) has vanished. Such events have implications that extend beyond the treasury market because, as is well-known, the yield on Treasury debt serves as a benchmark for many other financial assets. Unnecessary and avoidable problems in the treasury market can spillover into other financial markets, bringing grief to the broader economy.

From this perspective then, I am led to ask the question: in what world does it make sense to permit risk-free claims to fiat money like treasury securities to suddenly become illiquid? (This question is distinct from the one that asks whether risk-free claims to fiat money should be made illiquid--as in, the issuance of non-marketable debt; see here, for example) There is really no good reason, as far as I know.

I therefore continue to believe that a standing repo facility makes a lot of sense for the U.S. economy. And I again want to stress that this is not an hypothetical proposal. Many of the world's leading central banks operate such facilities. The Fed has had its ON RRP facility in place since 2013. Indeed, the Fed even implemented a repo facility (called the FIMA repo facility) in March of this year where foreign central banks can borrow funds at 25bp above IOER by presenting U.S. Treasury securities as collateral. The same type of facility set up for domestic purposes (ideally with Treasury support) could simultaneously help the FOMC achieve interest rate control, shrink the size of its balance sheet, and prevent unnecessary violent disruptions in the treasury market by setting a corridor around treasury yields at different maturities. The size of the corridor could ultimately be adjusted to help achieve yield curve control if desired. But this is a separate issue, so let me end here. Please feel free to comment below. 

Health epidemics have a multilayered, long-standing impact on society as a whole, and an inordinate impact on women. Particularly in a country like Iraq where progress on women's rights and issues has been slowly gaining more traction in recent years, the coronavirus threatens to halt progress on these key issues and give lower priorities to women's concerns that are still vital during such a time of crisis. While more men than women seem to get infected with the new coronavirus globally--there is no gender-disaggregated data for Iraq--, the social impact of the virus in countries that already have been through the worst of the pandemic can serve as important indicators for Iraq.

The social impact of the coronavirus has had an uneven impact on women more than men in the first countries hit by the coronavirus in East Asia. Notably, in South Korea, women have taken on a larger burden than men in taking care of children forced to stay at home due to school closures, as societal norms more often place the burden for childcare on women. Not only does this put greater pressure on women who are in many cases already the primary caretakers at home, but it makes them more likely to lose their jobs as they are forced to divert more time to childcare. These societal norms also mean women are more likely to be exposed by the virus, as they are stuck in a caretaker role for sick family members and makeup over 70% of the healthcare sector according to a World Health Organization Report.

Women forced to stay home and work less in order to dedicate more time to caretaking also means that women are more likely to suffer from the economic impact of the virus, whether that means job loss or wage reductions. This means that even after the virus has effectively contained, women are more likely to suffer from the economic fallout than men long after the virus is gone.

In addition, in China, rights activists reported an increase in domestic violence cases, as lockdowns and economic pressure have increased tensions in many households. Particularly at the epicenter of the virus in Wuhan, China, activists reported a threefold increase in domestic abuse cases. The quarantine measures in place, while cases were at their height in China, made it difficult for activists to provide aid, and diverted police attention away from assisting women who suffered from domestic abuse. This disruption of support networks makes it more difficult for women to report domestic abuse cases and to get away from their abusers.

Social, cultural, and political barriers to women's participation in Iraq might lead to disproportionate effects based on gender. First, there have already been voices raising concerns that some families might not allow women who had tested positive for the virus to be quarantined, as more traditional culture is against women to remain unaccompanied. Not only would this present a serious threat to the health of individual women, but such refusals by conservative families to follow the recommendations of medical personnel may contribute to undermining the government measures to contain the virus. Second, women's representation in government is already limited in Iraq, and with a limited voice in the decision-making chambers of government, their gender-sensitive concerns will likely be less of a priority to Iraq's policy makers. And finally, Iraq's economic situation that was in decline even before the outbreak might further impact the poor economic opportunities already facing women in Iraq.

Beyond the loss of life and social and economic impacts on men and women in Iraq, the crisis is also an opportunity for the government and civil society to increase engagement with the most vulnerable groups, including women, and bring them in as a major element of preventing the spread of the virus. Societal norms placing women into the primary caretaker role in homes means they will have a greater awareness of how the virus is spreading, so they can report more accurate information. In addition, polling conducted in several countries suggests that women are more concerned with the spread of the virus than men. The government could take advantage of this trend by bringing women into the process of raising awareness and concern about the virus among Iraq's population.

Given the unequal impact, the social impact of coronavirus will have on women, the Iraqi government and civil society partners should prioritize making sure issues that impact women are not sidelined during the crisis. Support networks should strengthen their outreach efforts and make resources for women's health and domestic abuse support more accessible, ideally with government backing. It is especially important that the government prioritize getting out accurate information on the coronavirus and work with the support of tribal and religious leaders to encourage families to follow quarantine procedures for women who test positive for the virus.


Women participating in NDI's National Reconciliation Program prepare food baskets in Kirkuk to help their community cope with movement restrictions taken in response to COVID-19

Gender, Women and Democracy, Countries: Iraq

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Nurses in Sri Lanka attend to their work. Photo: Dominic Sansoni/World Bank






















The COVID-19 pandemic is prompting a fresh look at options to ensure reliable power for health facilities , including the Vavuniya General Hospital in Sri Lanka's Northern Province. In line with an overall push to boost the share of renewables, the government of Sri Lanka is pursuing new power solutions for Vavuniya and about 20 other hospitals across the nation.

The World Bank is assisting as part of a multi-sectoral pandemic response in Sri Lanka. Similar initiatives are underway in other countries around the world, including Afghanistan, Madagascar, and Nigeria, to name a few.

Parts of a solution

Distributed photovoltaics (DPV), installed on rooftops or open spaces near buildings, are proliferating as a low-cost option for emergency power supplies. Many developing countries already use DPV as a long-term primary or secondary power source for health care facilities in rural and urban settings. While operating costs are minimal, average investment costs are dramatically lower today than even a few years ago, making DPV more economically attractive. When coupled with batteries, which are also becoming cheaper, DPV systems can contribute to reliable power around the clock.

With these solutions, diesel generators can become more of a last resort, instead of being the main or only source of essential back-up power when the grid is unavailable. Less use of diesel generators helps avoid the high cost of fuel, vulnerability to shortages, and toxic emissions.

Diverse technology options are available for distributed renewables. They range from individual components to pre-packaged "box" solutions which combine DPV, batteries and generators of varying sizes, including up to mini-grid level for larger sites. Under the auspices of the Energy Storage Partnership facilitated by the World Bank, a survey of suppliers has found that significant inventory is available despite logistics disruptions.

Electrical devices are also increasingly available in more energy efficient models, which can help avoid oversized power systems in new health care units. Correct system sizing is crucial where financial resources are limited, but many variables need to be considered.

For example, the electricity needs of intensive care units (ICU) differ greatly depending on how many beds are occupied: temporary ICU wards need significant power, but only for a limited time period. Another key factor to consider is that electricity demand from certain medical services may drop while stay-at-home measures are in force. For instance, some hospitals are deferring elective surgeries during the crisis. System sizing strategies need to examine such factors when addressing the health care sector's power needs in response to the pandemic.

Bringing the parts together

Given all the options, what tools are available to design power solutions for hospitals without full grid electricity? One resource is the HOMER Powering Health Tool, a free online model to help simplify the design process for distributed generation systems for health care facilities. Standing for Hybrid Optimization Model for Multiple Energy Resources, HOMER is a leading resource for mini-grid analyses.

Originally commissioned for USAID's Powering Health program, the HOMER Powering Health Tool has recently been updated to reflect typical COVID-19 response needs with support from the World Bank's Energy Sector Management Assistance Program (ESMAP). Users enter the electrical needs manually or select default values for pre-listed devices from one of four health facility tiers as a starting point. The tiers include, for example, a small rural dispensary that would typically screen and refer serious cases to larger facilities such as a district hospital. Based on user inputs, the tool calculates least-cost combinations of batteries, PV, and diesel generators sets – including as back-up to grid electricity if this is available for some hours each day.

The tool runs entirely online and can be used an unlimited number of times with no need to sign in or to download a software. It's kept simple for non-specialists to use without requiring special training. This comes with limitations, of course. For certain advanced needs, other products are available, such as the full, licensed software of HOMER Energy by UL or the free System Advisor Model (SAM) of the U.S. National Renewable Energy Laboratory (NREL). The latter is especially useful for systems that may feed DPV power to the grid when it is not needed on site. In Sri Lanka, the World Bank is applying these tools to optimize solutions to strengthen power for Vavuniya and other hospitals.

From one to many

With a standard lifetime of 20 years, DPV systems can supply clean energy to the national grid. They can also become the backbone of community mini-grids. The value of both options goes well beyond the pandemic. DPV can help not only the consumers who host the systems but also a power system that it feeds. DPV can reduce grid congestion and energy losses for utilities. It can also displace more costly generation from wholesale sources while promoting resilience.

Sri Lanka has already been promoting DPV such as through its Rooftop Solar Power Generation Project, in partnership with the Asian Development Bank. Nationwide, rooftop installations are on track to reach a total of 200 megawatts capacity by the end of 2020, equivalent to around 7 percent of system peak demand. Northern Province alone has added over 3 megawatts since 2017, including 17 projects in Vavuniya for businesses and households. Consumers with DPV can choose to feed some or all the power generated into the national grid through the utility providers. In all cases, the DPV significantly reduces consumers' bills while providing clean energy to the system at a lower cost than fuel-based generation for grid.

Sri Lanka's initiative shows that solutions to the current crisis can also address longer-term challenges. With a strategic approach, health care facilities can be well-positioned to combat COVID-19 while preparing for the "new normal."

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I was recently asked whether I'd like to share my thoughts on monetary policy in a post-pandemic world. Sure, why not? Thanks to Jan Eckhout for thinking of me. The panel was hosted by the European Economic Association last month and moderated by Diane Coyle. I was honored to speak alongside Ricardo Reis and Beata Javorcik, both of whom provided riveting presentations. For what it's worth, I thought I'd provide a transcript of my remarks here. Lunch Panel EEA-ESEM CopenhagenAugust 25, 2021I want to focus my discussion on the U.S. economy
and from the perspective of a Fed official concerned with the challenges the
Fed may face in fulfilling its Congressional mandates in a post-pandemic world.

First, to provide a bit of context, let me offer
a bit of history on policy and, in particular, on what I think were some
policy mistakes. Let me begin with the 2008-09 financial crisis, which is
something I think most people would agree should never have happened. Whether a sufficiently aggressive Fed lender-of-last-resort operation would have averted the crisis remains a open question. Even if it had been successful, such an operation would have had costs. It may, for example, have elicited
an even greater political backlash than we saw at the time--and who knows how this
may have manifested itself as undesirable changes to the FRA. As well, such an
intervention may have just pushed mounting structural problems down the road.
In particular, while it's now clear that some private sector lending practices
needed to change, it's not clear where the incentive to do so would have come
from absent a crisis. In any case, the crisis happened. How was it managed?

The ensuing recession was deep and the recovery
dynamic very slow. The prime-age employment-to-population ratio did not reach
its pre-pandemic level until 2019, a full decade later. Nevertheless, on the
whole, I think the Fed followed an appropriate interest rate policy. There were
one or two times the FOMC exhibited a little too much enthusiasm for
"normalizing" policy, but I think the slow recovery dynamic had more to do with
insufficient fiscal stimulus—especially at the state and local level—rather
than a consequence of inappropriate monetary policy. The evidence for this can
also be seen by the fact that inflation remained below the Fed's 2% target for
most of the time the policy rate was close to its ELB. The Fed has interpreted
this low inflation episode as partly a monetary policy mistake, something its
new AIT regime is designed to address. But my own view is that persistently low
inflation—and the low money market yields that go along with it—have more to do
with the supply and demand for U.S. Treasury securities. This is something the
Fed does not have very much direct control over.

I know many people are skeptical of fiscal
theories of the price-level, but in virtually every economic model I know, a
fiscal anchor is necessary to pin down the long-run rate of inflation. Monetary
policy—specifically, interest rate policy—can, of course, influence the
price-level, so monetary policy can influence inflation dynamics. But it can do
so only in the "short run." Interest rate policy alone cannot, in my view,
determine the long-run rate of inflation, at least, not without appropriate
fiscal support.

Now, I know many of you may be asking how I can
think fiscal policy has very much to do with inflation given how rapidly the
debt has risen since the financial crisis and again with the C-19 crisis, all
with little apparent pressure on long-run inflation expectations and on
long-term bond yields. We should, however, keep in mind that an observed change
in the quantity of an object may entail both supply and demand considerations.
And one can easily point to several forces that have contributed to increases
in the global demand for UST securities in recent decades. For example, the
growing use of USTs as collateral in repo and credit derivatives markets
beginning in the 1970s and accelerating through the 1980s. The growing demand
for USTs as a safe store of value from EMEs. The evaporation of private-label
safe assets during the financial crisis that left a gaping hole for USTs to
fill. Next, we had a large increase in the regulatory demand for USTs coming
out of Dodd-Frank and Basel III. The Fed's SRF and FIMA facility should further
enhance the demand for USTs. On top of all this, we've witnessed an emergent
class of money funds called "stablecoins" that are further contributing to the
demand for USTs. These forces have been disinflationary, leading bond investors
to revise down their expectation of the future path of policy interest rates.
It is interesting to ponder a counterfactual here. In particular, think of what
may have transpired absent an accommodating U.S. fiscal policy. We may very
well have experienced the mother of all deflations. If this is correct, then an
elevated debt-to-GDP ratio, given a relatively stable inflation and interest
rate structure, reflects an elevated real demand for outside assets. The
problem is not that the debt-to-GDP ratio is going up. The problem is what
disruptions might occur if it goes down
owing to a sudden and unexpected inflation.

The recent rise in inflation is concentrated in
durable goods, and I think is mostly attributable to ongoing supply-chain
issues associated with the pandemic. This effect is likely to reverse itself,
the way lumber prices recently have. Some of what I think is temporarily high
inflation may not reverse itself, leading to a permanently higher price-level. In
this case, households will worry whether their wages will keep pace with the
higher the cost of living. There is even the possibility—though I think less
likely—that the rate of inflation itself will remain elevated and that
inflation expectations will rise well above the Fed's 2% target. This may
happen, for example, if the traditional bipartisan support for fiscal anchoring
in the new generation of Congressional representatives is perceived to wane, or
if the global demand for safe assets slows. If either or both of these things happen
and are persistent, then the Fed may find itself faced with what Sargent and
Wallace phrase an "unpleasant monetarist arithmetic." That paper, which was
published exactly 40 years ago, warned how tightening monetary policy without
fiscal support might actually make inflation go higher rather than lower.

The implications for U.S. monetary policy are
quite interesting should an event like this unfold. A determined Fed may try to
fight inflation by raising its policy rate. The result is likely to be a temporary
disinflation and recession.  Should fiscal policy remain unaltered, the
logic provided by Sargent and Wallace implies that inflation will return even
higher than before as the deficit must increase to finance a larger interest
expense on the debt. The best the Fed can do in this case is to lower its
policy rate, announce a temporarily higher inflation target, and hope that the
fiscal authority gets its house in order. The notion that a Volcker-like policy
would lower the long-run rate of inflation depends on fiscal capitulation. This
capitulation to some extent did happen under Volcker, although keep in mind he
had considerable Congressional support from both sides of the aisle. I do not
think this type of political support is something one can count on, especially
given today's political climate. So, you may want to buckle up, as we may be in
for some interesting times ahead.Related Readings:Is it Time for Some Unpleasant Monetarist Arithmetic? Link to blog post. Link to paper.

The monetary policy program at the Mercatus Center recently released a new measure called the NGDP gap. We created it as an alternative way to gauge the stance of monetary policy and have provided a website that will update the measure as new data become available. In this post, I will briefly summarize the NGDP Gap and then highlight a few extensions that some readers may find useful. 

Summary of the NGDP Gap 

As mentioned above, the NGDP Gap provides a cross check on the stance of monetary policy. Its use does not require the Fed to adopt a NGDP target, but it does draw upon the fact that NGDP is comprised of both real GDP and the price level and therefore captures both elements of the Fed's dual mandate. Moreover, since NGDP is a nominal variable it can be shaped by the Fed over the medium to long run. 



The basic idea behind this measure is to construct a benchmark growth path for nominal GDP (NGDP) where monetary policy is neither expansionary nor contractionary. Deviations of actual NGDP from this neutral level of NGDP provide a way to assess the stance of monetary policy. These deviations, in percent form, are called the NGDP gap. 



The NGDP gap can also be called the nominal income gap since NGDP equals NGDI. In fact, the construction of the neutral level of NGDP can be most easily understood from a nominal income perspective. To see this, consider that people make many economic decisions based on forecasts of their nominal incomes. Examples include households' decisions to take out mortgages and car loans or firms' decisions to finance with debt and commit to multiyear contracts on plants, raw materials, and labor. Sometimes, however, actual nominal incomes may turn out very different from what people expected and, as a result, may be disruptive for households and firms that are not able to quickly adjust their economic plans. These disruptions can be minimized by maintaining nominal income on the growth path expected by the public.



The neutral level of NGDP, then, is the public's expected growth path of nominal income. Both this measure and the NGP Gap are shown below up through 2020:Q1 and come from a NGDP Fact Sheet we will be publishing each quarter. 





To be clear, non-zero NGDP gap outcomes need not be the result of Fed policy but of monetary conditions more generally. For example, the current NGDP gap exists because of the severe nominal income shortfall that has emerged from the COVID-19 shock. Consequently, the job of the Fed and U.S. Treasury during this crisis is to close this gap and avoid the secondary spillover effects (e.g. mass insolvency) this shortfall could create. Failure to close it would indicate a failure of countercyclical policy. This measure, then, provides a useful guide for the economic relief efforts during the pandemic. 


Extension I: Blue Chip Forecast Version

A key goal of this project was to provide a measure that is relatively simple to calculate and uses publicly available data. To that end, the neutral level of NGDP is based off of forecasts from the Philadelphia Fed's Survey of Professional Forecasters (SPF) and BEA data on NGDP. There is no use of r-star or u-star and therefore no "navigating by the stars" in this measure. The neutral level of NGDP is just an averaging of NGDP level forecasts from accessible data sources. Below is the formula for the neutral level of NGDP:




where NGDPt* is the neutral level and NGDPt-iSPF forecast(t) are NGDP level forecasts for period t coming from the past 20 quarters. NGDPt*, in short, is just a rolling average of NGDP level forecasts for a particular period. The difference between it and actual NGDP is the NGDP gap. 



Given the five-year (20 quarter) window in creating NGDPt*, there is a need for long-term NGDP forecasts. They are available in the SPF, but begin only in 1992 and therefore limit our series to a start date of 1997. 



The Blue Chip forecast database provides a long-term NGDP forecast that goes back further than the SPF. Alexander Schibuola and Andrew Martinez (2020) use it to construct an even longer time series of the NGDP gap. It is shown in the figure below along with the SPF version we use at Mercatus. The two NGDP gaps are very similar. 






Interestingly, Schibuola and Martinez use the data to construct a forecasted NGDP gap and it is disturbingly large. Even the recovery looks nasty. 



The use of Blue Chip data is a nice extension of the NGDP gap. However, we still plan to use the SPF version as our baseline version since the data is free and we can show the underlying calculations to the public. Eventually, we plan to provide the Blue Chip version as a complement to our baseline SPF version, but since it uses proprietary data only the final measure will be available. 

Extension II: Precision Version

Schibuola and Martinez also provide another useful extension of the NGDP gap that looks at its precision. They motivate this by noting two potential issues: (1) the forecasters in the SPF sample change over time and (2) individual forecasts in the SPF may be very different. Accounting for these two issues they produce the following chart that shows the range of individual forecasts for a semi-fixed sample of forecasters in the SPF. 







The median of the semi-fixed sample provides a very similar result to the overall median of all the forecasters. Also, the range of forecasts provides a way to better think about the stance of monetary policy. For example, one could make the case that monetary policy was neutral in 2019 since the range of estimates span both sides of 0 percent. 


Extension III: NGDP Targeting Application

As noted above, the use of the NGDP gap does not require the adoption of a NGDP target by the Fed. Nonetheless, a closer look at the forecasts used in constructing the neutral level of NGDP reveal that it could be used by the Fed as the target growth path for a NGDP target. For it would amount to a NGDP level target that slowly changes the target NGDP growth path based on changes to forecasts of potential real GDP.





To see why this is the case, note that we use a combination of short-run and long-run forecasts of NGDP to construct the neutral level estimate of NGDP. The SPF provides distinct quarterly NGDP forecasts for five quarters out: t+1 to t+5. After that, we use the average annual NGDP forecast over the next 10 years adjusted to a quarterly basis for quarters t+6 to t+20. This is seen in the table below. 







What this means is that three-fourths of each NGDP neutral level estimate is being shaped by a long-term forecast of NGDP. This long-term forecast, in turn, is the sum of a 10-year average GDP deflator inflation forecast and a 10-year average real GDP growth rate forecast. The long-term inflation forecast is determined by the Fed's inflation target while the long-term real GDP growth rate forecast is shaped by expected changes in the potential real GDP growth rate. 



Consequently, as the neutral level of NGDP series moves through time, it can be seen as a rolling average of expected changes to potential real GDP growth plus the Fed's inflation target. This is the kind of NGDP level target some advocates, like Jeff Frankel, would like to see implemented.  



The figure below shows the neutral level of NGDP constructed with the Blue Chip data, complements of Schibuola and Martinez. This version allows us to see a hypothetical NGDP level target from late 1987 to present based on the neutral level measure of NGDP. 







Again, the original intent of the neutral level of NGDP and the NGDP gap is simply to provide a crosscheck against other measures of the stance of monetary policy. The discussion of a NGDP level target is simply an extension of this work. 



Here's hoping, though, that the Fed and Treasury keep this measure front and central in their efforts to provide economic relief during the COVID-19 crisis.