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Daily Non-Ponzi Conditions Report

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The following is largely an excerpt taken from the Not the Fed Tealbook series that the Central Bank of Armenia regularly publishes around the time of the Fed’s FOMC meeting which simulates a state-of-the-art Forecasting and Policy Analysis System with an emphasis on risk and uncertainty using the US as a testing ground.

Although it could have been discerned prior to, it should have been apparent by the Global Financial Crisis (GFC) the important role of endogenous money creation. The GFC showed us that by not understanding the implications of endogenous money creation the potential problems that could arise. 

Despite the enormous uncertainty around this topic, we believe the central bank should be open and transparent
about its worst fears when it believes it is warranted to help financial markets position themselves in a manner where risk is priced appropriately. In similar fashion to before the GFC, it would have been beneficial had central banks joined the chorus of economists, such as Raghuram Rajan, that were warning about a potential collapse in the subprime mortgage market as early as 2005.

Since the GFC, we continue to live in an era of what Mohamed El-Erian refers to as tremendous economic and financial distortions that have yet to be resolved. El-Erian is looking at these distortions through the lens of equity and real estate prices which indeed look overvalued to this day relative to their pre-pandemic levels. These conditions typically incentivize bubbles in asset prices to form which we can see in the explosion in net worth among households that dwarf the height of the GFC. The potential for a further asset price correction is clear. However, in our view, these distortions are broader and run a gamut of different areas but ultimately begins with the aftermath of the GFC and the era where the non-ponzi game condition was not satisfied i.e. the real interest rate was below the real growth rate or r-g < 0. The figure below illustrates the history of the non-ponzi condition in the US as well as the perceived influence it has had on wealth accumulation mainly via higher asset price

A massive amount of debt was built up under this regime and since this paradigm persisted for so long, did financial markets interpret it as a structural change? If so, then that can have a major impact on the planning behavior of financial institutions and furthermore if they were wrong and interest rates were to rise to more sustainable levels then they would be exposed to substantial capital losses under such a scenario. Then COVID came along, and this was an opportunity to naturally resolve some of these distortions in the financial system, however, due to its extreme and uncertain nature, policymakers opted for a “policy of least regrets” – overstimulating the economy and risk inflation vs under-stimulating and risk deflation. This policy unfortunately has led to a further round of distortions that complicate monetary policy further.

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First, fiscal policy is distorted through the same mechanism, years of low interest rates have normalized deficit spending and there have yet to be serious discussions about long-run debt sustainability. The US government continues to run large deficits in the first quarter of 2023, at a time when the central bank is trying to bring inflation down.


Second, households by proxy have benefited enormously from government deficits with a large cache of excess savings built over the pandemic period. It is true that those at the lower end of the income distribution have likely used up most of their excess savings but in the interim have benefitted most by the labor bottlenecks that formed during COVID and are currently experiencing extremely low levels of unemployment and high wage growth relative to their higher income counterparts.

Third, COVID itself is likely to have a lasting impact in terms of the bullwhip effect caused by the large shift from
services to goods and back again. Is likely to complicate tracking a monetary policy relevant business cycle as previous “leading” indicators like manufacturing and housing are simply reverting to their pre-pandemic levels as opposed to inducing the next broad-based business cycle.

Finally, there has been a rich debate among those in the upper echelons of our field that have discussed the outlook for the long-term real interest rate. Historically, there is an unmistakable downward trend in real rates

which begs the question of whether low rates are here to stay or not? From our perspective, it’s a complicated question to produce any precise solution. All we want to stress here is that there is huge uncertainty around where long-term real rates are headed, however, the implications of being wrong in one direction versus another are asymmetric. In our view, financial markets are being highly complacent about the inherent risk in the economy that should reflect the uncertainty around these distortions correcting or reverting to a more stable equilibrium.

The Daily Non-Ponzi Conditions Report pulls data from 45 countries principally on the 10-year nominal bond rate and compares it against an estimate for the sustainable level of nominal GDP growth (i.e. inflation target and long-run potential real growth rate) for each country. In the US, we set the sustainable level of nominal GDP growth at 3.7% reflecting the Fed’s inflation target of 2% and long-run real growth at 1.7% taken from the IMF’s April 2022 WEO long-run real growth forecast. In March 2023, Olivier Blanchard and Lawrence Summers held a public debate on the future of interest rates and this debate has helped drive part of our research agenda given its global implications and profound effects on monetary and fiscal policy going forward. We call the Summers view, the Great Renormalization where higher global interest rates are here to stay against the Blanchard view referred to as the Return of r less than g.

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