My 2013 Predictions
So, as it turned out, my predictions were right but for the wrong reasons. How can we explain such positive macro outcomes despite a decline in money growth?
I have emphasized the role of credit growth in facilitating money growth. Credit growth did pick up last year (bullish), but had no apparent impact on money growth! So that explanation doesn’t work.
There is no doubt about the decline in money growth: it is reflected in all of the aggregates, both official and unofficial. There is no mistake. And an increase in velocity is not the answer, because velocity continued to decline.
Here is a stab at an explanation for what happened in 2013:
Given the above hypotheses, we need to ask how much the equity risk premium can decline further. If the only thing holding stock prices up is confidence, what’s the outlook for confidence? I think it’s reasonably good. All of the financial stress indices remain low. Bank stocks are way up, which is a clear sign of confidence. So now to 2014.
My Predictions for 2014 (YoY):
Yellen and Bernanke are very close ideologically, but different in personality. Bernanke is a low-key academic who placed a high priority on consensus and institutional credibility. He wanted to cure the recession while preserving the authority of the institution. The price of this decision has been subpar growth and high unemployment. Bernanke was not going to go to war with the hawks, and allowed them to stymie his efforts.
Yellen, by contrast, is an outspoken dove who might be more willing to jeopardize consensus to achieve a more muscular policy. In other words, she might sacrifice institutional credibility in order to achieve the Fed’s statutory mandates. (Only in central banking can you weaken your credibility by achieving your goals.)
I am going to put my chips on scenario #1, in which Yellen succeeds in pushing the committee in a more dovish and unconventional direction. I’m not talking about the pace of the taper which is only symbolic. I am talking about moving the needle on money growth and inflation by doing something more radical. By more radical I mean things like reducing interest on reserves, new asset purchase categories, or price-level targeting. All the kind of things that Bernanke used to advocate before he became chairman.
Based on this "Yellen Succeeds" scenario, here are my predictions for the key indices one year from now: