For macro investors, the end of summer is usually signalled by the Kansas City Fed's annual conference at Jackson Hole. On occasions, former Fed chairman Ben Bernanke used this gathering to indicate major changes in monetary policy, going far beyond the minor, incremental adjustments that central bankers undertake in their regular policy meetings. Two years ago, he described high unemployment as a "grave concern" and presented the case for an open-ended increase in the Fed's balance sheet, which came to be known as QE3.
With US quantitative easing ending in October, the focus this year was on whether Fed chairwoman Janet Yellen would provide any fireworks. She did not. But Mario Draghi did, raising expectations in the markets that the European Central Bank might be ready to follow in the footsteps of Bernanke two years ago. This may be going a bit far, but the ECB President certainly stole the show this year. After Jackson Hole 2014, the world's two major central banks are clearly headed in very different directions.
Let's set the scene:
1. When Bernanke was at Jackson Hole in August 2012, the most recent unemployment reading was 8.2%, for July. And that's exactly where unemployment started the year---at 8.2% in January 2012. No wonder Bernanke expressed "grave concern."
2. Many people argued the unemployment problem was "structural." Even the demand-siders were pessimistic, with the Fed expecting an exceedingly gradual reduction in unemployment over the next few years.
3. Bernanke knew that lots of fiscal austerity was likely to occur in 2013.
4. If you had claimed that 2 years later unemployment would have fallen to 6.2%, people would have thought you were crazy.
Bernanke responded with QE3, and (more importantly) more aggressive forward guidance. To be sure, the recovery has been too slow, even with the rapid fall in unemployment. Labor force growth has been weak. Nonetheless, the fall in unemployment (which I expect to continue) is a major achievement. Bernanke was right and the structuralists were wrong. And don't think of it as the unemployment rate falling by roughly 1/4th. While that's technically correct, as a practical matter the natural rate of unemployment is about 5%. Thus the Bernanke policy eliminated almost 2/3 of the "excess unemployment." Yes, there are other labor force problems, but that doesn't mean the specific problem of people who say they are looking for work but can't find work is something to be minimized. And that problem has been greatly reduced by monetary stimulus. God knows it wasn't fiscal stimulus!
Lots of people talk about the "Yellen Fed," but so far it seems a continuation of the Bernanke policy. I see no important changes. There is also optimism that Draghi may act to boost the eurozone economy. While he makes the right noises, the markets don't seem convinced. The 10-year German Bund yields 0.94%, the 30-year is at 1.8%. Those yields suggest to me that Draghi's vague promises lack credibility. Eurozone trend inflation is well below US levels. Interest parity implies the euro is likely to appreciate strongly over the next 30 years. He needs the eurozone establishment to get behind monetary stimulus; markets assume he can't do much by himself. Recall that Japan moved very aggressively and inflation is still only in the 1% to 2% range. Japanese bond yields are still quite low. The eurozone is far from being out of the woods.
I will present a paper at the Mont Pelerin meetings in Hong Kong next month. My session is entitled "The Coming Inflation Threat." I wonder how long it will take me to say; "there is none." And to back up my claim with "TIPS spreads."