Category Archive for: Inflation [Return to Main]

Tuesday, July 16, 2013

'Both are Below the Fed's Target'

From Calculated Risk:

CPI increases 0.5% in June, Core CPI 0.2%: From the Bureau of Labor Statistics (BLS): Consumer Price Index - June 2013

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.5 percent in June on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 1.8 percent before seasonal adjustment. The gasoline index rose sharply in June and accounted for about two thirds of the seasonally adjusted all items change. ... The index for all items less food and energy increased 0.2 percent in June, the same increase as in May. ...

On a year-over-year basis, CPI is up 1.8 percent, and core CPI is up also up 1.6 percent. Both are below the Fed's target. ...

Thursday, June 27, 2013

Inflation is Too Low

Inflation is too low (and unemployment is too high):

Yes, We Have No Inflation, by Binyamin Appelbaum, NY Times: Inflation remained sluggish in May. Prices continued to rise at the slowest pace in at least half a century, up just 1.1 percent over the previous year, the Bureau of Economic Analysis said Thursday. ...

As he goes on to explain:

Slow inflation may sound like a good thing, but it’s not. Particularly not now.

However:

Ben S. Bernanke ... and other Fed officials have shown relatively few signs of concern lately. The Fed’s most recent policy statement, and its economic projections, both released last week, show that Fed officials expect the pace of inflation to increase gradually. ...
“There are a number of transitory factors that may be contributing to the very low inflation rate,” Mr. Bernanke said last week. “For example, the effects of the sequester on medical payments, the fact that nonmarket prices are extraordinarily low right now. So these are some things that we expect to reverse and we expect to see inflation come up a bit. If that doesn’t happen, we will obviously have to take some measures to address that. And we are certainly determined to keep inflation not only — we want to keep inflation near its objective, not only avoiding inflation that’s too high, but we also want to avoid inflation that’s too low.”

If they "want to avoid inflation that’s too low," they should be doing more about it now instead of coming up with reasons, yet again, to wait and see. Why not say, for example, we'll do more now, and if it turns out we overshoot our target a bit due to medical prices going up, "we will obviously have to take some measures to address that."

Saturday, June 22, 2013

'Debased Economics'

I need a quick post today, so I'll turn to the most natural blogger I can think of, Paul Krugman:

Debased Economics: John Boehner’s remarks on recent financial events have attracted a lot of unfavorable comment, and they should. ... I mean, he’s the Speaker of the House at a time when economic issues are paramount; shouldn’t he have basic familiarity with simple economic terms?
But the main thing is that he’s clinging to a story about monetary policy that has been refuted by experience about as thoroughly as any economic doctrine of the past century. Ever since the Fed began trying to respond to the financial crisis, we’ve had dire warnings about looming inflationary disaster. When the GOP took the House, it promptly called Bernanke in to lecture him about debasing the dollar. Yet inflation has stayed low, and the dollar has remained strong — just as Keynesians said would happen.
Yet there hasn’t been a hint of rethinking from leading Republicans; as far as anyone can tell, they still get their monetary ideas from Atlas Shrugged.
Oh, and this is another reminder to the “market monetarists”, who think that they can be good conservatives while advocating aggressive monetary expansion to fight a depressed economy: sorry, but you have no political home. In fact, not only aren’t you making any headway with the politicians, even mainstream conservative economists like Taylor and Feldstein are finding ways to advocate tighter money despite low inflation and high unemployment. And if reality hasn’t dented this dingbat orthodoxy yet, it never will.

I'll be offline the rest of today ...

Tuesday, June 11, 2013

Fed Watch: Bullard Holds His Ground

Tim Duy:

Bullard Holds His Ground, by Tim Duy: St. Louis Federal Reserve President James Bullard reaffirmed his commitment to the current policy stance. From his press release:

“Labor market conditions have improved since last summer, suggesting the Committee could slow the pace of purchases, but surprisingly low inflation readings may mean the Committee can maintain its aggressive program over a longer time frame,” Bullard concluded.

This is not surprising. Bullard has long been more focused on the implications of inflation for policy, believing that employment is largely out of the Fed's hands at this point. More from Reuters:

"What's not encouraging in this picture is that it's (inflation) just going down and so far it hasn't moved back at all. So I would have expected our very aggressive purchase program to turn that process, inflation expectations would go up and actual inflation would follow behind, which is what happened in the QE2 period," said St. Louis Fed President James Bullard.

I think that Bullard is something of an outlier at this point. Ongoing declines in inflation would eventually cause his worries to spread further through the Fed, and could very well delay any effort to cut back on asset purchases. That, however, is not the baseline case. As a general rule, policymakers are more focused on the path of unemployment, which leads them to expect tapering to begin as early as in a few months. See Robin Harding here.

On the subject of tapering, Jon Hilsenrath had this to say over the weekend:

The hangup for Fed officials is the word “tapering” suggests a slow, steady and predictable reduction from the current level of $85 billion a month at a succession of Fed meetings, say to $65 billion per month, then to $45 billion and so on. And that’s not necessarily what Fed officials envision.

Because Fed officials are uncertain about the economic outlook and the pros and cons of their own program, they might reduce their bond purchases once and then do nothing for a while. Or they might cut their bond buying once and then later increase it if the economy falters. Or they might indeed reduce their purchases in a series of steps if warranted by economic developments — but they don’t want the markets to think that’s a set plan. It is, as Fed officials like to say, “data dependent.”

Which is interesting given that Bullard had this to say regarding inflation and policy:

"Maybe this is noise in the data, maybe this will turn around, but I'd like to see some reassurance that this is going to turn around before we start to taper our asset purchase program," he said.

If the Fed wants us to stop using the word "taper," they will need to take the lead. Or is Bullard just being honest - any reasonable forecast matched against their past behavior suggests the Fed tapers. On financial stability, Bullard adds this:

He noted that the Fed remains vigilant about the potential for financial market excess in the U.S. “An important concern for the FOMC is that low interest rates can be associated with excessive risk-taking in financial markets,” Bullard said. “So far, it appears that this type of activity has been limited since the end of the recession in 2009.” While the Dodd-Frank Act is meant to help contain some dimensions of this activity, “Still, this issue bears careful watching: Both the 1990s and the 2000s were characterized by very large asset bubbles,” he added.

The Fed is keeping an eye out for bubbles, but the bulk of policymakers aren't finding them. Consequently, the issue of financial stability is not a primary driver of policy. At best it is a distant third, far behind unemployment first and inflation second.

Bottom Line: Bullard remains focused on inflation. If his colleagues were to join him, they would stop pointing us toward cutting asset purchases in the next few months. As a general rule, however, for now low inflation is seen as an aberration, not the forecast.

Monday, June 10, 2013

Paul Krugman: The Big Shrug

Why don't politicians care about the unemployed?:

The Big Shrug, by Paul Krugman, Commentary, NY Times: ...For more than three years some of us have fought the policy elite’s damaging obsession with budget deficits ... that led governments to cut investment when they should have been raising it, to destroy jobs when job creation should have been their priority. That fight seems largely won —... I don’t think I’ve ever seen anything quite like the sudden intellectual collapse of austerity economics as a policy doctrine.
But while insiders no longer seem determined to worry about the wrong things, that’s not enough; they also need to start worrying about the right things — namely, the plight of the jobless and the immense continuing waste from a depressed economy. And that’s not happening. Instead, policy makers both here and in Europe seem gripped by a combination of complacency and fatalism, a sense that nothing need be done and nothing can be done. Call it the big shrug.
Even the people I consider the good guys ... aren’t showing much sense of urgency these days. For example,... the Federal Reserve’s ... talk of “tapering,” of letting up on its efforts, even though inflation is below target, the employment situation is still terrible and the pace of improvement is glacial at best. ...
Why isn’t reducing unemployment a major policy priority? One answer may be that inertia is a powerful force... As long as we’re adding jobs, not losing them, and unemployment is basically stable or falling ... policy makers don’t feel any urgent need to act.
Another answer is that the unemployed don’t have much of a political voice. ... A third answer is that while we aren’t hearing so much these days from the self-styled deficit hawks, the monetary hawks ... have, if anything, gotten even more vociferous. It doesn’t seem to matter that the monetary hawks, like the fiscal hawks, have an impressive record of being wrong about everything (where’s that runaway inflation they promised?). ...
The tragedy is that it’s all unnecessary. Yes, you hear talk about a “new normal”..., but all the reasons given for this ... fall apart when subjected to careful scrutiny. If Washington would reverse its destructive budget cuts, if the Fed would show the “Rooseveltian resolve” that Ben Bernanke demanded of Japanese officials back when he was an independent economist, we would quickly discover that there’s nothing normal or necessary about mass long-term unemployment.
So here’s my message to policy makers: Where we are is not O.K. Stop shrugging, and do your jobs.

Saturday, June 01, 2013

'Little Cause for Inflation Worries'

Remember those predictions that we'd have runaway inflation by now?:

Little Cause for Inflation Worries, by Catherine Rampell, NYT: Periodically I am asked whether we should worry about inflation, given how much money the Federal Reserve has pumped into the economy. Based on the Bureau of Economic Analysis data released Friday morning, this answer is still emphatically no.
The personal consumption expenditures, or P.C.E., price index, which the Fed has said it prefers to other measures of inflation, fell from March to April by 0.25 percent. On a year-over-year basis, it was up by just 0.74 percent. Those figures are quite low by historical standards...
When looking at price changes, a lot of economists like to strip out food and energy, since costs in those spending categories can be volatile. Instead they focus on so-called “core inflation.” On a monthly basis, core inflation was flat. But year over year, this core index grew just 1.05 percent, which is the lowest pace since the government started keeping track more than five decades ago. ...

Friday, May 10, 2013

Fed Watch: When Will The Divergence Between PCE and CPI Matter?

Tim Duy:

When Will The Divergence Between PCE and CPI Matter?, by Tim Duy: The divergence between PCE and CPI measures of inflation remains in the headlines. Pedro da Costa at Reuters sees a test of the Fed's credibility at hand:

With the inflation rate about half of the Federal Reserve's 2.0 percent target, the central bank is facing a major test and some experts wonder whether it will eventually need to ramp up its already aggressive bond buying program.

The challenge for policymakers is that they are clearly falling short of their dual mandate and that should open the door for additional asset purchases. But, but, but...I think that additional asset purchases is just about the last thing they want to do right now. We will see if their thinking evolved much at the last FOMC meeting, but the minutes of the March meeting clearly indicate that a large contingent of FOMC members are looking to end the asset purchase program by the end of this year. Take ongoing improvements in labor markets, add in concerns about financial stability, mix in some cost-benefit analysis about the efficacy of additional QE, and top-off with a dash of improving housing markets, bake at 350 for 40 minutes, and you get monetary policymakers hesitant to push the QE lever any further.

My sense is that policymakers will thus try to find reasons to dismiss falling PCE inflation as a non-issue. From an email exchange last week, today da Costa quotes me as saying:

"The Fed may view the divergence between the two measures as indicating that worries about deflation are premature," said Tim Duy, a professor of economics at the University of Oregon. "If core CPI was trending down as well, the Fed would be more likely to conclude that their inflation forecasts should be guided lower."

And also last week, Greg Ip at the Economist had this observation:

If CPI inflation were to converge to PCE inflation, that would be a concern. Goldman expects CPI inflation to drop to 1.8% in coming years and PCE inflation to rise to 1.5%. It would be preferable for both to converge to 2%; but so long as inflation expectations remain where they are, it is of little consequence for monetary policy – and a tangible plus for incomes and spending.

Yesterday, Philadelphia Federal Reserve President Charles Plosser had this to add, via the Wall Street Journal:

As of right now, “I’m not concerned” about inflation drifting too far under the central bank’s price target of 2%, Federal Reserve Bank of Philadelphia President Charles Plosser said in response to reporter’s questions at a conference here.

Inflation expectations “look pretty well anchored,” and it’s likely that price pressures as measured by the personal consumption expenditures price index will drift back up to 2% over time and reconverge with the consumer price index, he said.

Today, Chicago Federal Reserve President Charles Evans seemed resigned to low inflation. Again, from the Wall Street Journal:

“Inflation is low, and it’s lower than our long-run objective,” Mr. Evens said in an interview on Bloomberg Television, adding that he would like to see inflation closer to 2% but expects it to stay below 2% for several more years. Inflation, he said, “can be too low” when the central bank’s objective is 2%.

Asked if low inflation should prompt a policy response from the Fed, Mr. Evans said “I think it’s way too early to think like that.” In the debate over how the Fed might exit from the asset purchase program, Mr. Evans, a voting member of the policy-setting Federal Open Market Committee, said he remains “open minded [and] I’m listening to my colleagues.”

The general story seems to be that as long as inflation expectations remain anchored, and CPI inflation does not drift much below 2%, then the Fed will resist accelerating the pace of asset purchases.

Also note that the downward inflation drift is an underlying trend, or so concludes the Federal Reserve Bank of Atlanta's macroblog. The authors use a principle component model to estimate a common trend in the price data, and get these results:

Macroblog

The author's note that by this measure, the decline in PCE is not as ominous as it first seems, but it is clear that inflation by either measure is missing the Fed's target and currently trending away from that target. They conclude:

Does that mean we should ignore the recent disinflation being exhibited in the core PCE inflation measure? Well, let’s put it this way: If you’re a glass-half-full sort, we’d say that the recent disinflation trend exhibited by the PCE price index doesn’t seem to be “woven” into the detailed price data, and it certainly doesn’t look like what we saw in 2010. But to you glass-half-empty types, we’d also point out that getting the inflation trend up to 2 percent is proving to be a curiously difficult task.

Indeed, very curious given that we tend to think that at a minimum the monetary authority should be able to raise inflation rates. You are left with thinking that either the Federal Reserve still had more work to do or that monetary policy can do little more at this point than put a floor under the economy. If the latter, and if you want something more, you need to turn to fiscal policy.

Bottom Line: I suspect that at this point the Fed tends to think the costs of additional action still outweigh the benefits, and thus below-target inflation only induces pressure to maintain the current pace of QE longer than they currently anticipate rather than increase the pace of purchases.

Wednesday, May 08, 2013

About Those Inflation Fears

Via Cardiff Garcia at FT Alphaville, Inflation is falling everywhere:


(Charts via Capital Economics.)

... It’s probably worth noting that the wild fluctuations in the headline rate have had only a muted impact on core inflation in the past decade. Just something to keep in mind when you start hearing calls for policy action at the first hint of commodity price gyrations.
Capital Economics writes that there is divergence among some of the bigger emerging economies, with India and Brazil headed in opposite directions, but across the developed world the story is similar (though Japanese inflation expectations are heading higher, and are now above the eurozone’s, by one popular market measure):

Friday, May 03, 2013

Paul Krugman: Not Enough Inflation

Inflation is the wrong thing to worry about:

Not Enough Inflation, by Paul Krugman, Commentary, NY Times: Ever since the financial crisis struck, and the Federal Reserve began “printing money” in an attempt to contain the damage, there have been dire warnings about inflation...
And now, sure enough, the Fed really is worried about inflation. You see, it’s getting too low. ...
It’s not hard to see where inflation fears were coming from. In its efforts to prop up the economy, the Fed has bought more than $2 trillion of stuff — private debts, housing agency debts, government bonds. It has paid for these purchases by crediting funds to the reserves of private banks, which isn’t exactly printing money, but is close enough for government work. Here comes hyperinflation!
Or, actually, not. From the beginning, it ... should have been obvious that the financial crisis had plunged us into a “liquidity trap”... Economists who had studied such traps ... knew that some of the usual rules of economics are in abeyance as long as the trap lasts. Budget deficits, for example, don’t drive up interest rates; printing money isn’t inflationary; slashing government spending has really destructive effects on incomes and employment.
The usual suspects dismissed all this analysis; it was “liquidity claptrap,” declared Alan Reynolds of the Cato Institute. But ... the liquidity trappers seem to have been right, after all. ...
So all those inflation fears were wrong..., at this point, inflation — at barely above 1 percent by the Fed’s favored measure — is dangerously low. ...
So why is inflation falling? The answer is the economy’s persistent weakness, which keeps workers from bargaining for higher wages and forces many businesses to cut prices. And if you think about it,,,, you realize that this is a vicious circle, in which a weak economy leads to too-low inflation, which perpetuates the economy’s weakness.
And this brings us to a broader point: the utter folly of not acting to boost the economy, now.
Whenever anyone talks about the need for more stimulus, monetary and fiscal, to reduce unemployment, the response from people who imagine themselves wise is always that we should focus on the long run, not on short-run fixes. The truth, however, is that ... by letting short-run economic problems fester we’re setting ourselves up for a long-run, perhaps permanent, pattern of economic failure.
The point is that we are failing miserably in responding to our economic challenge — and we will be paying for that failure for many years to come.

Wednesday, May 01, 2013

Fed Watch: What About Inflation?

Tim Duy:

What About Inflation?, by Tim Duy: I find Binyamin Applelbaum's Fed preview to be rather depressing and distressing. Appelbaum begins with a solid insight - reducing the unemployment rate is not the same as maximizing employment:

The Federal Reserve is making modest progress in its push to reduce the unemployment rate. But that is not the jobs goal Congress actually established for the Fed. The central bank is supposed to be maximizing employment. And on that front, it is not making progress.

Applelbaum points to the employment to population ratio as evidence that the Fed is falling short of the mandate. But are Fed officials ready to do more? No:

There is little sign, however, that Fed officials are considering an expansion of their four-year-old stimulus campaign as the Fed’s policy-making committee prepares to convene Tuesday and Wednesday in Washington.

Applelbaum notes that the recent flow of data has forced monetary policymakers to back away from talk of ending large scale assets purchases. But among the reasons to avoid expansion of the program we find this:

Another reason the Fed is not embracing new measures is that it already has tied the duration of low interest rates to the unemployment rate. The Fed said in December that it intended to hold interest rates near zero at least as long as the unemployment rate remained above 6.5 percent, provided that inflation remained under control. The theory is that the economy will get as much stimulus as it needs.

But what if the inflation rate is persistently below the target? Or, worse, trending lower? Clearly then the economy is not getting the stimulus it needs. If we are missing on both targets, then the economy needs more stimulus. And while we can debate the efficacy of monetary policy in influencing the pace of employment growth, surely monetary policy can influence the inflation rate. Correct?

The distressing part of this article is that it reads as if the Fed has given up not only on its ability to influence the pace of employment growth, but also on its ability to influence the inflation rate. Or, possibly worse, that the Fed is simply no longer concerned with the inflation rate now that the obvious threat of deflation has passed. This again feeds suspicion that the Fed's 2 percent target is really an upper bound.

Bottom Line: The Fed is supposed to have a dual mandate. Dual, as in two. Maximum employment and price stability. One would think that failing at the latter would be at least as important as failing at the former. Perhaps we are learning that the Evan's rule is flawed - it should not be about only conditions before which the Fed considers removing stimulus, but also conditions by which the Fed deliberately considers adding additional stimulus. A two-side Evan's rule is needed.

Tuesday, April 30, 2013

Why Do We Use Core Inflation?

Paul Krugman:

Blogging is a bit like teaching the same class year after year; inevitably there are moments when you feel exasperated at the class’s failure to grasp some point you know you explained at length — then you realize that this was last year or the year before, and it was to a different group of people.
So, I gather that the old core inflation bugaboo is rearing its head again — the complaint that it’s somehow stupid, dishonest, or worse to measure inflation without food and energy prices, often coupled with the claim that the statistics are being manipulated anyway. So, time for a refresher. ...

Hs refresher is here. Let me offer one of my own (from 2008):

Why Do We Use Core Inflation?: There is a lot of confusion over the Fed's use of core inflation as part of its policy making process. One reason for confusion is that we using a single measure to summarize three different definitions of the term "core inflation" based upon how it is used.

First, core inflation is used to forecast future inflation. For example, this recent paper uses a "bivariate integrated moving average ... model ... that fits the data on inflation very well," and finds that the long-run trend rate of inflation "is best gauged by focusing solely on prices excluding food and energy prices." That is, this paper finds that predictions of future inflation based upon core measures are more accurate than predictions based upon total inflation.

Second, we also use the core inflation rate to measure the current trend inflation rate. Because the inflation rate we observe contains both permanent and transitory components, the precise long-run inflation rate that consumers face going forward is not observed directly, it must be estimated. When food and energy are removed to obtain a core measure, the idea is to strip away the short-run movements thereby giving a better picture of the core or long-run inflation rate faced by households. I should note, however that this is not the only nor the best way to extract the trend and the Fed also looks at other measures of the trend inflation rate that have better statistical properties. Thus while the first use of core inflation was for forecasting future inflation rates, this use of core inflation attempts to find today's trend inflation rate [There is a way to combine the first and second uses into a single conceptual framework that encompasses both, but it seemed more intuitive to keep them separate. In both cases, the idea is to find the inflation rate that consumers are likely to face in the future.]

Let me emphasize one thing. If the question is "what is today's inflation rate," the total inflation rate is the best measure. It's intended to measure the cost of living and there's no reason at all to strip anything out. It's only when we ask different questions that different measures are used.

Third, and this is the function that is ignored most often in discussions of core inflation, but to me it is the most important of the three. The inflation target that best stabilizes the economy (i.e. best reduces the variation in output and employment) is a version of core inflation.

In theoretical models used to study monetary policy, the procedure for setting the policy rule is to find the monetary policy rule that maximizes household welfare (by minimizing variation in variables such as output, consumption, and employment). The rule will vary by model, but it usually involves a measure of output and a measure of prices, and those measures can be in levels, rates of change, or both depending upon the particular model being examined.

In general, a Taylor rule type framework comes out of this process ( i.e. a rule that links the federal funds rate to measures of output and prices). However, in the policy rule, the best measure of prices is usually something that looks like a core measure of inflation. Essentially, when prices are sticky, which is the most common assumption driving the interaction between policy and movements in real variables in these models, it's best to target an index that gives most of the weight to the stickiest prices (here's an explanation as to why from a post that echoes the themes here).  That is, volatile prices such as food and energy are essentially tossed out of the index used in the policy rule.

The indexes that come out of this type of theoretical exercise often includes both output and input prices, and occasionally asset prices as well. That is, a core measure of inflation composed of just output prices isn't the best thing for policymakers to target, a more general core inflation rate combining both input and output prices works better. ...

Finally, there is also a question of what we mean by inflation conceptually. Does a change in relative prices, e.g. from a large increase in energy costs, that raises the cost of living substantially count as inflation, or do we require the changes to be common across all prices as would occur when the money supply is increased? Which is better for measuring the cost of living? Which is a better target for stabilizing the economy? The answers may not be the same. For a nice discussion of this topic, see this speech given yesterday by Dennis Lockhart, President of the Atlanta Fed:

Inflation Beyond the Headlines, by Dennis P. Lockhart, President, Federal Reserve Bank of Atlanta: ...Let me begin by posing the simple question: What do we mean by "inflation"? The answer to that simple question isn't as simple as it may seem.

The popular treatment of inflation in our sound bite society risks confusing inflation with relative price movements and the cost of living. By cost of living, I'm referring to the costs you and I incur to maintain our level of consumption of various goods and services including essential items such as food, gasoline, and lodging. 

Relative price movements occur continuously in an economy as individual prices react to market forces affecting that good or service. Neither relative price movements nor sustained high living costs constitute inflation as economists commonly use the term....

And I think I'll end with this part of his remarks:

Attempts to measure the aggregate rate of price change—no matter how sophisticated—remain imperfect. As a result, when it comes to measuring inflation, judgment is needed to distinguish persistent price movements that underlie overall inflation from the relative price adjustments. Separating the inflation signal from noise involves much uncertainty—especially when making decisions in real time. Discerning accurately the underlying trend is difficult. It is essential for those of us who have responsibility for responding to these trends to use a wide variety of core measures and inflation projections to make the most informed judgment we can.

Monday, April 15, 2013

Paul Krugman: The Antisocial Network

The two huge misconceptions surrounding goldbugism and bitbugism:

The Antisocial Network, by Paul Krugman, Commentary, NY Times: Bitcoin’s wild ride may not have been the biggest business story of the past few weeks, but it was surely the most entertaining. Over the course of less than two weeks the price of the “digital currency” more than tripled. Then it fell more than 50 percent in a few hours. ...
The biggest declared investors in bitcoins are the Winklevoss brothers ... and they make claims for the digital product similar to those made by goldbugs... “We have elected,” declared Tyler Winklevoss recently, “to put our money and faith in a mathematical framework that is free of politics and human error.”
The similarity to goldbug rhetoric isn’t a coincidence, since goldbugs and bitcoin enthusiasts — bitbugs? — tend to share both libertarian politics and the belief that governments are vastly abusing their power to print money. ...
However,... let’s focus on the two huge misconceptions — one practical, one philosophical — that underlie both goldbugism and bitbugism.
The practical misconception here — and it’s a big one — is ... that we live in an era of wildly irresponsible money printing, with runaway inflation just around the corner... The truth is that Ben Bernanke’s promises that his actions wouldn’t be inflationary have been vindicated..., while goldbugs’ dire warnings of inflation keep not coming true.
The philosophical misconception, however, seems to me to be even bigger. Goldbugs and bitbugs alike seem to long for a pristine monetary standard, untouched by human frailty. But that’s an impossible dream. Money is, as Paul Samuelson once declared, a “social contrivance,” not something that stands outside society. Even when people relied on gold and silver coins, what made those coins useful wasn’t the precious metals they contained, it was the expectation that other people would accept them as payment.
Actually, you’d expect the Winklevosses, of all people, to get this, because in a way money is like a social network, which is useful only to the extent that other people use it. But I guess some people are just bothered by the notion that money is a human thing, and want the benefits of the monetary network without the social part. Sorry, it can’t be done.
So do we need a new form of money? I guess you could make that case if the money we actually have were misbehaving. But it isn’t. We have huge economic problems, but green pieces of paper are doing fine — and we should let them alone.

Friday, April 12, 2013

Paul Krugman: Lust for Gold

What explains "goldbuggism"?:

Lust for Gold, by Paul Krugman, Commentary, NY Times: News flash: Recent declines in the price of gold, which is off about 17 percent from its peak, show that this price can go down as well as up. You may consider this an obvious point, but ... it has come as a rude shock to many small gold investors, who imagined that they were buying the safest of all assets.
And thereby hangs a tale. One of the central facts about modern America is that everything is political; on the right, in particular, people choose their views about everything, from environmental science to gun safety, to suit their political prejudices. And the remarkable recent rise of “goldbuggism,” in the teeth of all the evidence, shows that this politicization can influence investments as well as voting.
What do I mean by goldbuggism? Not the notion that buying gold sometimes makes sense..., gold is like a very long-term bond that’s protected from inflation...
No, being a goldbug means asserting that gold offers unique security in troubled times; it also means asserting that all would be well if we abolished the Federal Reserve and returned to the good old gold standard... And both forms of goldbuggism soared after ... the financial crisis of 2008... (although that surge has abated a bit since 2011). But why..., how can we rationalize the modern goldbug position? Basically, it depends on the claim that runaway inflation is just around the corner. ...

Conservative-minded people tend to support a gold standard — and to buy gold — because they’re very easily persuaded that “fiat money” ... created ... to stabilize the economy is really just part of the larger plot to take away their hard-earned wealth and give it to you-know-who.
But the runaway inflation that was supposed to follow reckless money-printing — inflation that the usual suspects have been declaring imminent for four years and more — keeps not happening. For a while, rising gold prices helped create some credibility for the goldbugs even as their predictions about everything else proved wrong, but now gold as an investment has turned sour, too. So will we be seeing prominent goldbugs change their views, or at least lose a lot of their followers?
I wouldn’t bet on it. In modern America, as I suggested at the beginning, everything is political; and goldbuggism, which fits so perfectly with common political prejudices, will probably continue to flourish no matter how wrong it proves.

Thursday, March 14, 2013

Inflation is *Not* What We Should Be Worried About

Dave Henderson responds to an article called "If There's No Inflation, Why are Prices Up So Much?":

...the main thing he does in the ... article is look selectively at relative prices that have increased a lot...

I had started a response to the same article a couple of days ago, and then decided to let it go. But I may as well resurrect it. As noted, the article looks selectively at a few prices that have gone up a lot, and then asks "why haven’t these more rapid increases shown up in the Consumer Price Index?" They have, but they are offset by falling prices elsewhere. This is easy to see in the underlying data.

This is the PCE rather than the CPI, but the story is the same (this is what the Fed monitors, and it's a better measure to look at anyway -- I used month-to-month data because it seems like the article used a similar measure -- year over year is less volatile, but again the story is basically the same). Shown below is a list of the inflation rates for the individual components that make up the PCE (the changes are from December to January, the latest data available). Notice how many prices of the goods and services consumed by a typical household fell on a month-to-month basis. You rarely hear people talking about how well they made out due to falling prices, but you hear a lot --- see the article -- about prices that are going up (the overall month-to-month figure, where prices are weighted by their share of a typical consumption basket, was 0.2 percent, i.e. less than one percent -- that means price increases and price decreases nearly canceled each other out).

Despite scare stories in the media about all the hidden inflation, it's just not there. Thus, there's no reason for the Fed to start raising interest rates to combat this phantom threat. If inflation (or the threat of inflation) does kick-up, we'll have to balance the costs of higher than expected inflation with the costs of fighting it and prolonging the recovery of output and employment -- even then, relative to a moderate outbreak of inflation I think unemployment is the more important problem to address -- but presently it's not a close call at all. Alleviating unemployment and all the struggles that come with it ought to be our top priority.

[Note: The entries marked in yellow are the trim points for the Dallas Fed's trimmed mean estimate of the inflation rate (which is similar to excluding food and energy). Inflation was 1.3 percent from December to January according to the trimmed-mean measure (excluding food and energy gives an estimate of 1.8 percent). People usually complain that trimming volatile prices from the inflation measure hides inflation that hits households, e.g. it hides increases in the price of gas. But in this case excluding volatile prices such as food and energy increases the measured inflation rate from .2 percent to either 1.3 percent or 1.8 percent depending on which prices are excluded. The very first entry in the table helps to explain why.]

Component Annualized 1-month % change
PCE: Gasoline & Other Motor Fuel Price Index   -32.7
Personal Consumption Expenditures: Clothing Materials Price Index   -30.9
Personal Consumption Expenditures: Sewing Items Price Index   -30.9
Personal Consumption Expenditures: Commercial Banks Price Index   -26.1
Sales Receipts: Foundatns/Grant Making/Giving Svcs to HH Price Idx  -25.8
Personal Consumption Expenditures: Eggs  Price Index   -21.0
Personal Consumption Expenditures: Photographic Equip Price Index   -20.4
Personal Consumption Expenditures: Natural Gas  Price Index   -18.7
Personal Consumption Expenditures: Fresh Fruit  Price Index   -18.6
PCE: Film & Photographic Supplies Price Index   -15.7
PCE: Othr Depository Instns & Regulated Invest Companies Price Idx  -12.8
PCE: Sporting Equip, Supplies, Guns & Ammunition Price Index   -12.0
PCE: Employment Agcy Services Price Index   -10.3
PCE: Computer Software & Acc Price Index   -10.0
PCE: Net Health Insurance Price Index   -9.5
Personal Consumption Expenditures: Tires Price Index   -9.2
PCE: Personal Computers & Peripheral Equip Price Index   -8.2
Personal Consumption Expenditures: Other Meats  Price Index   -8.1
Personal Consumption Expenditures: Furniture Price Index   -7.5
PCE: Household Cleaning Products Price Index   -7.3
Personal Consumption Expenditures: Fats and Oils Price Index   -7.2
PCE: Coffee, Tea & Other Beverage Mtls Price Index   -7.1
PCE: Children's & Infants' Clothing Price Index   -7.0
Personal Consumption Expenditures: Nursing Homes  Price Index   -6.8
PCE: Mineral Waters, Soft Drinks & Vegetable Juices Price Index   -6.7
PCE: Moving, Storage & Freight Services Price Index   -6.5
PCE: Hair/Dental/Shave/Misc Pers Care Prods ex Elec Prod Price Idx  -6.0
PCE: Elec Appliances for Personal Care Price Index   -6.0
PCE: Motor Vehicle Leasing Price Index   -6.0
Personal Consumption Expenditures: Cereals Price Index   -5.9
PCE: Flowers, Seeds & Potted Plants Price Index   -5.8
Personal Consumption Expenditures: Fresh Milk  Price Index   -5.4
PCE: Food Products, Not Elsewhere Classified Price Index   -5.2
Personal Consumption Expenditures: Window Coverings  Price Index   -5.1
Personal Consumption Expenditures: Wine Price Index   -5.0
Personal Consumption Expenditures: Lubricants & Fluids Price Index  -4.7
Personal Consumption Expenditures: Air Transportation Price Index   -4.6
PCE: Nonprescription Drugs Price Index   -4.0
Personal Consumption Expenditures: Social Assistance Price Index   -4.0
PCE: Stationery & Misc Printed Mtls Price Index   -3.9
Personal Consumption Expenditures: Televisions Price Index   -3.1
PCE: Maintenance & Repair of Rec Vehicles & Sports Eqpt Price Idx  -2.6
PCE: Processed Dairy Products Price Index   -2.5
PCE: Cosmetic/Perfumes/Bath/Nail Preparatns & Implements Price Idx  -2.3
Personal Consumption Expenditures: Fuel Oil  Price Index   -2.0
Personal Consumption Expenditures: Beef and Veal  Price Index   -2.0
PCE: Tax Preparation & Other Related Services Price Index   -1.8
PCE: Misc Household Products Price Index   -1.7
Personal Consumption Expenditures: Other Video Equip Price Index   -1.6
Personal Consumption Expenditures: Physician Services Price Index   -1.0
PCE: Veterinary & Other Services for Pets Price Index   -1.0
PCE: Household Paper Products Price Index   -0.7
PCE: Tools, Hardware & Supplies Price Index   -0.6
Personal Consumption Expenditures: Jewelry  Price Index   -0.6
PCE: Major Household Appliances Price Index   -0.2
Personal Consumption Expenditures: Accessories & Parts Price Index  0.0
Personal Consumption Expenditures: Prescription Drugs Price Index   0.1
PCE: Other Medical Products Price Index   0.3
PCE: Therapeutic Medical Equip Price Index   0.3
Personal Consumption Expenditures: Casino Gambling Price Index   0.3
Personal Consumption Expenditures: Lotteries  Price Index   0.3
PCE: Pari-Mutuel Net Receipts Price Index   0.3
Personal Consumption Expenditures: Legal Services Price Index   0.6
Personal Consumption Expenditures: Prof Assn Dues Price Index   0.6
PCE: Net Motor Vehicle & Other Transportation Insur Price Index   0.6
Personal Consumption Expenditures: New Light Trucks Price Index   0.9
PCE: Motion Picture Theaters Price Index   0.9
Personal Consumption Expenditures: Used Autos Price Index   0.9
Personal Consumption Expenditures: Museums & Libraries Price Index  0.9
PCE: Live Entertainment, ex Sports Price Index   0.9
PCE: Nonprofit Hospitals' Services to Households Price Index   1.0
PCE: Proprietary Hospitals Price Index   1.0
Personal Consumption Expenditures: Spirits  Price Index   1.0
Personal Consumption Expenditures: Govt Hospitals Price Index   1.0
Personal Consumption Expenditures: Taxicabs  Price Index   1.0
PCE: Intercity Mass Transit Price Index   1.0
PCE: Financial Service Charges, Fees & Commissions Price Index   1.1
Personal Consumption Expenditures: Used Light Trucks Price Index   1.3
PCE: Paramedical Services Price Index   1.4
Personal Consumption Expenditures: Motorcycles  Price Index   1.4
PCE: Other Purchased Meals Price Index   1.5
PCE: Video Cassettes & Discs, Blank & Prerecorded Price Index   1.5
Personal Consumption Expenditures: Beer  Price Index   1.5
Personal Consumption Expenditures: Pleasure Aircraft Price Index   1.6
Personal Consumption Expenditures: Pleasure Boats Price Index   1.6
PCE: Other Recreational Vehicles Price Index   1.6
Personal Consumption Expenditures: Bicycles & Acc Price Index   1.6
PCE: Pets & Related Products Price Index   1.8
Personal Consumption Expenditures: Watches Price Index   2.0
Final Consumptn Exps of Nonprofit Instns Serving HH Price Idx  2.0
PCE: Alcohol in Purchased Meals Price Index   2.1
PCE: Amusement Parks, Campgrounds & Related Recral Svcs Price Idx   2.1
PCE: Garbage & Trash Collection Price Index   2.1
Personal Consumption Expenditures: Package Tours  Price Index   2.1
PCE: Owner-Occupied Mobile Homes Price Index   2.2
PCE: Rental Value of Farm Dwellings Price Index   2.2
PCE: Owner-Occupied Stationary Homes Price Index   2.2
Personal Consumption Expenditures: Recreational Books Price Index   2.2
Personal Consumption Expenditures: Spectator Sports  Price Index   2.3
PCE: Other Household Services Price Index   2.3
PCE: Standard Clothing Issued to Military Personnel Price Index   2.6
PCE: Tenant-Occupied Stationary Homes Price Index   2.7
PCE: Tenant-Occupied Mobile Homes Price Index   2.7
Personal Consumption Expenditures: Group Housing   Price Index   2.7
PCE: Other Personal Business Services Price Index   2.8
PCE: Hairdressing Salons & Personal Grooming Estab Price Idx  3.0
PCE: Membership Clubs & Participant Sports Centers Price Index   3.1
PCE: Luggage & Similar Personal Items Price Index   3.2
Personal Consumption Expenditures: Communication Price Index   3.5
PCE: Shoes & Other Footwear Price Index   3.5
Personal Consumption Expenditures: Domestic Services Price Index   3.7
PCE: Food Supplied to Military Price Index   3.7
PCE: Elementary & Secondary School Lunches Price Index   3.7
PCE: Food Supplied to Civilians Price Index   3.7
PCE: Higher Education School Lunches Price Index   3.7
PCE: Elementary & Secondary Schools Price Index   3.8
PCE: Outdoor Equip & Supplies Price Index   4.0
Personal Consumption Expenditures: Fish and Seafood  Price Index   4.1
PCE: Motor Vehicle Maintenance & Repair Price Index   4.3
Personal Consumption Expenditures: New Domestic Autos Price Index   4.3
Personal Consumption Expenditures: New Foreign Autos Price Index   4.3
PCE: Parking Fees & Tolls Price Index   4.3
PCE: Net Household Insurance Price Index   4.5
Personal Consumption Expenditures: Pork Price Index   4.7
Personal Consumption Expenditures: Child Care  Price Index   4.8
PCE: Day Care & Nursery Schools Price Index   4.8
PCE: Corrective Eyeglasses & Contact Lenses Price Index   4.9
PCE: Water Supply & Sewage Maintenance Price Index   5.2
Personal Consumption Expenditures: Housing at Schools Price Index   5.3
Personal Consumption Expenditures: Dental Services  Price Index   5.3
PCE: Audio-Video, Photographic & Info Processing Svcs Price Index   5.5
Personal Consumption Expenditures: Life Insurance  Price Index   5.7
PCE: Water Transportation Price Index   5.7
PCE: Prerec/Blank Audio Disc/Tape/Digital Files/Download Price Idx  6.1
Personal Consumption Expenditures: Bakery Products  Price Index   6.4
PCE: Telephone & Facsimile Equip Price Index   6.5
PCE: Calculators/Typewriters/Othr Info Processing Eqpt Price Idx  6.5
Personal Consumption Expenditures: Musical Instruments Price Index  6.5
Personal Consumption Expenditures: Tobacco  Price Index   6.7
PCE: Funeral & Burial Services Price Index   7.0
PCE: Processed Fruits & Vegetables Price Index   7.0
PCE: Social Advocacy & Civic & Social Organizations Price Index   7.9
PCE: Religious Organizations' Services to Households Price Index   8.2
PCE: Laundry & Dry Cleaning Services Price Index   8.2
PCE: Tenant Landlord Durables Price Index   8.3
Personal Consumption Expenditures: Sugar and Sweets  Price Index   8.5
Personal Consumption Expenditures: Educational Books Price Index   8.7
Personal Consumption Expenditures: Poultry Price Index   9.1
PCE: Carpets & Other Floor Coverings Price Index   9.3
PCE: Proprietary & Public Higher Education Price Index   9.8
PCE: Nonprofit Pvt Higher Education Svcs to Households Price Index  9.8
PCE: Nonelectric Cookware & Tableware Price Index   10.3
PCE: Labor Organization Dues Price Index   11.2
Personal Consumption Expenditures: Other Fuels Price Index   11.4
PCE: Railway Transportation Price Index   11.5
PCE: Clock/Lamp/Lighting Fixture/Othr HH Decorative Item Price Idx  11.7
PCE: Men's & Boys' Clothing Price Index   12.2
Personal Consumption Expenditures: Household Linens  Price Index   13.0
PCE: Repair of Household Appliances Price Index   13.8
PCE: Repair of Furn, Furnishings & Floor Coverings Price Index   13.8
Personal Consumption Expenditures: Electricity   Price Index   14.0
PCE: Commercial & Vocational Schools Price Index   15.1
Personal Consumption Expenditures: Audio Equipment Price Index   16.8
PCE: Women's & Girls' Clothing Price Index   17.4
Personal Consumption Expenditures: Intercity Buses Price Index   18.0
PCE: Other Road Transportation Service Price Index   18.0
Personal Consumption Expenditures: Hotels and Motels Price Index   18.0
PCE: Clothing Repair, Rental & Alterations Price Index   18.4
PCE: Repair & Hire of Footwear Price Index   18.4
PCE: Misc Personal Care Services Price Index   18.4
Personal Consumption Expenditures: Pension Funds Price Index   20.5
PCE: Small Elec Household Appliances Price Index   21.6
PCE: Games, Toys & Hobbies Price Index   21.8
Personal Consumption Expenditures: Fresh Vegetables Price Index   32.2
PCE: Newspapers & Periodicals Price Index   37.6
Personal Consumption Expenditures: Dishes and Flatware Price Index  66.2
PCE: Motor Vehicle Rental Price Index   78.6
PCE: Food Produced & Consumed on Farms Price Index   124.4

Wednesday, March 06, 2013

How Much Should We Worry About Debt, Inflation, and Unemployment?

Here are the slides from a talk I gave last night:

How Much Should We Worry About Debt, Inflation, and Unemployment? (ppt ) (pdf)

The last slide concludes with:

We face a tradeoff. Attempts to lower unemployment can increase the risk of inflation and increase the debt . The reverse is true as well. Attempts to lower the debt and reduce the risk of inflation can increase unemployment.

In my view, presently we are too worried about inflation and debt, and not worried enough about unemployment.

Thursday, January 31, 2013

There Is An Inflation Problem: It's Falling Below Target

Inf[data source]

Annualized 6 and 12 Month Trimmed Mean
PCE Inflation Rates from 1/12 - 12/12


6-month 12-month
Jan-12 2.02 2.08
Feb-12 1.86 2.02
Mar-12 1.97 2.02
Apr-12 1.96 1.94
May-12 1.85 1.89
Jun-12 1.75 1.87
Jul-12 1.62 1.82
Aug-12 1.62 1.74
Sep-12 1.54 1.75
Oct-12 1.44 1.70
Nov-12 1.45 1.65
Dec-12 1.34 1.55

Tuesday, January 29, 2013

'Trillion Dollar Deficits are Sustainable for Now – Unfortunately'

John Makin and Daniel Hanson of the conservative American Economic Institute talk sense on the deficit. Now if we could just get them over their inflation fears -- the source of the "unfortunately" part of the title -- we might be able to get somewhere in addressing our biggest problem right now, high and persistent unemployment, and enhance our long-tern growth prospects at the same time:

Trillion dollar deficits are sustainable for now – unfortunately, by John H. Makin and Daniel Hanson, Commentary, FT: An abrupt spending sequester at a rate of about $110bn per year ($1.1tn over 10 years) scheduled to begin March 1 could cause a US recession, coming as it does on top of tax increases worth about 1.5 per cent of GDP enacted in January. The April deadline for a continuing resolution to fund federal spending could lead to a fight that shuts down the government, placing a further drag on growth.
These ad hoc measures, aimed at creation of an artificial crisis, will fail to produce prompt, sustainable progress towards reduction of “unsustainable” deficits because deficits have been, and will continue to be for some time, eminently sustainable. The Chicken Little “sky is falling” approach to frightening Congress into significant deficit reduction has failed because the sky has not fallen. Interest rates have not soared as promised... Trillion-dollar federal budget deficits have continued to be sustainable because the federal government is able to finance them at interest rates of half a per cent or less. Two per cent inflation means that the real inflation-adjusted cost of deficit finance averages −1.5 per cent...
The real danger facing American policy makers is ... the current sustainability of trillion-dollar deficits, thanks to very low borrowing costs relative to GDP growth. Eventually, the Federal Reserve’s QE programme of large government debt purchases at a current rate of $800bn per year, largely aimed at sustaining the growth of outlays on entitlements that do not support economic growth, will cause inflation to rise. The Fed’s latest move to target the unemployment rate with more quantitative easing only adds to the threat of inflation because the only way monetary policy can affect growth or employment is by engineering a higher-than-expected rate of inflation.
Despite the current absence of rising inflation, Washington is flirting with a debt trap, where abrupt austerity forced by the sequester and/or a government shut down would actually boost the ratio of debt to GDP by depressing growth too rapidly. That outcome will be far more costly in terms of forgone income and unemployment than moving preemptively to reduce American primary deficits to about 3 per cent of GDP over a half decade. ...
By 2018, once the debt-to-GDP ratio has stabilised under such a programme, reducing the primary deficit to 2 percent a year (given a growth rate of 3 percent above borrowing costs) will reduce the debt-to-GDP ratio gradually by 1 per cent a year. That is the meaning of sustainable long-run reduction of government debt relative to income, which will ensure moderate deficit financing costs for decades to come.

I can't let this pass:

the Federal Reserve’s QE programme of large government debt purchases at a current rate of $800bn per year, largely aimed at sustaining the growth of outlays on entitlements that do not support economic growth...

That's NOT what Fed policy is aimed at. There is no third part of its mandate that says it needs to sustain the growth of entitlements. (And the casual, but empirically unsupported claim that entitlement spending is anti-growth is troublesome as well.)

Wednesday, January 23, 2013

'King Stands by Inflation Targeting'

I don't get this argument from Bank of England governor Mervyn King:

The governor of the Bank of England... Sir Mervyn King ... dismissed suggestions made by his designated successor, Mark Carney, now governor of the Bank of Canada, for the Bank to ease monetary policy further by abandoning its inflation target if meaningful growth continues to elude the UK. Mr Carney succeeds him at the start of July. ...
With the UK government pursuing fiscal consolidation, monetary policy has been the mainstay of policy makers’ strategy to boost economic output... But the governor, speaking in Belfast, warned against over-reliance on monetary easing. “In many countries, including the UK, fiscal policy is constrained by the size of government indebtedness, and monetary policy has come to be seen as the only game in town,” Sir Mervyn said. “Relying on monetary policy alone, however, is not a panacea.”

That says nothing at all about whether monetary policy should be easier, tighter, or is currently just right. Actually, he does offer this:

The governor suggested the government should introduce supply-side reforms to support the UK’s shift towards higher exports and lower imports.
“It cannot be for a central bank to design a programme of such supply initiatives, but in economic terms there has never been a better time for supply-side reform,” he said.

He is suggesting that the UK's problems are entirely on the supply-side, and that further demand side measures cannot help (e.g. through further monetary easing). Bluntly, I think that's wrong. I have my doubts about nominal GDP targeting as the solution to our economic problems, but that doesn't imply that the current policy approach is optimal, or that deviating from a strict inflation target in the short-run (or the path to the target) cannot help.

Monday, January 21, 2013

Fed Watch: Is There a Big Inflation Mystery in Greece?

Tim Duy:

Is There a Big Inflation Mystery in Greece?, by Tim Duy: Tyler Cowen confuses me:

The rates of price inflation in Greece have been running in the range of 0.8% to 2%...It’s funny how many people pretend to understand what is going on here. If Greece were seeing a stronger bout of price deflation, the situation would be much clearer.

This seems to me to be a case of trying to find a problem where none exists. Greece consumer prices excluding energy:

Greece1

What part of the deflation is not clear? Seems like any inflation is being driven by energy costs:

Greece2

So what going on in the energy sector? Stories like this:

Greeks cutting back on household expenses are turning from oil to wood to heat their homes, but in turn are filling the night air with potentially hazardous pollutants, health care officials have warned.

The coalition government, under pressure from the EU-IMF-ECB Troika to impose more austerity measures, has pushed the price of heating oil to about 1.50 euros per litre by raising the tax on heating oil by 40 percent. Besides being a revenue-raiser, the government said the tax was meant to deter people from putting the oil in their cars instead of more expensive diesel.

And:

Greece raised electricity prices for households by up to 15 percent this year to help state-controlled power company PPC cover costs for transmission rights, the government said on Sunday...

...They come after a 9.2 percent average increase in prices last year.

PPC is the dominant player in the Greek energy market, and the country's EU and IMF lenders are pressing the government to make room for private companies. The company's tariffs are regulated by the state.

The Troika is remaking the energy sector, with the consequence of rising prices in a way that looks like a sectoral supply shock that is very obviously distinct from the demand side disturbance. What exactly is the big mystery here?

Saturday, January 19, 2013

Sumner's Reply to Altig

Scott Sumner replies to David Altig :

David Altig on NGDPLT

[See here for David's post.]

Tuesday, January 08, 2013

'Inflation versus Price-Level Targeting in Practice'

David Altig and Mike Bryan argue that if the Fed had adopted a price-level target instead of an inflation target, it wouldn't have made much practical difference for policy:

Inflation versus Price-Level Targeting in Practice, by David Altig and Mike Bryan: In last Wednesday's Financial Times, Scott Sumner issued a familiar indictment of "modern central banking practice" for failing to adopt nominal gross domestic product (GDP) targets, for which he has been a major proponent. I have expressed my doubts about nominal GDP targeting on several occasions—most recently a few posts back—so there is no need to rehash them. But this passage from Professor Sumner's article provoked my interest:

Inflation targeting also failed because it targeted the growth rate of prices, not the level. When prices fell in the U.S. in 2009, the Federal Reserve did not try to make up for that shortfall with above target inflation. Instead it followed a "let bygones be bygones" approach.

In principle, there is no reason why a central bank consistently pursuing an inflation target can't deliver the same outcomes as one that specifically and explicitly operates with a price-level target. Misses with respect to targeted inflation need not be biased in one direction or another if the central bank is truly delivering on an average inflation rate consistent with its stated objective.

So how does the Federal Reserve—with a stated 2-percent inflation objective—measure up against a price-level targeting standard? The answer to that question is not so straightforward because, by definition, a price-level target has to be measured relative to some starting point. To illustrate this concept, and to provide some sense of how the Fed would measure up relative to a hypothetical price-level objective, I constructed the following chart.

Mb_130107

Consider the first point on the graph, corresponding to the year 1993. (I somewhat arbitrarily chose 1993 as roughly the beginning of an era in which the Fed, intentionally or not, began operating as if it had an implicit long-run inflation target of about 2 percent.) This point on the graph answers the following question:

By what percent would the actual level of the personal consumption expenditure price index differ from a price-level target that grew by 2 percent per year beginning in 1993?

The succeeding points in the chart answer that same question for the years 1994 through 2009.

Here's the story as I see it:

  1. If you accept that the Fed, for all practical purposes, adopted a 2 percent inflation objective sometime in the early to mid-1990s, there arguably really isn't much material distinction between its inflation-targeting practices and what would have likely happened under a regime that targeted price-level growth at 2 percent per annum. The actual price level today differs by only about 1/2 to 1 1/2 percentage points from what would be implied by such a price-level target.

    Hitting a single numerical target for the price level at any particular time is of course not realistic, so an operational price-level targeting regime would have to include a description of the bounds around the target that defines success with respect to the objective. Different people may have different views on that, but I would count being within 1 1/2 percentage points of the targeted value over a 20-year period as a clear victory.

  2. If you date the hypothetical beginning of price-level targeting sometime in the first half of the 2000s, then the price level would have deviated above that implied by a price-level target by somewhat more. There certainly would be no case for easing to get back to the presumed price-level objective.

  3. A price-level target would start to give a signal that easing is in order only if you choose the reference date for the target during the Great Recession—2008 or 2009.

I'm generally sympathetic to the idea of price-level targeting, and I believe that an effective inflation-targeting regime would not "let bygones be bygones" in the long run. I also believe that the Federal Open Market Committee (FOMC) has effectively implemented the equivalent price-level target outcomes via its flexible inflation-targeting approach over the past 15 to 20 years (as suggested in point number 1 above).

In fact, the FOMC has found ample scope for stimulus in the context of that flexible inflation targeting approach (which honors the requirements of the Fed's dual mandate of price stability and maximum employment). I just don't think it is necessary or helpful to recalibrate an existing implicit price-level target by restarting history yesterday.

Wednesday, December 19, 2012

Inflation is Caused by Monopoly Power?

Why would a reputable economist endorse nonsense like this from Mickey Kaus (you know who you are):

If increased concentration lets ”corporations use their growing monopoly power to raise prices” couldn’t that be, you know, inflationary? But Krugman’s spent another trillion pixels lecturing us about how inflation is not a threat. Discuss.

One possible answer, Krugman Derangement Syndrome. [There's more nonsense where that came from, and not just in this article, but I just can't link the Daily Caller in good conscience.]

Monday, December 17, 2012

Is the Fed Risking "Dangerous Side Effects"?

Robert Samuelson:

The Fed rolls the dice, by Robert J. Samuelson, Commentary, Washington Post: It was big news last week when the Federal Reserve announced that it wants to maintain its current low-interest rate policy until unemployment, now 7.7 percent, drops to at least 6.5 percent. The Fed was correctly portrayed as favoring job creation over fighting inflation, though it also set an inflation target of 2.5 percent. What was missing from commentary was caution based on history: the Fed has tried this before and failed — with disastrous consequences.
By “this,” I mean a twin targeting of unemployment and inflation. In the 1970s, that’s what the Fed did. Targets weren’t announced but were implicit. The Fed pursed the then-popular goal of “full employment,” defined as a 4 percent unemployment rate; annual inflation of 3 percent to 4 percent was deemed acceptable. The result was economic schizophrenia. Episodes of easy credit to cut unemployment spurred inflation... By 1980, inflation was 13 percent and unemployment, 7 percent. ...
Today’s problem is similar. Although the Fed has learned much since the 1970s ... its economic understanding and powers are still limited. It can’t predictably hit a given mix of unemployment and inflation. Striving to do so risks dangerous side effects, including a future financial crisis. ...
It’s seductive to think the Fed can engineer the desired mix of unemployment and inflation. And the motivation is powerful. About 5 million Americans have been jobless for six months or more. The present job market represents, as Bernanke said, “an enormous waste of human and economic potential.” But the Fed is bumping against the limits of its powers. Are potential short-term benefits worth the long-term risks? It’s a close call.

What does he think a dual mandate means if not the "twin targeting of unemployment and inflation"? That's not unique to the 1970s, it's essentially the Taylor rule (the Taylor principle comes into play as well, but I want to focus on something else). Anyway, he is trying to tell the story about shifting Phillips curve due to rising inflationary expectations, but he misses a key part of the story. A popular explanation for problems in the 1970s, one I think has a lot of veracity, is that the Fed was shooting at the wrong unemployment target (you can find this story in most textbooks, e.g. see Mishkin's text on demand-pull inflation). The Fed was shooting at a 4 percent unemployment target, but because of a large influx of new workers from the baby boom and women entering the workforce, the natural rate of unemployment was actually much higher than 4 percent (new workers tend to have high frictional unemployment rates, and there were also structural changes going on within the economy that led to a higher natural rate of unemployment as well). All told, it's not unreasonable to think of the natural rate had drifted as high as 7 percent, maybe even higher. It eventually came down to closer to 4 percent as the surge of new workers ended and structural change abated somewhat, but for awhile it was elevated above the Fed's 4 percent target. Unfortunately, the Fed didn't not realize this.

Here's how the story goes. The Fed, seeing unemployment drifting toward its natural rate of, say, 7 percent responded to its full employment mandate by using more aggressive policy to create inflation. In the short-run, the policy worked, unemployment did fall due to the inflationary surprise, but as soon as people adjusted their inflationary expectations (and demanded higher wages, etc.), the Phillips curve shifted and we ended up with the inflation we wanted, but the employment gains were lost as the unemployment rate moved toward its natural rate of 7 percent. At that point the Fed says to itself, we must not have been aggressive enough, we need a second round of stimulus and it pumps up the inflation rate even further. Again, this works so long as the inflation is a surprise, unemployment falls in the short-run, but as soon as inflationary expectations adjust once again the employment gains are eliminated, but the inflation remains. As this continues, inflation continues to drift upward until eventually we end up with double-digit inflation and nothing whatsoever to show for it in terms of employment gains.

The fundamental problem here is a miscalculation of the natural rate of the natural rate of unemployment. So the question is, has the Fed made this mistake again? Is the natural rate of unemployment a lot higher than 6.5 percent so that shooting for this target is likely to end up with double-digit, 1970s type inflation?

No for several reasons. First, the Fed is fully aware of this past mistake, and many opposed more stimulus for precisely this reason (e.g. Narayana Kockerlakoata would not support more stimulus until Bernanke convinced him in a series of phone calls that the employment problem was largely cyclical, not structural). If they are shooting at the wrong target, then the policy will not work and they will not continue doing so as they did in the 1970s. They are much more aware of the signs to look for that indicate they've made this mistake. Second, there has been considerable effort to measure the structural/cyclical/frictional unemployment mix for precisely this reason, and the estimates, for the most part, point to a mostly cyclical problem. We didn't have this type of information in the 1970s, in fact we weren't even asking this question. We simply assumed that full employment meant 4 percent and set policy accordingly. Finally, there is an inflation threshold of 2.5 percent, a relatively low level of tolerance for mistakes of this type. If the Fed is wrong about the structural rate, we'll see inflation, and if it the projected inflation rate drifts above 2.5 percent, the program will be reversed. I have no doubt that the Fed is serious abut pulling the plug if inflation rises above 2.5 percent. That's true even if unemployment is still above 6.5 percent.

Samuelson can worry all he wants, he's good at playing the Very Serious Person role (inflation is coming!, the debt will cause interest rates to spike!, there could even be "dangerous side effects, including a future financial crisis"!), but the Fed is not risking a repeat of the 1970s, not even close.

Update: Dean Baker comments on the Samuelson article.

Thursday, December 13, 2012

The Fed and Long-Run Expectations

Paul Krugman on the Fed:

Bernanke’s Non-Stupidity Pact: So, how big a deal was yesterday’s Fed announcement? Philosophically, it was pretty major; in terms of substantive policy implications, not so much.
What the Fed did was pledge not to raise rates until unemployment is considerably lower than it is now, or inflation is running significantly above the 2 percent target. One fairly important wrinkle I haven’t seen emphasized: the inflation criterion was couched in terms of the inflation projection, rather than past inflation. This would let the Fed hold rates low even in the face of a blip caused by, say, a sharp rise in commodity prices.
It’s fairly clear — although not explicitly stated — that the goal of this pronouncement is to boost the economy right now through expectations of higher inflation and stronger employment than one might otherwise have expected. ...

What do we know about the expectations channel? Larry Ball via Greg Mankiw:

Interpreting the Fed: My friend and sometime coauthor Larry Ball sends me his quick analysis of the Federal Reserve's recent announcement:

I think the FOMC announcement is big news: for the first time, the Fed clearly says it will be more dovish in the future than the pre-crisis Taylor Rule (TR) dictates. ...

This deviation from the TR has not happened since the TR was discovered. In particular, the Fed was NOT more dovish than the TR in 2003. ...

It is not clear whether the Fed’s announcement of future dovishness will have significant effects today. The efficacy of announcements about future monetary policy is unproven.

There are two expectations channels here. One is expected inflation (the traditional channel), the other is "stronger employment than one might otherwise have expected" due to interest rates staying lower for a longer period of time than might have otherwise been expected (this is the channel that many at the Fed are relying upon). We have little evidence on this latter channel. As for the traditional channel, it may be difficult to move inflation expectations now that they "are almost perfectly anchored" (there is much more background and explanation in the article):

Inflation Expectations Have Become More Anchored Over Time, Economic Letter, by J. Scott Davis, FRB Dallas: The Organization of Arab Petroleum Exporting Countries imposed an oil embargo on the United States in October 1973 in response to U.S. support of Israel during the Yom Kippur War. The embargo was lifted in March 1974, and although it lasted less than six months, the effects on inflation and inflation expectations in the United States would persist for a decade.
Oil prices spiked, increasing by more than 350 percent from June 1973 to June 1974, propelling a sharp increase in U.S. inflation (Chart 1). Consumer prices jumped 12 percent in 1974, from a 3 percent rise in 1972. Although the 1973 oil price shock was transitory—the price of oil declined over the next two years—inflation proved more persistent. After exceeding 5 percent in 1973, it didn’t fall below that level again until 1982.
The experiences of the 1970s show that when inflation expectations become unanchored, they may become self-fulfilling, or in the words of former Federal Reserve Chairman Paul Volcker, “inflation feeds in part on itself.” This helps explain how a transitory oil price spike in 1973—along with a second oil shock in the late 1970s (associated with the 1979 Iranian Revolution)—could lead to a decade of high inflation. Over the past 30 years, Federal Reserve policy has succeeded in better anchoring inflation expectations, producing diminished expectations that a short-term shock leads to sustained high inflation. ...
Measuring Inflation Anchoring
One way to gauge such anchoring is calculating the responsiveness of expected inflation in the next few years to a shock to current inflation. If expectations are well-anchored, the response will be minimal. ...
A plot of the changes in the five-year-ahead, five-year-forward expected inflation rate shows that during the early part of the 1983–2011 period, long-run inflation expectations were quite variable and highly correlated with unexpected inflation (Chart 3). For instance, in early 1984, when inflation turned out to be almost 1 percentage point higher than expected, the expectation of long-run inflation also increased by nearly 1 percentage point. A few years later, in 1986, when inflation turned out to be 3 percentage points lower than expected, people reduced their expectations of long-run inflation by 1 percentage point.
The chart shows that over this nearly 30-year sample, long-run inflation expectations became less volatile and less responsive to surprises in current inflation. For example, between 2008 and 2011, unexpected inflation fluctuated: 3 percent in 2008, negative 5 percent in 2009, 3 percent in early 2010, negative 2 percent later in 2010 and 3 percent in 2011—yet, long-run inflation expectations over this period, as measured by revisions in the five-year-ahead, five-year-forward rate, barely moved.
The statistical methodology of ordinary least-squares regression allows analysis of the relationship between two or more variables. This “averaging” tool helps measure how short-run surprises affect long-term inflation expectations. For example, if inflation over the past year is 1 percentage point higher than expected, the least-squares regression results show that people tend to raise their long-run expectations by some number γ of percentage points—for 1983–2011, γ is 0.11 (Table 1). This means that, on average over the period 1983 to 2011, a 1 percentage point surprise in the inflation rate raised long-term inflation expectations by 0.11 percentage points. The smaller the value of γ, the more anchored are long-run inflation expectations—if γ is not significantly different from zero, then long-run expectations are perfectly anchored.

Exp-table

Anchoring of inflation expectations over the past 30 years has changed markedly, as shown by the results in the bottom half of Table 1. In the 1980s, confronted with a 1 percentage point higher-than-anticipated inflation rate, people boosted their expectations for long-run inflation by 0.28 percentage points. However, since 2000, people raise their expectations by about 0.03 percentage points following a similar surprise, suggesting that long-run expectations are almost perfectly anchored.
As few as 30 years ago, long-run inflation expectations were quite responsive to short-term shocks. Over the ensuing period, the Fed has been better able to anchor such expectations so that now long-run expectations barely change following a series of dramatic, but ultimately transitory, inflation surprises. ...

Fed Watch: Gas Prices Falling

Tim Duy:

Gas Prices Falling: Gas prices continued to decline last week, falling to the bottom of the roughly $3.50-$4.00 range of the past two years:

Gas

Ever notice that when gas prices rise, Fed critics starting jumping up-and-down and screaming inflation, but never say a word about deflation when gas prices fall?

Tuesday, November 20, 2012

'Compensation Growth and Slack in the Current Economic Environment'

This is a bit technical at times, but it makes an important point that is a bit buried in the discussion that I'd like to highlight.

The first step in the discussion is to explain what a non-linear Phillips curve is, and why a non-linear specification is needed:

Compensation Growth and Slack in the Current Economic Environment, by M. Henry Linder, Richard Peach, and Robert Rich, NY Fed: ...Our analysis is based on the estimation of a nonlinear wage-inflation Phillips curve that draws upon the modeling approach outlined in a Boston Fed paper by Fuhrer, Olivei, and Tootell. The key feature of the nonlinear Phillips curve is that the impact of a change in slack depends on the level of slack. These features are illustrated in the chart below, where the slope of the Phillips curve becomes steeper as the unemployment rate moves further below the natural rate of unemployment (higher resource utilization), while the slope becomes flatter as the unemployment rate moves further above it (lower resource utilization).

Nonlinear-Compensation-Phillips-Curve

Why might the Phillips curve flatten out as the unemployment rate rises further above the natural rate of unemployment? As a reminder, what matters for labor market decisions is the real wage rate—the nominal wage adjusted for the price level (or cost of living). One explanation for the flattening of the Phillips curve is downward real wage rigidity—that is, a more sluggish response of real wages when the unemployment rate is high (see the Boston Fed paper by Holden and Wulfsberg for a more detailed discussion of theories of real wage resistance during an economic downturn). In a situation of high unemployment, wage growth becomes relatively stable around the recent level of underlying inflation, so that real wages don’t fall sufficiently to clear the labor market.

Here's how they estimate the non-linear Phillips curve and an explanation of why the sample begins in 1997:

Our Phillips curve model relates four-quarter growth in nominal compensation per hour (for the nonfarm business sector) to economic slack, controlling for movements in trend productivity growth and expected inflation. Our measure of slack is the Congressional Budget Office (CBO) estimate of the unemployment gap—the percentage point deviation between the actual unemployment rate and the CBO estimate of the natural rate of unemployment. For trend productivity growth, we use an average of the (annualized) quarterly growth rate of productivity. For expected inflation, we construct a ten-year personal consumption expenditure (PCE) survey measure by adjusting the Survey of Professional Forecasters’ ten-year expected CPI inflation series to account for the average differential between CPI and PCE inflation. As the chart below shows, expected inflation has been extremely stable during the post-1997 period. To provide additional observations for estimation and to conduct the analysis in a low-inflation environment with well-anchored expectations, we use data that cover the period from 1997 through the present.

Long-term-Inflation-Expectations

Our model relates economic slack to an adjusted compensation measure, where we subtract the values of trend productivity growth and expected inflation from the compensation growth series. This adjustment imposes the standard restriction that increases in the real wage rate equal increases in labor productivity in the long run. The chart below provides a scatter plot of the adjusted compensation growth series and the unemployment gap. Negative (positive) values of the unemployment gap represent conditions in which unemployment is below (above) the natural rate of unemployment.

The estimated Phillips curve should have the shape predicted above, and it does:

Adjusted-Compensation-Growth-and-Unemployment-Gap

An examination of the scatter plot shows that the general shape of the data points bears a close resemblance to the chart of the nonlinear Phillips curve, and estimation of the model provides evidence of a statistically significant nonlinear relationship between (adjusted) compensation growth and slack. ...
We also consider two additional criteria to evaluate the nonlinear Phillips curve model—within-sample fit and out-of-sample forecast performance. The within-sample fit is based on estimation of the model using data from the full sample to compare the predicted and actual values of growth in compensation per hour. The out-of-sample forecast performance is based on estimation of the model only using data through 2007:Q4 on the unemployment gap, trend productivity growth, and expected inflation. With the resulting estimated model, we input the actual values of the unemployment gap, trend productivity growth, and expected inflation during the post-2007:Q4 period to generate forecasts of compensation growth. The first forecast corresponds to compensation growth from 2008:Q1 to 2009:Q1.
The next chart plots the four-quarter change in compensation growth, the within-sample predictions, and the post-2007:Q4 out-of-sample forecasts. While the within-sample predictions fail to track some short-run movements in compensation growth, they do capture the general movements in the series. Moreover, both the within-sample predictions and out-of-sample forecasts capture the magnitude of the decline in compensation growth since 2008 as well as its subsequent stability.

Within-Sample-Fit-of-Model-and-Out-of-Sample-Forecasts

Our analysis suggests that a nonlinear wage-inflation Phillips curve fits the data well during the post-1997 episode and complements the results of Fuhrer, Olivei, and Tootell, who find evidence of a nonlinear relationship between price inflation and activity gap measures.

Here's what I want to highlight:

An important conclusion from our analysis is that recent stability in the growth rate of labor compensation measures may not be informative about the extent of slack or its change. That is, stability in labor compensation measures doesn’t imply that the output gap has closed, while changes in the output gap may only have a modest impact on compensation growth.

They also note that this implies real rather than nominal wage rigidity:

In an inflation environment where actual and expected price changes are low, someone might interpret the earlier scatter plot as reflective of downward nominal wage rigidity—the idea that workers and firms have incentives to avoid reductions in nominal wages. However, the nonlinearity between wage growth and slack appears to be evident in other episodes in which large fluctuations in real activity were accompanied by high inflation and high compensation growth (this point is also discussed by Fuhrer, Olivei, and Tootell). Thus, the mild trade-off between compensation/wage growth and resource slack when slack is sizable isn’t unique to recent experience. Moreover, the source of the nonlinearity must stem from downward real wage rigidity, as downward nominal wage rigidity can generate this feature only in a low-inflation environment.

They conclude with:

We recognize that our analysis comes with important caveats... Nevertheless, if the nonlinear relationship between slack and wage/price inflation is an important feature of the data, then it will be critical for policymakers to identify other indicators that may be more responsive to slack and provide a quick and more reliable read on its movements.

It is not surprising at all that wage movements would be uninformative about labor market conditions when wages adjust sluggishly to economic conditions, but the prevalence of claims about the condition of the labor market based upon measures of compensation is a signal that people have missed this point. There can be both considerable slack in the economy (so let's do something about it), and relatively stable wages.

Friday, November 02, 2012

Should We Use Above-Normal Inflation To Address Economic Ills?

The Economist asks:

Above-normal inflation has been proposed as a solution (or salve) to a number of the rich world's economic problems. In conjunction with financial repression, it could help erode sovereign debt loads. In the euro area, differential inflation could facilitate rebalancing. It could help lower real interest rates in economies up against the zero lower bound, and it could help facilitate real wage adjustments in economies plagued by nominal wage stickiness. Of course, there are risks to higher inflation, including efficiency costs and the possibility that "de-anchored" inflation expectations could be difficult and costly to contain.
Will the rich world use above-normal inflation as a way to address economic ills? Should it?

Here are the responses, including mine:

Sunday, October 14, 2012

Bernanke: Accommodative Policies Do Not Impose (Net) Costs on Developing Countries

Ben Bernanke responds to foreigners complaining about US monetary policy (including saying that if some countries want to enjoy the benefits of an undervalued currency, then they must also pay the costs, "including reduced monetary independence and the consequent susceptibility to imported inflation":

U.S. Monetary Policy and International Implications, Speech by Ben Bernanke: Thank you. It is a pleasure to be here. This morning I will first briefly review the U.S. and global economic outlook. I will then discuss the basic rationale underlying the Federal Reserve's recent policy decisions and place these actions in an international context. ...
Federal Reserve's Recent Policy Actions
All of the Federal Reserve's monetary policy decisions are guided by our dual mandate to promote maximum employment and stable prices. With the disappointing progress in job markets and with inflation pressures remaining subdued, the FOMC has taken several important steps this year to provide additional policy accommodation. ...
As I have said many times, however, monetary policy is not a panacea. Although we expect our policies to provide meaningful help to the economy, the most effective approach would combine a range of economic policies and tackle longer-term fiscal and structural issues as well as the near-term shortfall in aggregate demand. Moreover, we recognize that unconventional monetary policies come with possible risks and costs; accordingly, the Federal Reserve has generally employed a high hurdle for using these tools and carefully weighs the costs and benefits of any proposed policy action.
International Aspects of Federal Reserve Asset Purchases
Although the monetary accommodation we are providing is playing a critical role in supporting the U.S. economy, concerns have been raised about the spillover effects of our policies on our trading partners. In particular, some critics have argued that the Fed's asset purchases, and accommodative monetary policy more generally, encourage capital flows to emerging market economies. These capital flows are said to cause undesirable currency appreciation, too much liquidity leading to asset bubbles or inflation, or economic disruptions as capital inflows quickly give way to outflows.
I am sympathetic to the challenges faced by many economies in a world of volatile international capital flows. And, to be sure, highly accommodative monetary policies in the United States, as well as in other advanced economies, shift interest rate differentials in favor of emerging markets and thus probably contribute to private capital flows to these markets. I would argue, though, that it is not at all clear that accommodative policies in advanced economies impose net costs on emerging market economies, for several reasons.
First, the linkage between advanced-economy monetary policies and international capital flows is looser than is sometimes asserted. Even in normal times, differences in growth prospects among countries--and the resulting differences in expected returns--are the most important determinant of capital flows. The rebound in emerging market economies from the global financial crisis, even as the advanced economies remained weak, provided still greater encouragement to these flows. Another important determinant of capital flows is the appetite for risk by global investors. Over the past few years, swings in investor sentiment between "risk-on" and "risk-off," often in response to developments in Europe, have led to corresponding swings in capital flows. All told, recent research, including studies by the International Monetary Fund, does not support the view that advanced-economy monetary policies are the dominant factor behind emerging market capital flows.1 Consistent with such findings, these flows have diminished in the past couple of years or so, even as monetary policies in advanced economies have continued to ease and longer-term interest rates in those economies have continued to decline.
Second, the effects of capital inflows, whatever their cause, on emerging market economies are not predetermined, but instead depend greatly on the choices made by policymakers in those economies. In some emerging markets, policymakers have chosen to systematically resist currency appreciation as a means of promoting exports and domestic growth. However, the perceived benefits of currency management inevitably come with costs, including reduced monetary independence and the consequent susceptibility to imported inflation. In other words, the perceived advantages of undervaluation and the problem of unwanted capital inflows must be understood as a package--you can't have one without the other.
Of course, an alternative strategy--one consistent with classical principles of international adjustment--is to refrain from intervening in foreign exchange markets, thereby allowing the currency to rise and helping insulate the financial system from external pressures. Under a flexible exchange-rate regime, a fully independent monetary policy, together with fiscal policy as needed, would be available to help counteract any adverse effects of currency appreciation on growth. The resultant rebalancing from external to domestic demand would not only preserve near-term growth in the emerging market economies while supporting recovery in the advanced economies, it would redound to everyone's benefit in the long run by putting the global economy on a more stable and sustainable path.
Finally, any costs for emerging market economies of monetary easing in advanced economies should be set against the very real benefits of those policies. The slowing of growth in the emerging market economies this year in large part reflects their decelerating exports to the United States, Europe, and other advanced economies. Therefore, monetary easing that supports the recovery in the advanced economies should stimulate trade and boost growth in emerging market economies as well. In principle, depreciation of the dollar and other advanced-economy currencies could reduce (although not eliminate) the positive effect on trade and growth in emerging markets. However, since mid-2008, in fact, before the intensification of the financial crisis triggered wide swings in the dollar, the real multilateral value of the dollar has changed little, and it has fallen just a bit against the currencies of the emerging market economies. ...

Wednesday, October 10, 2012

'Supporting Price Stability'

David Altig of the Federal Reserve Bank of Atlanta argues that the Fed's quantitative easing and twist polices were necessary to preserve price stability (Dave will be in Portland, Oregon on Thursday along with Bruce Bartlett and others at the annual Oregon Economic Forum (scroll down) that Tim Duy puts on, and I am disappointed I can't be there this year -- I'm headed to the St. Louis Fed today for a conference):

Supporting Price Stability, by David Altig: All of the five questions that Chairman Ben Bernanke addressed in his October 1 speech to the Economic Club of Indiana rank high on the list of most frequently asked questions I encounter in my own travels about the Southeast. But if I had to choose a number one question, on the scale of intensity if not frequency, it would probably be this one: "What is the risk that the Fed's accommodative monetary policy will lead to inflation?"

The Chairman gave a fine answer, of course, and I hope it is especially noted that Mr. Bernanke was not dismissive that risks do exist:

"I'm confident that we have the necessary tools to withdraw policy accommodation when needed, and that we can do so in a way that allows us to shrink our balance sheet in a deliberate and orderly way. ...

"Of course, having effective tools is one thing; using them in a timely way, neither too early nor too late, is another. Determining precisely the right time to 'take away the punch bowl' is always a challenge for central bankers, but that is true whether they are using traditional or nontraditional policy tools. I can assure you that my colleagues and I will carefully consider how best to foster both of our mandated objectives, maximum employment and price stability, when the time comes to make these decisions."

While the world waits for "take away the punch bowl" time to arrive, here is another question that I think worthy of consideration: "Looking back over the past several years, what is the risk that the Fed's price stability mandate would have been compromised absent accommodative monetary policy?"

As the Chairman noted in his speech, it isn't easy to take the evidence at hand and argue any inconsistency between the Federal Open Market Committee's (FOMC) policy actions and its price stability mandate:

"I will start by pointing out that the Federal Reserve's price stability record is excellent, and we are fully committed to maintaining it. Inflation has averaged close to 2 percent per year for several decades, and that's about where it is today. In particular, the low interest rate policies the Fed has been following for about five years now have not led to increased inflation. Moreover, according to a variety of measures, the public's expectations of inflation over the long run remain quite stable within the range that they have been for many years."

To the question I posed earlier, I am tempted to take those observations one step further. Without the policy steps taken by the FOMC over the past several years, the "excellent" price stability record would indeed have been compromised.

Consider the so-called five-year/five-year-forward breakeven inflation rate, a closely monitored market-based measure of longer-term inflation expectations. If you are not completely familiar with this statistic—and you can skip this paragraph if you are—think about buying a Treasury security five years from now that will mature five years after you buy it. When you make such a purchase, you are going to care about the rate of inflation that prevails between a period that spans from five years from today (when you buy the security) through 10 years from today (when the asset matures and pays off). By comparing the difference between the yield on a Treasury security that provides some insurance against inflation and one that does not, we can estimate what the people buying these securities believe about future inflation. The reason is that, if the two securities are otherwise similar, you would only buy the security that does not provide inflation insurance if the interest rate you get is high enough relative to inflation-protected security to compensate you for the inflation that you expect over the five years that you hold the asset. In other words, the difference in the interest rates across an inflation-protected Treasury and a plain-vanilla Treasury that does not provide protection should mainly reflect the market's expected rate of inflation.

When you look at a chart of these market-based inflation expectations along with the general timing of the FOMC's policy actions, from the first large-scale asset purchase in 2008–2009 (QE1) to the second asset purchase program (QE2) in 2010 to the maturity extension program (Operation Twist) in 2011, the relationship between monetary policy and inflation expectations is pretty clear:

In each case, policy actions were generally taken in periods when the momentum of inflation expectations was discernibly downward. A simple-minded conclusion is that FOMC actions have been consistent with holding the bottom on inflation expectations. A bolder conclusion would be that as inflation expectations go, so eventually goes inflation and, had these monetary policy actions not been taken, the Fed's price stability objectives would have been jeopardized.
Statements like this do not come without caveats. A perfectly clean measure of inflation expectations requires that Treasuries that do and do not carry inflation protection really are otherwise identical. If that is not the case, differences in rates on the two types of assets can be driven by changes in things like market liquidity, and not changes in inflation expectations. Calculations of five-year/five-year-forward breakeven rates attempt to control for some of these non-inflation differences, but certainly only do so imperfectly.
Perhaps more pertinent to the current policy discussion, inflation expectations have, in fact, moved up following the latest policy action—which I guess people are destined to call QE3. But unlike the periods around QE1, QE2, and Twist, QE3 was not preceded by a period of generally falling longer-term breakeven inflation rates. So this time around there will be another, and perhaps more challenging, chance to test the proposition that monetary accommodation is consistent with price stability. As for previous actions, however, I'm pretty comfortable arguing the case that the price stability mandate was not only consistent with accommodation, it actually required it.

Monday, October 08, 2012

'Trimmed-Mean Inflation Statistics'

Preliminary evidence from Brent Meyer and Guhan Venkatu of the Cleveland Fed shows that the median CPI is a robust measure of underlying inflation trends:

Trimmed-Mean Inflation Statistics: Just Hit the One in the Middle Brent Meyer and Guhan Venkatu: This paper reinvestigates the performance of trimmed-mean inflation measures some 20 years since their inception, asking whether there is a particular trimmed-mean measure that dominates the median CPI. Unlike previous research, we evaluate the performance of symmetric and asymmetric trimmed-means using a well-known equality of prediction test. We find that there is a large swath of trimmed-means that have statistically indistinguishable performance. Also, while the swath of statistically similar trims changes slightly over different sample periods, it always includes the median CPI—an extreme trim that holds conceptual and computational advantages. We conclude with a simple forecasting exercise that highlights the advantage of the median CPI relative to other standard inflation measures.

In the introduction, they add:

In general, we find aggressive trimming (close to the median) that is not too asymmetric appears to deliver the best forecasts over the time periods we examine. However, these “optimal” trims vary slightly across periods and are never statistically superior to the median CPI. Given that the median CPI is conceptually easy for the public to understand and is easier to reproduce, we conclude that it is arguably a more useful measure of underlying inflation for forecasters and policymakers alike.

And they conclude the paper with:

While we originally set out to find a single superior trimmed-mean measure, we could not conclude as such. In fact, it appears that a large swath of candidate trims hold statistically indistinguishable forecasting ability. That said, in general, the best performing trims over a variety of time periods appear to be somewhat aggressive and almost always include symmetric trims. Of this set, the median CPI stands out, not for any superior forecasting performance, but because of its conceptual and computational simplicity—when in doubt, hit the one in the middle.
Interestingly, and contrary to Dolmas (2005) we were unable to find any convincing evidence that would lead us to choose an asymmetric trim. While his results are based on components of the PCE chain-price index, a large part (roughly 75% of the initial release) of the components comprising the PCE price index are directly imported from the CPI. It could be the case that the imputed PCE components are creating the discrepancy. The trimmed-mean PCE series currently produced by the Federal Reserve Bank of Dallas trims 24 percent from the lower tail and 31 percent from the upper tail of the PCE price-change distribution. This particular trim is relatively aggressive and is not overly asymmetric—two features consistent with the best performing trims in our tests.
Finally, even though we failed to best the median CPI in our first set of tests, it remains the case that the median CPI is generally a better forecaster of future inflation over policy-relevant time horizons (i.e. inflation over the next 2-3 years) than the headline and core CPI.

One note. They are not saying that trimmed or median statistics are the best way to measure the cost of living for a household. They are asking what variable has the most predictive power for future (untrimmed, non-core, i.e. headline) inflation ("specifically the annualized percent change in the headline CPI over the next 36 months," though the results for 24 months are similar). That turns out, in general, to be the median CPI.

Monday, October 01, 2012

Fed Watch: If QE Causes Commodity Price Inflation...

Tim Duy:

If QE Causes Commodity Price Inflation..., by Tim Duy: If QE causes commodity price inflation, what caused commodity prices to rise before QE? It never ceases to amaze me that critics of quantitative easing fail to remember that commodity prices were rising well before the Federal Reserve engaged in quantitative easing:

Commodity

If anything, commodity prices have been moving generally sideways since the Fed began expanding its balance sheet:

Fed

And please don't say "commodity prices have surged since the beginning of 2009." I think it is pretty obvious that virtually everyone would not want to return to the economic conditions of 2009 to achieve lower commodity prices. The rebound of commodity prices was a natural consequence of expanding global activity; if QE is to blame, it must also be blamed for the economic rebound. Also, why have headline consumer prices grown more slowly since the Fed initiated quantitative easing?

Pcepath

What about the surging inflation expectations in the TIPS markets (not necessarily the best measures of inflation expectations, and the ones already falling anyway)?

Infexplong

At best, quantitative easing is keeping inflation expectations propped up, barely. And once again, does anyone really want to return to the collapsing inflation expectations at the height of the recession? And are expectations any higher than before quantitative easing? No.
Bottom Line: If anything, inflation is lower, both for commodity prices and headline PCE, after quantitative easing. So isn't it finally time to put to rest the myth that quantitative easing is causing runaway inflation? Nothing to see here folks, move along.

Saturday, August 25, 2012

Unfounded Fear of Inflation

As a follow up to this post on Inflation Lessons from Paul Krugman:

Demand-siders like me saw this as very much a slump caused by inadequate spending: thanks largely to the overhang of debt from the bubble years, aggregate demand fell, pushing us into a classic liquidity trap.

But many people — some of them credentialed economists — insisted that it was actually some kind of supply shock instead. Either they had an Austrian story in which the economy’s productive capacity was undermined by bad investments in the boom, or they claimed that Obama’s high taxes and regulation had undermined the incentive to work (of course, Obama didn’t actually impose high taxes or onerous regulations, but leave that aside for now).

How could you tell which story was right? One answer was to look at the behavior of ... inflation. For if you believed a demand-side story, you would also believe that even a large monetary expansion would have little inflationary effect; if you believed a supply-side story, you would expect lots of inflation from too much money chasing a reduced supply of goods. And indeed, people on the right have been forecasting runaway inflation for years now.

Yet the predicted inflation keeps not coming. ... So what we’ve had is as good a test of rival views as one ever gets in macroeconomics — which makes it remarkable that the GOP is now firmly committed to the view that failed.

Note what's been happening to estimated inflation expectations lately:

Expinf
[Source: Cleveland Fed]

The Fed has used fear of inflation to argue against doing more for the unemployed, but what's the Fed so afraid of? Where's the evidence fo their fears?

(When fear of inflation fails as an argument against further easing, as it has, the Fed also relies upon a vague fear that further quantitative easing would somehow break overnight money markets. But as FT Alphaville has noted several times -- and I've noted this as well -- those fears are hard to understand, and the minutes from the last Fed meeting seemed to indicate they were largely unfounded.

So I, too, "remain curious to get some details about exactly what Bernanke meant when he said that further easing shouldn’t be undertaken lightly because it would pose a risk to 'market functioning' and 'financial stability.'" That's especially true in light of the statement in the the most recent FOMC minutes that they have looked at this worry and determined that, repeating a quote from FT Alphaville, there is "substantial capacity for additional purchases without disrupting market functioning."

Thus, it appears the biggest worries about further easing -- inflation and market disruption -- are unfounded, and it will be intersting to see what new excuses are invented to forestall action. I'm guessing it will be the old, "it's not in the data yet, but just wait, you'll see, inflation really will be a problem. Soon. Very soon." Never mind that we've been hearing this for years already.)

Tuesday, August 07, 2012

Rogoff: Central Banks will Eventually ... be Driven to Tolerate Higher Inflation

Ken Rogoff:

...many (if not necessarily all) central banks will eventually figure out how to generate higher inflation expectations. They will be driven to tolerate higher inflation as a means of forcing investors into real assets, to accelerate deleveraging, and as a mechanism for facilitating downward adjustment in real wages and home prices.
It is nonsense to argue that central banks are impotent and completely unable to raise inflation expectations, no matter how hard they try. In the extreme, governments can appoint central bank leaders who have a long-standing record of stating a tolerance for moderate inflation – an exact parallel to the idea of appointing “conservative” central bankers as a means of combating high inflation.

But Bernanke did have this reputation, at least among some on the right, e.g. John Tamney in the NRO when Bernanke's name came up as a possible successor to Greenspan:

a June New York Times article noted Bernanke’s belief that the gold standard made the Great Depression worse. Plus, in a 2002 speech, he lauded the ability of the government to use the printing press to “generate higher spending and hence positive inflation.” If his adherence to a Phillips Curve orthodoxy made his belief in a price-rule already seem shaky, his direct comments about money should remove all doubt. ... For his views on money, Bernanke has the potential to be very dangerous.

Despite his reputation among the Tamney types, I think Bernanke favors more aggressive policy, but he hasn't been unable to sway others on the committee that further easing is needed. But maybe that gives him too much credit, or credit for a view he doesn't really hold. If Bernanke does believe the Fed should do more, he's kept it pretty well hidden lately and it would be nice to see more leadership from the Fed Chair.

As for Rogoff's claim that "central banks will eventually ... be driven to tolerate higher inflation," I am not as convinced of this as he is where the Fed is concerened. The argument for tolerating higher inflation is strong already, yet the Fed hasn't acted yet, and it appears to be looking for excuses not to act in the future (and some members of the Fed want to raise interest rates now to head off the possibility of future inflation). It's easy to imagine the Fed fighting inflation no matter what, or at least having policy gridlocked by the inflation hawks, and arguing that in doing so it is helping rather than hurting the recovery.

Saturday, August 04, 2012

Trimmed Mean Inflation

PCE Trimmed mean inflation since March. This measure from the Dallas Fed is intended to isolate and highlight trends in inflation and help the Fed stay near its target inflation rate of 2%:


1-month 6-month 12-month
Mar-12 2.30 1.97 2.02
Apr-12 1.50 1.95 1.93
May-12 1.49 1.85 1.90
Jun-12 1.42 1.75 1.86

Notice any trends?

Saturday, July 28, 2012

What Draghi Hasn’t Done

Will the ECB come to the rescue? Paul Krugman is skeptical:

What Draghi Didn’t Do, by Paul Krugman: ...it’s now widely hoped that the ECB will start buying government bonds (although it’s not at all clear whether the Germans will allow this, particularly on a sufficient scale); this has caused a significant decline in Spanish interest rates from their peak.
Limiting interest rates on peripheral borrowing is, however, only part of what the euro needs. ...Europe also needs sufficiently high inflation over the next few years to make it possible for Spain etc. to regain competitiveness without devastating deflation. So have market expectations of inflation risen from their unworkably low levels of recent months? No:
This still looks unworkable.
Update: And this sounds like a “nein” from the Germans.

Tuesday, July 24, 2012

Fed Watch: A Missing Ingredient

Tim Duy:

A Missing Ingredient, by Tim Duy: Ryan Avent makes a good point about San Francisco Federal Reserve President John Williams' recent FT interview.
Avent is less impressed than me on Williams' conversion to open-ended QE as a policy tool because it by itself does not communicate a willingness to allow inflation to exceed 2%. I think that Avent is on the right path. While Williams did make what I think is a big step, he could go one step further and not only call for open-ended QE, but to do so in the context of Chicago President Charles Evans' suggestion for explicitly tolerating inflation up to 3%. That said, I also think this is too much to hope for, as I haven't seen any indication that Williams would be willing to deviate from the 2% target.
Also, you can interpret open-ended QE as a higher possibility that the Federal Reserve will not be able to pull-back the increase in the money supply, thus one could expect higher inflation in the future. And by leaving the program as open-ended, you remove the uncertainty created by arbitrary end dates and purchase amounts. So I do think that Williams is making a significant shift in the right direction. But I agree with Avent that a clear communication of tolerance for higher inflation would be even more effective.
Ultimately, I think the Federal Reserve made a huge policy error in committing to an explicit 2% inflation target. I think policymakers were under the impression that such a commitment would give them more flexibility by removing concerns that QE would be inflationary. In reality, I think it had the opposite effect - it eliminated a policy tool, thereby reducing their flexibility. And that commitment stands as a barrier to Evans' suggested policy path. I think the rest of the Fed would loathe accepting inflation as high as 3% given they just committed to 2% at the beginning of this year. In doubt, they would view such backtracking as a threat to their much-cherished credibility.
Interestingly, they don't see Treasury rates below 1.4% as a threat to their credibility. They really should.

Here's what I said on this topic a few months ago:

...why does the Fed put so much value on its credibility?

An abundance of credibility allows the Fed to bring the inflation rate down from, for example, 5 percent to 2 percent at minimal cost to the economy. It also makes it less likely that inflation will become a problem in the first place, because high credibility makes long-run inflation expectations less sensitive to temporary spells of inflation. So maintaining high credibility has substantial benefits.

Does this mean the Fed should do its best to keep the inflation rate at 2 percent?

Sticking to a 2 percent target independent of circumstances is not optimal. There are times, such as now, when allowing the inflation rate to drift above target would help the economy. Higher inflation during a recession encourages consumers and businesses to spend cash instead of sitting on it, it reduces the burden of pre-existing debt, and it can have favorable effects on our trade with other countries.  
If inflation begins to rise before the recovery is complete the Fed could, for example, announce that it is willing to allow the inflation rate to stay above target temporarily in the interest of helping the economy. But once unemployment hits a pre-set rate, for example 6.25 percent, or core inflation rises above some predetermined threshold, for example, 5 percent, then, and only then, will the Fed step in and take action. ...

So no disagreement here, except that I would set the limit even higher than 3 percent inflation since I am not at all worried about the Fed's long-run credibility on inflation. As I noted, "I have no doubt that, once the economy has finally recovered, the Fed will ensure that the inflation rate is near its target value, so long-run credibility is not at risk."

One further note: I have asked Federal Reserve officials directly why the 2% inflation target is treated as a ceiling rather than a central value, and have been assured that it is, in fact, a central value (so that inflation should fluctuate around the target value instead of staying at or below target as it would if the target is a ceiling). But the data suggests otherwise -- the errors have been mostly one-sided (i.e. inflation has generally been below target). Even if the Fed is unwilling to raise the target, it should at least tolerate enough of a rise in the inflation rate to get two-sided errors, but it hasn't even been willing to do that.

Saturday, June 02, 2012

Catastrophic Credibility

Paul Krugman today:

Catastrophic Credibility, by Paul Krugman: A little while ago Ben Bernanke responded to suggestions that the Fed needed to do more — in particular, that it should raise the inflation target — by insisting that this would undermine the institution’s “hard-won credibility”. May I say that what recent events in Europe, and to some extent in the US, really suggest is that central banks have too much credibility? Or more accurately, their credibility as inflation-haters is very clear, while their willingness to tolerate even as much inflation as they say they want, let alone take some risks with inflation to rescue the real economy, is very much in doubt. ...

I took this up in a recent column:

Breaking through the Inflation Ceiling: At some point during the recovery, the Fed may face an important decision. If the inflation rate begins to rise above the Fed’s 2 percent target and the unemployment rate is still relatively high, will the Fed be willing to leave interest rates low and tolerate a temporary increase in the inflation rate?
Probably not. Even though higher inflation can help to stimulate a depressed economy, Ben Bernanke, Chairman of the Federal Reserve, is not in favor of allowing higher inflation because it could undermine the Fed’s “hard-won inflation credibility.” And recent Fed communications seem to be setting the stage for the Fed to abandon its commitment to keep interest rates low through the end of 2014. This adds to the likelihood that the Fed will raise interest rates quickly if inflation begins increasing above the 2 percent target even if the economy has not yet fully recovered.
As I’ll explain in a moment, that’s the wrong thing to do. But first, why does the Fed put so much value on its credibility?
An abundance of credibility allows the Fed to bring the inflation rate down from, for example, 5 percent to 2 percent at minimal cost to the economy. It also makes it less likely that inflation will become a problem in the first place, because high credibility makes long-run inflation expectations less sensitive to temporary spells of inflation. So maintaining high credibility has substantial benefits.
Does this mean the Fed should do its best to keep the inflation rate at 2 percent?
Sticking to a 2 percent target independent of circumstances is not optimal. There are times, such as now, when allowing the inflation rate to drift above target would help the economy. Higher inflation during a recession encourages consumers and businesses to spend cash instead of sitting on it, it reduces the burden of pre-existing debt, and it can have favorable effects on our trade with other countries.  
If inflation begins to rise before the recovery is complete the Fed could, for example, announce that it is willing to allow the inflation rate to stay above target temporarily in the interest of helping the economy. But once unemployment hits a pre-set rate, for example 6.25 percent,  or core inflation rises above some predetermined threshold, for example,  5 percent, then, and only then, will the Fed step in and take action. And it should leave no doubt at all about its commitment to step in if either condition is met.
But there is a tradeoff to consider. Allowing a temporary spell of higher inflation during the recovery does pose some risk to the Fed’s credibility. I think the risk is small precisely because the Fed has been so careful to establish its inflation fighting credibility in the past. And the risk is even smaller with the 5 percent limit on the Fed’s tolerance for inflation described above. But the risk is there.
When the economy is near full employment, the tradeoff between the risk to credibility and the prospect for a faster recovery is unattractive. There’s little room to stimulate the economy and hence little room to benefit from a higher inflation rate. And the loss of credibility is potentially large because creating inflation in such a circumstance – when the economy is already growing robustly – would be viewed as irresponsible. Thus, the tradeoff is negative overall.
But when there is considerable room for the economy to expand, as there is now, the potential benefits from the increase in employment  that this policy is likely to bring about are much larger. Why the Fed places so little weight on these benefits when unemployment remains so high is a mystery.
In comparison to the risks to credibility, which are smaller than they are near full employment, the benefits are large and the tradeoff is positive rather than negative. There does come a point when the tradeoff is negative again – hence the 6.25 percent unemployment and 5 percent inflation triggers described above – but in the interim we should be willing to allow modestly higher inflation. I have no doubt that, once the economy has finally recovered, the Fed will ensure that the inflation rate is near its target value, so long-run credibility is not at risk.
If inflation begins to rise before the economy has fully recovered, the Fed shouldn’t react as though its world is coming to an end and immediately begin reversing its stimulus efforts. The resulting increase in interest rates would make the recovery even slower. In fact, given the net benefits that more inflation would provide right now, the Fed should try to raise the inflation rate through additional stimulus programs.
Unfortunately, the Fed has made it abundantly clear that’s not going to happen. But at the very least the Fed should continue its present attempts to help the economy, even if that means a temporary increase in the inflation rate.

Monday, May 28, 2012

Plosser on the Risks from Europe

Philadelphia Fed president Charles Plosser on the risks from Europe:

Q&A: Philadelphia Fed President Charles Plosser, by Brian Blackstone, WSJ: On whether Europe could have a significant effect on the U.S. economy:
Plosser: Europe is clearly near recession. That impacts the U.S. in part through trade ... but Europe is not our largest trading partner at the end of the day. The thing that people really worry about is you have some financial implosion in Europe and markets freeze up and you have some serious financial disruptions.
There are several ways this could go. At one level the U.S. has been trying to insulate itself from that risk. The Fed and regulators have tried to stress to money market funds, for example, to reduce their exposure to European financial institutions. So on a pure exposure basis I would say U.S. financial institutions are taking the steps they need to ensure that ... financial distress in Europe it doesn’t necessarily lead to distress for them...
People have made the analogy that an implosion in Europe would be a Lehman Brothers-type event. It might be a Lehman Brothers-kind of event for Europe. And if the market is sort of indiscriminate in whom they withdraw funding to, you could have indiscriminate funding restrictions on U.S. institutions just because everybody’s scared.
There’s another scenario that is exactly the opposite. There might be–and you already see some of this–a flight to safety. So rather than the markets freezing access to short-term funding for U.S. institutions, you could have a flood of liquidity that gets withdrawn from European institutions ... and floods into the United States. That’s exactly the opposite problem.
On which scenario is more likely:
Plosser: I don’t have the answer to that. ... I don’t think a flood of liquidity is a huge problem. That would be manageable. The bigger problem is if it dries up for everybody. The Fed still has the tools it used during the crisis. ... So I think we have the tools at our disposal if they become necessary. ...

Thus, he thinks the Fed can handle whatever comes its way, and hence sees no need to alter his forecast:

On his economic forecasts:
Plosser: I’m still looking for 2.5% to 3% growth over the course of this year. I think the unemployment rate is going to continue to drift downward to 7.8% by the end of this year. I would think for 2013 we’ll see similar developments. As long as that’s continuing then I don’t see the case for ever increasing degree of accommodation.

Since he believes output will grow no matter what happens in Europe, inflation is the biggest risk:

On inflation:
Plosser: I think headline will drift down just because of oil and gasoline. It will be interesting to see what happens with the core. The inflation risk we have is longer term. The problem is that as the U.S. economy grows we have provided substantial amounts of accommodation. We have $1.5 trillion in excess reserves. Inflation is going to occur when those excess reserves start flowing into the economy. When that begins to happen we’ll have to restrain it somehow. The challenge for the Fed is will we act quickly enough or aggressively enough to prevent that from happening.
It may be a challenge politically when we have to start selling assets, particularly if we have to start selling (mortgage backed securities) to shrink the balance sheet and to prevent those reserves from becoming money.

My view is different. I'm more worried about output and employment being affected by events in Europe than he is, and less worried about long-run risks from inflation (both the chance that it will happen and the consequences if it does). So I see a far greater need for policymakers -- monetary and fiscal -- to take action now as insurance against potential problems down the road.

It is interesting, however, that he sees the political risk as the primary challenge  for controlling inflation for a supposedly independent Fed, especially since several Fed presidents recently assured us that politics plays no role whatsoever in the Fed's decision making process (I also wonder why he didn't mention raising the amount paid on reserves as a way of keeping reserves in the banks).

Finally, I'm glad he said "I don’t see the case for ever increasing degree of accommodation," rather than saying he thought we needed to begin reducing accommodation. We may not get any further easing, but perhaps there's a chance we can keep what we have, at least for now.

Thursday, May 17, 2012

Break Them Up

This was unexpected:

Federal Reserve Bank of St. Louis President James Bullard said Thursday that banks deemed “too big to fail” should be split up. “We do not need these companies to be as big as they are,” Bullard said. His remarks come a week after J.P. Morgan Chase & Co. disclosed a $2 billion trading loss. “We should say we want smaller institutions so that they can safely fail if they need to fail,” he said...

I don't like excessively large banks because of the economic and political power that they have. For me, that is the main reason to break them up (especially since I have yet to see convincing evidence that we need banks this large in order to exploit economies of scope and scale).

But when it comes to stabilizing the financial system, it's not so clear. If we break a big bank into smaller banks, and a systemic shock hits that threatens to cause all of the small banks to fail, it may be harder to shore up the system and prevent a domino-style collapse than it would be if there was just one large bank to deal with. The Great Depression, for example, was characterized by the failure of many, many smaller banks rather than the toppling of a few large, systemically important institutions.

But that is not an insurmountable problem. A coordinated policy across the smaller banks can be equivalent to policy at a single, large institution, and we simply have to be ready to implement the appropriate policies when trouble threatens. So although it may be somewhat easier to deal with one bank rather than, say, 10 or 20, that's not a reason to allow banks to be so large. So I'm glad to see Bullard's comments.

However, Tim Duy is less pleased with his views on inflation:

Don't Let the Data Get in the Way of Your Story, by Tim Duy: St. Louis Federal Reserve President James Bullard:

The main risk lies in potentially overcommitting to the ultra-easy monetary policy, reigniting the global inflation debacle of the 1970s.

Ten-year inflation expectations via the Cleveland Federal Reserve:

Cleveland

Bullard is obviously a Serious Central Banker, because Serious Central Bankers only see inflation everywhere.

Undue fear of inflation generally among FOMC memebers is holding policy back. There are those who favor more aggressive policy, but not enough to make a difference.

Tuesday, May 08, 2012

Inflation Can Help to Stimulate a Depressed Economy

If inflation begins to increase before the economy has fully recovered, the Fed shouldn't panic:

Federal Reserve Policy: Exceptions Improve the Rule: At some point during the recovery, the Fed may face an important decision. If the inflation rate begins to rise above the Fed’s 2% target and the unemployment rate is still relatively high, will the Fed be willing to leave interest rates low and tolerate a temporary increase in the inflation rate?
Probably not. Even though higher inflation can help to stimulate a depressed economy, Ben Bernanke, Chairman of the Federal Reserve, is not in favor of allowing higher inflation because it could undermine the Fed’s “hard-won inflation credibility.” And recent Fed communications seem to be setting the stage for the Fed to abandon its commitment to keep interest rates low through the end of 2014. This adds to the likelihood that the Fed will raise interest rates quickly if inflation begins increasing above the 2% target even if the economy has not yet fully recovered.
As I’ll explain in a moment, that’s the wrong thing to do. But first, why does the Fed put so much value on its credibility? ...[continue reading]...

Tuesday, May 01, 2012

Please Sirs, May We Have Some More?

Nobel Prize winner Robert Engle says more inflation would help:

New York University professor Robert Engle said policy makers should consider allowing slightly higher inflation as a way to spur the U.S. economy, joining fellow Nobel Prize winner Paul Krugman who says it could reduce unemployment.

“A little bit of inflation would do a whole lot of good for the U.S. economy, would certainly do a lot of good for the housing market,” Engle, who won the Nobel Prize in economics in 2003...

Friday, April 20, 2012

"Plutocrats and Printing Presses"

Paul Krugman:

Plutocrats and Printing Presses, by Paul Krugman: These past few years have been lean times in many respects — but they’ve been boom years for agonizingly dumb, pound-your-head-on-the-table economic fallacies. The latest fad — illustrated by this piece in today’s WSJ — is that expansionary monetary policy is a giveaway to banks and plutocrats generally. Indeed, that WSJ screed actually claims that the whole 1 versus 99 thing should really be about reining in or maybe abolishing the Fed. And unfortunately, some good people, like Daron Agemoglu and Simon Johnson, have bought into at least some version of this story.
What’s wrong with the idea that running the printing presses is a giveaway to plutocrats? Let me count the ways.
First, as Joe Wiesenthal and Mike Konczal both point out,... quantitative easing isn’t being imposed on an unwitting populace by financiers and rentiers; it’s being undertaken, to the extent that it is, over howls of protest from the financial industry. ...
Beyond that, let’s talk about the economics. The naive (or deliberately misleading) version of Fed policy is the claim that Ben Bernanke is “giving money” to the banks. What it actually does, of course, is buy stuff, usually short-term government debt but nowadays sometimes other stuff. It’s not a gift.
To claim that it’s effectively a gift you have to claim that the prices the Fed is paying are artificially high, or equivalently that interest rates are being pushed artificially low. And you do in fact see assertions to that effect all the time. But if you think about it for even a minute, that claim is truly bizarre.
I mean, what is the un-artificial, or if you prefer, “natural” rate of interest? As it turns out,... the natural rate of interest is the rate that would lead to stable inflation at more or less full employment.
And we have low inflation with high unemployment, strongly suggesting that the natural rate of interest is below current levels... Fed policy isn’t some kind of giveway to the banks, it’s just an effort to give the economy what it needs.
Furthermore, Fed efforts to do this probably tend on average to hurt, not help, bankers. Banks are largely in the business of borrowing short and lending long; anything that compresses the spread between short rates and long rates is likely to be bad for their profits. And the things the Fed is trying to do are in fact largely about compressing that spread...
Finally, how is expansionary monetary policy supposed to hurt the 99 percent? Think of all the people living on fixed incomes, we’re told. But who are these people? ... The typical retired American these days relies largely on Social Security — which is indexed against inflation. ...
No, the real victims of expansionary monetary policies are the very people who the current mythology says are pushing these policies. And that, I guess, explains why we’re hearing the opposite. It’s George Orwell’s world, and we’re just living in it.

We shouldn't let fiscal policymakers -- who have their own set of "agonizingly dumb, pound-your-head-on-the-table economic fallacies" to support inaction -- off the hook either.

Thursday, April 12, 2012

Are the Hawks Correct about the Fall in Productive Capacity?

There is a growing contingent at the Fed advocating interest rate increases sooner rather than later. I continue to think that is a mistake.

The reasoning from those who think it's time to begin reducing monetary stimulus is that the natural rate of output -- the full employment level of output -- has fallen so much that even though the recovery to date has been slow, nevertheless we are nearing potential output. Thus, any further push to increase output further could be highly inflationary.

Why do I think this is incorrect? I believe there are several types of shocks that can hit the economy. There are both permanent and temporary shocks to aggregate demand, and there are both permanent and temporary shocks to aggregate supply. As I explained here, analysts who conclude we are almost back to potential output may very well be confusing permanent and temporary shocks to aggregate supply.

As Charlie Plosser explained to me recently, it is difficult to sort aggregate demand and aggregate supply shocks. Aggregate demand shocks can produce supply shocks, and supply shocks can have an effect on demand. The explanation I was given by Plosser was, I think, intended to convince me that what look like aggregate demand shocks are actually the result of supply shocks. However, I think the explanation works better in the other direction. For example, repeating a previous argument:

When there as a large AD shock in the form of a change in preferences, say that people no longer like good A as it has gone out of fashion and have now decided B is the must have good, then there will be high unemployment in industry A and excess demand for labor and other resources in industry B. As workers and resources leave industry A, our productive capacity falls and it stays lower until the workers and other resources eventually find their way into industry B. When this process is complete, productive capacity returns to where it was before, or perhaps goes even higher. Thus, there is a short-run cycle in productive capacity that mirrors the business cycle.
Even a standard business cycle type AD shock will temporarily depress capacity and produce similar effects. Suppose that interest rates go up, taxes go up, government spending goes down, investment falls --pick your story -- causing aggregate demand to fall. When, as a result, businesses lay people off, close factories, etc., productive capacity will fall. It can be cranked up again, and will be when the economy recovers, but rehiring labor and taking equipment out of mothballs takes time. In the interim the natural rate of output falls and, just as with a change in the preference for good A versus good B, a negative aggregate demand shock can cause "frictions" on the supply side that temporarily increase the natural rate of unemployment. And there are many other ways this can happen as well.
The point is that there can be short-run cyclical AS effects, and failing to account for these can lead to policy errors.

So it may be true that productive capacity has fallen, but I beleive the fall is largely temporary, not permanent. (To be clear, I think there is a permanent component, but it is nowhere near as large as the inflation hawks are assuming -- i.e. the full employment target, once temporary effects have been cleared out of the way, is higher than the estimates that are behind the hawkery. Essentially, what I am arguing is that the temporary supply shocks are, in part, a function of AD shocks, but the effect of the AD shocks on AS wanes over time.)

If this is correct, policymakers should not be concluding that the shocks are permanent, throwing up their hands, and saying there is nothing more we can do. Instead, if, as I believe, much of the fall in productive capacity is temporary, then the job of policymakers is to make sure that employment recovers as fast as the temporary supply shocks wane. That won't be easy, employment so far has been very slow to recover and if that continues it's entirely possible that productive capacity will recover faster than employment. If policymakers try to freeze employment at a level that is too high out of misguided worries about inflation, then they will hold back the recovery and make this problem worse. That's the opposite of what they should be doing.

I could be wrong, which is what I'd like the hawks to consider. That is, what are the costs of being wrong versus the costs of being correct? My view is that the costs of doing too much -- the inflation cost -- is much lower than the costs of doing too little, i.e. the costs of higher than necessary unemployment (though see David Altig). I'm aware that we differ on this point, those in favor of relatively immediate interest rate increases see the costs of inflation as very high and it's this point that I hope will generate further discussion. In reality, how high are the costs of a temporary bout of inflation -- I have faith that the Fed won't allow an increase in inflation to become a permanent problem -- and are they so high that they justify erring on the side of doing too little rather than too much? I don't think they are, but am willing to listen to other views.

Wednesday, April 11, 2012

Monetary Policy: More or Less?

Narayana Kocherlakota recently says (and Jason Rave is not happy):

I would say that it would be appropriate to change the Fed’s current forward guidance to the public about the future course of interest rates. Currently, the FOMC statement reads that the Committee believes that conditions will warrant extraordinarily low interest rates through late 2014. My own belief is that we will need to initiate our somewhat lengthy exit strategy sometime in the next six to nine months or so, and that conditions will warrant raising rates sometime in 2013 or, possibly, late 2012.

But I hope that John Williams, and others with similar views, carry the day:

Let me summarize where the Fed stands in terms of achieving its congressionally mandated goals. We are far below maximum employment and are likely to remain there for some time. The housing bust and financial crisis set in motion an extraordinarily harsh recession, which has held down consumer, businesses, and government spending. By contrast, inflation is contained and may even fall next year below our 2% target.
Under these circumstances, it’s essential that we keep strong monetary stimulus in place. The recovery has been sluggish nationwide... High unemployment, restrained demand, and idle production capacity are national in scope. These are just the sorts of problems monetary policy can address. ...

The hawks will keep pushing to tighten sooner rather than later, so let's hope those who want to do more, or at least not do less, can at least produce the gridlock needed to keep current policy in palce.

Friday, April 06, 2012

Paul Krugman: Not Enough Inflation

The unemployed need more help from the Fed:

Not Enough Inflation, by Paul Krugman, Commentary, NY Times: A few days ago, Alan Greenspan ... spoke out in defense of his successor. Attacks on Ben Bernanke by Republicans, he told The Financial Times, are “wholly inappropriate and destructive.” He’s right...
But why are the attacks on Mr. Bernanke so destructive? ... The attackers want the Fed to slam on the brakes when it should be stepping on the gas... Fundamentally, the right wants the Fed to obsess over inflation, when the truth is that we’d be better off if the Fed paid ... more attention to unemployment. ...
O.K.,... let me take this in stages. First, about inflation obsession: For at least three years, right-wing economists, pundits and politicians have been warning that runaway inflation is just around the corner, and they keep being wrong. ... At this point, inflation is ... a bit below the Fed’s self-declared target of 2 percent.
Now, the Fed has, by law, a dual mandate: It’s supposed to be concerned with full employment as well as price stability. And while we more or less have price stability by the Fed’s definition, we’re nowhere near full employment. So this says that the Fed is doing too little, not too much. ...
To be sure, more aggressive Fed policies to fight unemployment might lead to inflation above that 2 percent target. But remember that dual mandate: If the Fed refuses to take even the slightest risk on the inflation front, despite a disastrous performance on the employment front, it’s violating its own charter. And, beyond that,... a rise in inflation to 3 percent or even 4 percent ... would almost surely help the economy. ...
Which brings me back to those Republican attacks and their chilling effect on policy.
True, Mr. Bernanke likes to insist that he and his colleagues aren’t affected by politics. But that claim is hard to square with the Fed’s actions, or rather lack of action. As many observers have noted, the Fed’s own forecasts indicate that ... it still expects low inflation and high unemployment for years to come. Given that prospect, more of the “quantitative easing” ... should be a no-brainer. Yet the recently released minutes from a March 13 meeting show a Fed inclined to do nothing unless things take a turn for the worse.
So what’s going on? I think that Fed officials, whether they admit it to themselves or not, are feeling intimidated — and that American workers are paying the price for their timidity.

Thursday, April 05, 2012

Feldstein v. Lazear

pgl:

Feldstein v. Lazear on the Size of the Output Gap , econospeak: Martin Feldstein is worried that the Federal Reserve will not reverse its increase in the monetary base even as we approach full employment:

Here is what worries me... If the unemployment rate is still very high when product markets begin to tighten, the US Congress will want the Fed to allow more rapid growth in order to bring it down, despite the resulting risk to inflation. The Fed is technically accountable to Congress, which could apply pressure on the Fed by threatening to reduce its independence. So inflation is a risk, even if it is not inevitable. The large volume of reserves ... makes that risk greater. It will take skill – as well as political courage – for the Fed to avoid the rise in inflation that the existing liquidity has created.

Dr. Feldstein is implicitly saying that the GDP gap is not as large as what Ed Lazear wants us to believe:

During the postwar period up to the current recession (1947-2007), the average annual growth rate for the U.S. was 3.4%. The last three decades have experienced somewhat slower growth than the earlier periods, but even in the period 1977-2007, the average growth rate was 3%. According to the National Bureau of Economic Research, the recovery began in the second half of 2009. Since that time, the economy has grown at 2.4%, below our long-term trend by either measure. At this point, the economy is 12% smaller than it would have been had we stayed on trend growth since 2007. ...

Lazear wants us to believe that the economy could have continued to grow by 3.4% per year since 2007QIV... In other words, Lazear wants us to believe that the current GDP gap is 12%. ...

Republicans are simultaneously pushing two themes. One theme is that current Federal Reserve policy is endangering an inflationary spiral, which seems to be the concern of Dr. Feldstein. The other theme is that the Obama Administration is somehow making the recession worse, which Dr. Lazear was so happy to echo. Funny thing – these two themes appear to be contradictory.

Andy Harless on Twitter:

Feldstein says inflation is a "risk." I would express the same point by saying that there is "some hope" for inflation. Not much, though.

Andy will be disappointed to hear that James Bullard is also convinced that the gap is smaller than most people believe, and that the Fed's commitment to keep interest rates low through the end of 2014 is harming the economy:

Concerning the FOMC’s communications tool, the “late 2014” language describing the length of the near-zero rate policy may be counterproductive, he said.  “The Committee’s practice of including distant dates in the statement sends an unwarranted pessimistic signal concerning the future of the U.S. economy.”

Regarding the output gap and housing markets, “the U.S. output gap may be smaller than typical estimates suggest,” Bullard said, adding that typical estimates count the “housing bubble” as part of the normal level of output.  However, he said, “It is neither feasible nor desirable to attempt to re-inflate the U.S. housing bubble of the mid-2000s.”

At least he's not calling for interest rates to go up --- at least not yet:

Federal Reserve Bank of St. Louis President James Bullard ... said that brighter prospects for the U.S. economy provide the Federal Open Market Committee (FOMC) with the opportunity to pause in its aggressive easing campaign.  “An appropriate approach at this juncture may be to continue to pause to assess developments in the economy,” he stated.

But he seems to be setting the stage to call for the Fed to abandon its interest rate commitment, e.g. statements such as "low interest rates hurt savers" (see here on this point).

I think that would be a mistake. How much uncertainty does Bullard have around his estimate of potential output? If it's not a substantial amount, it ought to be and the best policy in the face of such uncertainty is to lean against the more costly outcome (it also seems to me that he has chosen a forecast with one-sided errors -- it's unlikely that potential output is much lower than his current estimate, but it couldbe much higher). As I've been stressing recently (along with Stevenson and Wolfers, DeLong, and others), since high unemployment is far more costly than a temporary bout of inflation, policy ought to be directed primarily at the unemployment problem. If and when there are signs that inflation is increasing, and that labor markets are close to full recovery, then the Fed can start laying the groundwork for interest rate increases prior to 2014. But any talk of easing off its commitment before then and the loss of credibility that comes with it would be, to echo Bullard's term, counterproductive.

Monday, April 02, 2012

No Sign of an Inflation Problem

Via the Dallas Fed, once the volatile prices have been stripped out there's no evidence of inflation. If anything, inflation has been falling in recent months (before objecting that these measures do not capture actual changes in the cost of living for households, please see here):

Trimmed Mean PCE Inflation Rate, FRB Dallas: February 2012 The trimmed mean PCE inflation rate is an alternative measure of core inflation in the price index for personal consumption expenditures (PCE). It is calculated by staff at the Dallas Fed, using data from the Bureau of Economic Analysis (BEA). ...
The trimmed mean PCE inflation rate for February was an annualized 1.4 percent. According to the BEA, the overall PCE inflation rate for February was 3.8 percent, annualized, while the inflation rate for PCE excluding food and energy was 1.6 percent.
The tables below present data on the trimmed mean PCE inflation rate and, for comparison, the overall PCE inflation and the inflation rate for PCE excluding food and energy. The tables give annualized one-month, six-month and 12-month inflation rates.
One-month PCE inflation, annual rate

Sep-11
Oct-11
Nov-11
Dec-11
Jan-12
Feb-12
PCE
2.0
0.1
1.1
0.8
2.7
3.8
PCE excluding food & energy
0.0
1.4
1.7
1.8
2.7
1.6
Trimmed mean PCE
1.4
1.7
2.2
1.8
1.8
1.4

 

Six-month PCE inflation, annual rate

Sep-11
Oct-11
Nov-11
Dec-11
Jan-12
Feb-12
PCE
2.4
1.7
1.6
2.0
1.7
1.7
PCE excluding food & energy
2.0
1.8
1.6
1.6
1.6
1.5
Trimmed mean PCE
2.0
1.8
1.9
1.9
1.8
1.7

 

12-month PCE inflation

Sep-11
Oct-11
Nov-11
Dec-11
Jan-12
Feb-12
PCE
2.9
2.7
2.7
2.5
2.4
2.3
PCE excluding food & energy
1.6
1.7
1.8
1.9
1.9
1.9
Trimmed mean PCE
1.7
1.8
1.9
1.9
1.9
1.9
NOTE: These data are subject to revision ...

James Bullard is trying to make the case that domestic inflation depends upon the global output gap, and that gap looks inflationary, but I just don't see evidence for an emerging inflation problem in the tables. For the last four months or so, inflation has been stable or falling depending on the measure you choose, and that's not what you'd expect if there was increasing price pressure due to either global or domestic forces.

Friday, March 30, 2012

Fed Watch: Inflation: Still Nothing to See Here

Tim Duy:

Inflation: Still Nothing to See Here, By Tim Duy: The Februrary Personal Income and Outlays report came out this morning, and with it a fresh read on the Federal Reserve's preferred inflation measure, the PCE price index. On a year-over-year basis, headline inflation is trending down to the 2% target, while core is settling in just below that target.  

Pcefeb12A

As a reminder, the Fed targets headline over the longer run, but watches core as a signal to where headline is headed.  Headline is trending down to core, as expected. The Fed was right to dismiss last year's energy-induced headline increase as a temporary phenomenon. Is there any near term trends to be concerned about? The three-month core trend edged down a notch to just above 2%:

Pcefeb12B

Still less than the rise experienced in the first part of 2011.  What about the path of prices? Still tracking along a trend below that of prior to the recession:

Pcefeb12C

Opportunistic disinflation at work.
Bottom Line:  Inflation remains contained - by itself, price trends provide no reason for the Fed to turn hawkish. Moreover, there is nothing here to stop Federal Reserve Chairman Ben Bernanke from easing policy should the US recovery falter.

Tuesday, March 27, 2012

The Economy’s Great Fall: Are the Losses Permanent?

DeLong and Summers, the debate over potential output, and whether Bernanke has the courage, foresight, and persuasiveness to follow Greenspan's lead:

The Economy’s Great Fall: Are the Losses Permanent?

I wrote this before Bernanke's speech on the labor market on Monday. He says, echoing the topic of the column:

Is the current high level of long-term unemployment primarily the result of cyclical factors, such as insufficient aggregate demand, or of structural changes, such as a worsening mismatch between workers' skills and employers' requirements? ... I will argue today that ... the continued weakness in aggregate demand is likely the predominant factor.

So maybe the structural impediment, inflation hawk types at the Fed will be vanquished after all. We shall see. [See Tim Duy's comments on as well.]

Thursday, March 15, 2012

Testing the Inflation "Floodgates"

Simon Wren-Lewis on fear of inflation:

The inflation floodgates, mainly macro: Mark Thoma bemoans the attitude of inflation hawks on the FOMC (the US equivalent of the Bank’s Monetary Policy Committee). He writes “Unfortunately, the hawks on the committee seem to be afraid that if they allow inflation to creep up even a little bit over their long-run target, the inflation flood gates will open and they won’t be able to help themselves from a repeat of the 1970s.” From this profile by Roger Lowenstein, the floodgates view may not be confined to the hawks (HT Karl Smith). It occurred to me that we have just had a little experiment in the UK to test this floodgates view, and it looks like being completely rejected. ...[continue reading]...

Robert Waldmann also comments.