Tuesday, July 15, 2014

Fed Watch: Yellen Testimony

Tim Duy:

Yellen Testimony, by Tim Duy: Fed Reserve Chair Janet Yellen testified before the Senate today, presenting remarks generally perceived as consistent with current expectations for a long period of fairly low interest rates. Binyamin Applebaum of the New York Times notes:
Ms. Yellen’s testimony is likely to reinforce a sense of complacency among investors who regard the Fed as convinced of its forecast and committed to its policy course. She reiterated the Fed’s view that the economy will continue to grow at a moderate pace, and that the Fed is in no hurry to start increasing short-term interest rates.
A key reason that Yellen is in no hurry to tighten is her clear belief that an accommodative monetary policy is warranted given the persistent damage done by the recession:
Although the economy continues to improve, the recovery is not yet complete. Even with the recent declines, the unemployment rate remains above Federal Open Market Committee (FOMC) participants' estimates of its longer-run normal level. Labor force participation appears weaker than one would expect based on the aging of the population and the level of unemployment. These and other indications that significant slack remains in labor markets are corroborated by the continued slow pace of growth in most measures of hourly compensation.
Another reminder to watch compensation numbers. Without an acceleration in wage growth, sustained higher inflation is unlikely and hence the Fed sees little need to remove accommodation prior to reaching its policy objectives.
The only vaguely more hawkish tone was that identified by Applebaum:
But Ms. Yellen added that the Fed was ready to respond if it concluded that it had overestimated the slack in the labor market, a more substantial acknowledgment of the views of her critics than she has made in other recent remarks.
The exact quote:
Of course, the outlook for the economy and financial markets is never certain, and now is no exception. Therefore, the Committee's decisions about the path of the federal funds rate remain dependent on our assessment of incoming information and the implications for the economic outlook. If the labor market continues to improve more quickly than anticipated by the Committee, resulting in faster convergence toward our dual objectives, then increases in the federal funds rate target likely would occur sooner and be more rapid than currently envisioned. Conversely, if economic performance is disappointing, then the future path of interest rates likely would be more accommodative than currently anticipated.
Her choice of words is important here. Note that she does not say "If the labor market improves more quickly". Yellen says "continues to improve more quickly" which means that the economy is already converging towards the Fed's objective more quickly than anticipated by current forecasts. This is a point repeatedly made by St. Louis Federal Reserve President James Bullard in recent weeks. For example, via Bloomberg:
Federal Reserve Bank of St. Louis President James Bullard said a rapid drop in joblessness will fuel inflation, bolstering his case for an interest-rate increase early next year.
“I think we are going to overshoot here on inflation,” Bullard said yesterday in a telephone interview from St. Louis. He predicted inflation of 2.4 percent at the end of 2015, “well above” the Fed’s 2 percent target.
“That is a break from where most of the committee seems to be, which is a very slow convergence of inflation to target,” he said in a reference to the policy-making Federal Open Market Committee.
His picture:

BULLARD071514

With Yellen at least acknowledging this point, it brings into question whether or not the Fed should maintain its "considerable period" language:
The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends...
Fed hawks, such as Philadelphia Federal Reserve President Charles Plosser, increasingly see the need to remove this language from the statement, and for some good reason. The Fed foresees ending asset purchases in October and can reasonably foresee raising interest rates in the first quarter given the trajectory of unemployment. Hence it is no longer clear that a "considerable period" between the end of asset purchases and the first rate hike remains a certainty.
To be sure, there will be resistance to changing the language now - the Fed will want to ensure that any change is interpreted as the result of a change in the outlook rather than a change in the reaction function. But the hawks will argue that the communications challenge is best handled by dropping the language sooner than later - later might appear like an abrupt change and be more difficult to distinguish from a shift in the reaction function. This I suspect is the next battlefield for policymakers.
Bottom Line: A generally dovish performance by Yellen today consistent with current expectations. But notice her acknowledgement of her critics, and watch for the "considerable period" debate to heat up as October approaches.

    Posted by on Tuesday, July 15, 2014 at 11:59 AM in Economics, Fed Watch, Monetary Policy | Permalink  Comments (26)


    Improving Social Insurance Can Narrow the 'Opportunity Gap'

    I have a new column:

    Improving Social Insurance Can Narrow the “Opportunity Gap”: The justification for social insurance programs that protect workers is usually based upon the fact that employment in capitalist economies is subject to substantial variation due to cyclical fluctuations and structural change. Economic systems such as socialism have much less variation in employment since everyone, pretty much, is guaranteed a job. But the growth rate of output in those systems is not as high as it is in capitalist economies, and that leads to a lower average standard of living. 
    Why not enjoy the benefits of a capitalist system while minimizing its costs through the use of social insurance programs that insulate workers from harm when they lose their jobs for one of these reasons? ...
    We don’t do enough to insulate workers from the fluctuations in employment inherent in capitalist economies. ...
    Doing more to help workers affected by economic downturns and structural change is not the only way in which social insurance could be improved. There other risks, in particular the risk of unequal opportunity, that are baked into capitalist systems. ...

      Posted by on Tuesday, July 15, 2014 at 07:50 AM in Economics, Income Distribution, Social Insurance | Permalink  Comments (21)


      Does Extending Unemployment Benefits Raise Joblessness?

      Me, at MoneyWatch:

      Can unemployment benefits raise joblessness?: Did the extension of unemployment compensation during the Great Recession cause joblessness to go up? ...

      The latest research on this topic from Katharine Bradbury of the Federal Reserve Bank of Boston ... finds that unemployment does go up when unemployment benefits are extended, but the question is why. Does it discourage workers from taking jobs, or discourage them from leaving the labor force?

      Bradbury pointed out that the earlier research shows it's mostly the latter, that extending unemployment benefits causes workers to stay in the labor force longer before dropping out. No notable impact was found on their willingness to take available jobs. ...

        Posted by on Tuesday, July 15, 2014 at 07:50 AM in Economics, Social Insurance, Unemployment | Permalink  Comments (13)


        Links for 7-15-14

          Posted by on Tuesday, July 15, 2014 at 12:06 AM in Economics, Links | Permalink  Comments (86)


          Monday, July 14, 2014

          'Empirical Evidence on Inflation Expectations in the New Keynesian Phillips Curve'

          Via email, a comment on my comments about the difficulty of settling questions about the Phillips curve empirically:

          Dear Professor Thoma,
          I saw your recent post on the difficulty of empirically testing the Phillips Curve, and I just wanted to alert you to a survey paper on this topic that I wrote with Sophocles Mavroeidis and Jim Stock: "Empirical Evidence on Inflation Expectations in the New Keynesian Phillips Curve". It was published in the Journal of Economic Literature earlier this year (ungated working paper).
          In the paper we estimate a vast number of specifications of the New Keynesian Phillips Curve (NKPC) on a common U.S. data set. The specification choices include the data series, inflation lag length, sample period, estimator, and so on. A subset of the specifications amount to traditional backward-looking (adaptive expectation) Phillips Curves. We are particularly interested in two key parameters: the extent to which price expectations are forward-looking, and the slope of the curve (how responsive inflation is to real economic activity).
          Our meta-analysis finds that essentially any desired parameter estimates can be generated by some reasonable-sounding specification. That is, estimation of the NKPC is subject to enormous specification uncertainty. This is consistent with the range of estimates reported in the literature. Even if one were to somehow decide on a given specification, the uncertainty surrounding the parameter estimates is typically large. We give theoretical explanations for these empirical findings in the paper. To be clear: Our results do not reject the validity of the NKPC (or more generally, the presence of a short-run inflation/output trade-off), but traditional aggregate time series analysis is just not very informative about the nature of inflation dynamics.
          Kind regards,
          Mikkel Plagborg-Moller
          PhD candidate in economics, Harvard University

            Posted by on Monday, July 14, 2014 at 01:49 PM in Academic Papers, Econometrics, Economics, Inflation, Unemployment | Permalink  Comments (14)


            Congress and Monetary Policy

            Zero percent agree that Congress should impose a monetary policy rule on the Fed:

            IGM Forum: Should the Fed be required to follow a rule?

            I am surprised that 11% are uncertain, but see their accompanying comments (the question also asks about how certain respondents are of their answers -- some people are fairly certain they are uncertain).

              Posted by on Monday, July 14, 2014 at 01:42 PM in Economics, Monetary Policy | Permalink  Comments (7)


              Is There a Phillips Curve? If So, Which One?

              One place that Paul Krugman and Chris House disagree is on the Phillips curve. Krugman (responding to a post by House) says:

              New Keynesians do stuff like one-period-ahead price setting or Calvo pricing, in which prices are revised randomly. Practicing Keynesians have tended to rely on “accelerationist” Phillips curves in which unemployment determined the rate of change rather than the level of inflation.
              So what has happened since 2008 is that both of these approaches have been found wanting: inflation has dropped, but stayed positive despite high unemployment. What the data actually look like is an old-fashioned non-expectations Phillips curve. And there are a couple of popular stories about why: downward wage rigidity even in the long run, anchored expectations.

              House responds:

              What the data actually look like is an old-fashioned non-expectations Phillips curve. 
              OK, here is where we disagree. Certainly this is not true for the data overall. It seems like Paul is thinking that the system governing the relationship between inflation and output changes between something with essentially a vertical slope (a “Classical Phillips curve”) and a nearly flat slope (a “Keynesian Phillips Curve”). I doubt that this will fit the data particularly well and it would still seem to open the door to a large role for “supply shocks” – shocks that neither Paul nor I think play a big role in business cycles.

              Simon Wren-Lewis also has something to say about this in his post from earlier today, Has the Great Recession killed the traditional Phillips Curve?:

              Before the New Classical revolution there was the Friedman/Phelps Phillips Curve (FPPC), which said that current inflation depended on some measure of the output/unemployment gap and the expected value of current inflation (with a unit coefficient). Expectations of inflation were modelled as some function of past inflation (e.g. adaptive expectations) - at its simplest just one lag in inflation. Therefore in practice inflation depended on lagged inflation and the output gap.
              After the New Classical revolution came the New Keynesian Phillips Curve (NKPC), which had current inflation depending on some measure of the output/unemployment gap and the expected value of inflation in the next period. If this was combined with adaptive expectations, it would amount to much the same thing as the FPPC, but instead it was normally combined with rational expectations, where agents made their best guess at what inflation would be next period using all relevant information. This would include past inflation, but it would include other things as well, like prospects for output and any official inflation target.
              Which better describes the data? ...
              [W]e can see why some ... studies (like this for the US) can claim that recent inflation experience is consistent with the NKPC. It seems much more difficult to square this experience with the traditional adaptive expectations Phillips curve. As I suggested at the beginning, this is really a test of whether rational expectations is a better description of reality than adaptive expectations. But I know the conclusion I draw from the data will upset some people, so I look forward to a more sophisticated empirical analysis showing why I’m wrong.

              I don't have much to add, except to say that this is an empirical question that will be difficult to resolve empirically (because there are so many different ways to estimate a Phillips curve, and different specifications give different answers, e.g. which measure of prices to use, which measure of aggregate activity to use, what time period to use and how to handle structural and policy breaks during the period that is chosen, how should natural rates be extracted from the data, how to handle non-stationarities, if we measure aggregate activity with the unemployment rate, do we exclude the long-term unemployed as recent research suggests, how many lags should be included, etc., etc.?).

                Posted by on Monday, July 14, 2014 at 12:21 PM in Economics, Inflation, Macroeconomics, Methodology, Unemployment | Permalink  Comments (5)


                Event Time vs. Clock Time

                I taught my first class at UT Austin today. I am staying a little over a mile and a half from the campus, so I decided to walk. I discovered that it's a lot hotter in Texas than in Oregon! I will have to get used to this so I'm not dripping wet during my classes...

                Anyway, back to the usual. This is from Chris Dillow (I am definitely an even time type, one of the big reasons I avoided the 8-5 world):

                Time, by Chris Dillow: Google boss Larry Page recently called for the end of the conventional 40-hour working week. Some new research suggests this could have more profound cultural effects than generally thought.
                Anne-Laure Sellier and Tamar Avnet primed people to choose between organizing some jobs in "clock-time" (scheduling a specific job at a specific time) or in "event-time" (doing a job until you reach a natural break). They found that the choice led to two big pyschological differences.
                First, clock-timers were more likely to have an external locus of control; they were more likely to see their lives as determined by fate or powerful others. Event-timers, on the other hand, tended to have an internal locus, regarding themselves as in control of their own fate. ...
                Secondly, clock-timers were less able to savour positive emotions than event-timers - perhaps because if you have an eye on the clock you are less likely to lose yourself in a job and so enjoy flow. ...
                Here, though, we need some history. One key feature of the emergence of industrial capitalism was that bosses replaced event-time with clock-time. ... But as Sellier and Avnet suggest, this replacement had some cultural and psychological effects...
                And herein lies the thing. If Mr Page is right and/or if some combination of robots and a citizens basic income create a post-scarcity economy in which we are ... less subject to the tyranny of the clock, this could lead to big cultural changes which we have barely begun to think about.

                  Posted by on Monday, July 14, 2014 at 11:32 AM in Economics | Permalink  Comments (8)


                  Paul Krugman: Obamacare Fails to Fail

                  Why don't we hear more about the success of Obamacare?:

                  Obamacare Fails to Fail, by Paul Krugman, Commentary, NY Times: How many Americans know how health reform is going? For that matter, how many people in the news media are following the positive developments?
                  I suspect that the answer to the first question is “Not many,” while the answer to the second is “Possibly even fewer”... And if I’m right, it’s a remarkable thing — an immense policy success is improving the lives of millions of Americans, but it’s largely slipping under the radar.
                  How is that possible? Think relentless negativity without accountability. The Affordable Care Act has faced nonstop attacks from partisans and right-wing media, with mainstream news also tending to harp on the act’s troubles. Many of the attacks have involved predictions of disaster, none of which have come true. But absence of disaster doesn’t make a compelling headline, and the people who falsely predicted doom just keep coming back with dire new warnings. ...
                  Yes, there are losers from Obamacare. If you’re young, healthy, and affluent enough that you don’t qualify for a subsidy (and don’t get insurance from your employer), your premium probably did rise. And if you’re rich enough to pay the extra taxes that finance those subsidies, you have taken a financial hit. But it’s telling that even reform’s opponents aren’t trying to highlight these stories. Instead, they keep looking for older, sicker, middle-class victims, and keep failing to find them.
                  Oh,... the overwhelming majority of the newly insured, including 74 percent of Republicans, are satisfied with their coverage.
                  You might ask why, if health reform is going so well, it continues to poll badly. It’s crucial ... to realize that Obamacare, by design, by and large doesn’t affect Americans who already have good insurance. As a result, many peoples’ views are shaped by the mainly negative coverage in the news... Still, the latest tracking survey from the Kaiser Family Foundation shows that a rising number of Americans are hearing about reform from family and friends, which means that they’re starting to hear from the program’s beneficiaries.
                  And as I suggested earlier, people in the media — especially elite pundits — may be the last to hear the good news, simply because they’re in a socioeconomic bracket in which people generally have good coverage.
                  For the less fortunate, however, the Affordable Care Act has already made a big positive difference. The usual suspects will keep crying failure, but the truth is that health reform is — gasp! — working.

                    Posted by on Monday, July 14, 2014 at 12:24 AM in Economics, Health Care, Politics, Press | Permalink  Comments (89)


                    Links for 7-14-14

                      Posted by on Monday, July 14, 2014 at 12:06 AM in Economics, Links | Permalink  Comments (29)


                      Sunday, July 13, 2014

                      New Classical Economics as Modeling Strategy

                      Judy Klein emails a response to a recent post of mine based upon Simon Wren Lewis's post “Rereading Lucas and Sargent 1979”:

                      Lucas and Sargent’s, “After Keynesian Macroeconomics,” was presented at the 1978 Boston Federal Reserve Conference on “After the Phillips Curve: Persistence of High Inflation and High Unemployment.” Although the title of the conference dealt with stagflation, the rational expectations theorists saw themselves countering one technical revolution with another.

                      The Keynesian Revolution was, in the form in which it succeeded in the United States, a revolution in method. This was not Keynes’s intent, nor is it the view of all of his most eminent followers. Yet if one does not view the revolution in this way, it is impossible to account for some of its most important features: the evolution of macroeconomics into a quantitative, scientific discipline, the development of explicit statistical descriptions of economic behavior, the increasing reliance of government officials on technical economic expertise, and the introduction of the use of mathematical control theory to manage an economy. [Lucas and Sargent, 1979, pg. 50]

                      The Lucas papers at the Economists' Papers Project at the University of Duke reveal the preliminary planning for the 1978 presentation. Lucas and Sargent decided that it would be a “rhetorical piece… to convince others that the old-fashioned macro game is up…in a way which makes it clear that the difficulties are fatal”; it’s theme would be the “death of macroeconomics” and the desirability of replacing it with an “Aggregative Economics” whose foundation was “equilibrium theory.” (Lucas letter to Sargent February 9, 1978). Their 1978 presentation was replete, as their discussant Bob Solow pointed out, with the planned rhetorical barbs against Keynesian economics of “wildly incorrect," "fundamentally flawed," "wreckage," "failure," "fatal," "of no value," "dire implications," "failure on a grand scale," "spectacular recent failure," "no hope." The empirical backdrop to Lucas and Sargent’s death decree on Keynesian economics was evident in the subtitle of the conference: “Persistence of High Inflation and High Unemployment.”

                      Although they seized the opportunity to comment on policy failure and the high misery-index economy, Lucas and Sargent shifted the macroeconomic court of judgment from the economy to microeconomics. They fought a technical battle over the types of restrictions used by modelers to identify their structural models. Identification-rendering restrictions were essential to making both the Keynesian and rational expectations models “work” in policy applications, but Lucas and Sargent defined the ultimate terms of success not with regard to a model’s capacity for empirical explanation or achievement of a desirable policy outcome, but rather with regard to the model’s capacity to incorporate optimization and equilibrium – to aggregate consistently rational individuals and cleared markets.

                      In the macroeconomic history written by the victors, the Keynesian revolution and the rational expectations revolution were both technical revolutions, and one could delineate the sides of the battle line in the second revolution by the nature of the restricting assumptions that enabled the model identification that licensed policy prescription. The rational expectations revolution, however, was also a revolution in the prime referential framework for judging macroeconomic model fitness for going forth and multiplying; the consistency of the assumptions – the equation restrictions - with optimizing microeconomics and mathematical statistical theory, rather than end uses of explaining the economy and empirical statistics, constituted the new paramount selection criteria.

                      Some of the new classical macroeconomists have been explicit about the narrowness of their revolution. For example, Sargent noted in 2008, “While rational expectations is often thought of as a school of economic thought, it is better regarded as a ubiquitous modeling technique used widely throughout economics.” In an interview with Arjo Klamer in 1983, Robert Townsend asserted that “New classical economics means a modeling strategy.”

                      It is no coincidence, however, that in this modeling narrative of economic equilibrium crafted in the Cold War era, Adam Smith’s invisible hand morphs into a welfare-maximizing “hypothetical ‘benevolent social planner’” (Lucas, Prescott, Stokey 1989) enforcing a “communism of models” (Sargent 2007) and decreeing to individual agents the mutually consistent rules of action that become the equilibrating driving force. Indeed, a long-term Office of Naval Research grant for “Planning & Control of Industrial Operations” awarded to the Carnegie Institutes of Technology’s Graduate School of Industrial Administration had funded Herbert Simon’s articulation of his certainty equivalence theorem and John Muth’s study of rational expectations. It is ironic that a decade-long government planning contract employing Carnegie professors and graduate students underwrote the two key modeling strategies for the Nobel-prize winning demonstration that the rationality of consumers renders government intervention to increase employment unnecessary and harmful.

                        Posted by on Sunday, July 13, 2014 at 03:00 PM in Economics, Macroeconomics, Methodology | Permalink  Comments (16)


                        'Why Macroeconomists, Not Bankers, Should Set Interest Rates'

                        Simon Wren-Lewis:

                        Why macroeconomists, not bankers, should set interest rates: More thoughts on the idea that interest rates ought to rise because of the possibility that the financial sector is taking excessive risks: what I called in this earlier post the BIS case, after the Bank of International Settlements, the international club for central bankers. I know Paul Krugman, Brad DeLong, Mark Thoma, Tony Yates and many others have already weighed in here, but - being macroeconomists - they were perhaps too modest to draw this lesson. ...

                          Posted by on Sunday, July 13, 2014 at 09:50 AM in Economics, Financial System, Monetary Policy, Regulation | Permalink  Comments (19)


                          Links for 7-13-14

                            Posted by on Sunday, July 13, 2014 at 12:06 AM in Economics, Links | Permalink  Comments (31)


                            Saturday, July 12, 2014

                            Are Interest Rates Artificially Low? Nope.

                            Discouraging:

                            The Meme is Out There, by Paul Krugman: I just answered some questions for Princeton magazine, and among them was this:

                            Please comment on how artificially low interest rates have impacted the current value of baby boomers’ retirement portfolios and should this be a consideration of the Federal Reserve?

                            I don’t blame the editor, who after all isn’t supposed to be an economist. But what this must reflect is what people are hearing on the financial news; I’m pretty sure that a lot of people think that all the experts regard interest rates as “artificially low”, and have no idea that to the extent that such a notion makes any sense at all — which is to say in terms of the Wicksellian natural rate — interest rates are too high, not too low.

                              Posted by on Saturday, July 12, 2014 at 12:15 PM in Economics, Monetary Policy | Permalink  Comments (71)


                              'The Collapse of the French Assignat and Its Link to Virtual Currencies Today'

                              In case you missed this in links, I thought it was interesting:

                              Crisis Chronicles: The Collapse of the French Assignat and Its Link to Virtual Currencies Today, by James Narron and David Skeie, Liberty Street Economics: In the late 1700s, France ran a persistent deficit and by the late 1780s struggled with how to balance the budget and pay down the debt. After heated debate, the National Assembly elected to issue a paper currency bearing an attractive 3 percent interest rate, secured by the finest French real estate to be confiscated from the clergy. Assignats were first issued in December 1789 and initially were a boon to the economy. Yet while the first issues brought prosperity, subsequent issues led to stagnation and misery. In this edition of Crisis Chronicles, we review how fiat money inflation in France caused the collapse of the French assignat and describe some interesting parallels between the politics of French government finance in the late 1700s and more recent fiscal crises.

                              Remembering John Law and the Mississippi Bubble
                              It was not without grave reservation that the National Assembly elected to pursue a new issue of paper currency. Some who spoke out against issuing the assignat recalled the wretchedness and ruin to which their families were subjected during John Law’s tenure as head of French finance and the Mississippi Bubble of 1720. But there was also great political willpower against raising taxes of any sort and deficits were already high. So the only option was to turn to the printing press once again.
                              But this time, the National Assembly was convinced it would be different. The currency would be secured by confiscated church property...[continue reading]...

                                Posted by on Saturday, July 12, 2014 at 10:03 AM in Economics, Financial System | Permalink  Comments (9)


                                Links for 7-12-14

                                  Posted by on Saturday, July 12, 2014 at 12:06 AM in Economics, Links | Permalink  Comments (57)


                                  Friday, July 11, 2014

                                  'Rereading Lucas and Sargent 1979'

                                  Simon Wren-Lewis with a nice follow-up to an earlier discussion:

                                  Rereading Lucas and Sargent 1979: Mainly for macroeconomists and those interested in macroeconomic thought
                                  Following this little interchange (me, Mark Thoma, Paul Krugman, Noah Smith, Robert Waldman, Arnold Kling), I reread what could be regarded as the New Classical manifesto: Lucas and Sargent’s ‘After Keynesian Economics’ (hereafter LS). It deserves to be cited as a classic, both for the quality of ideas and the persuasiveness of the writing. It does not seem like something written 35 ago, which is perhaps an indication of how influential its ideas still are.
                                  What I want to explore is whether this manifesto for the New Classical counter revolution was mainly about stagflation, or whether it was mainly about methodology. LS kick off their article with references to stagflation and the failure of Keynesian theory. A fundamental rethink is required. What follows next is I think crucial. If the counter revolution is all about stagflation, we might expect an account of why conventional theory failed to predict stagflation - the equivalent, perhaps, to the discussion of classical theory in the General Theory. Instead we get something much more general - a discussion of why identification restrictions typically imposed in the structural econometric models (SEMs) of the time are incredible from a theoretical point of view, and an outline of the Lucas critique.
                                  In other words, the essential criticism in LS is methodological: the way empirical macroeconomics has been done since Keynes is flawed. SEMs cannot be trusted as a guide for policy. In only one paragraph do LS try to link this general critique to stagflation...[continue]...

                                    Posted by on Friday, July 11, 2014 at 08:28 AM in Economics, Macroeconomics, Methodology | Permalink  Comments (55)


                                    Paul Krugman: Who Wants a Depression?

                                    Why has there been so much "hysteria over Fed policy"?:

                                    Who Wants a Depression?, by Paul Krugman, Commentary, NY Times: One unhappy lesson we’ve learned in recent years is that economics is a far more political subject than we liked to imagine. ...
                                    It’s not that many years since the administration of George W. Bush declared that one lesson from the 2001 recession and the recovery that followed was that “aggressive monetary policy can make a recession shorter and milder.” Surely, then, we’d have a bipartisan consensus in favor of even more aggressive monetary policy to fight the far worse slump of 2007 to 2009. Right?
                                    Well, no. I’ve written a number of times about the phenomenon of “sadomonetarism,” the constant demand that the Federal Reserve and other central banks stop trying to boost employment and raise interest rates instead, regardless of circumstances. I’ve suggested that the persistence of this phenomenon has a lot to do with ideology, which, in turn, has a lot to do with class interests. And I still think that’s true.
                                    But I now think that class interests also operate through a cruder, more direct channel. Quite simply, easy-money policies, while they may help the economy as a whole, are directly detrimental to people who get a lot of their income from bonds and other interest-paying assets — and this mainly means the very wealthy, in particular the top 0.01 percent. ...
                                    Complaints about low interest rates are usually framed in terms of the harm being done to retired Americans living on the interest from their CDs. But the interest receipts of older Americans go mainly to a small and relatively affluent minority..., and it surely explains a lot of the hysteria over Fed policy. The rich ... ensure that there are always plenty of supposed experts eager to find justifications for this attitude. Hence sadomonetarism.
                                    Which brings me back to the politicization of economics.
                                    Before the financial crisis, many central bankers and economists were, it’s now clear, living in a fantasy world, imagining themselves to be technocrats insulated from the political fray. ...
                                    It turns out, however, that using monetary policy to fight depression, while in the interest of the vast majority of Americans, isn’t in the interest of a small, wealthy minority. And, as a result, monetary policy is as bound up in class and ideological conflict as tax policy.
                                    The truth is that in a society as unequal and polarized as ours has become, almost everything is political. Get used to it.

                                      Posted by on Friday, July 11, 2014 at 12:24 AM in Economics, Monetary Policy | Permalink  Comments (120)


                                      Links for 7-11-14

                                        Posted by on Friday, July 11, 2014 at 12:06 AM in Economics, Links | Permalink  Comments (66)


                                        Thursday, July 10, 2014

                                        'In Search of Search Theory'

                                        John Quiggin:

                                        In search of search theory: This is going to be a long and wonkish post, so I’ll just give the dot-point summary here, and let those interested read on below the fold, for the explanations and qualifications.
                                        * The dominant model of unemployment, in academic macroeconomics at least, is based on the idea that unemployment can best be modelled in terms of workers searching for jobs, and remaining unemployed until they find a good match with an employer
                                        * The efficiency of job search and matching has been massively increased by the Internet, so, if unemployment is mainly explained by search, it should have fallen steadily over the past 20 years.
                                        * Obviously, this hasn’t happened, but economists seem to have ignored this fact or at least not worried too much about it
                                        * The fact that search models are more popular than ever is yet more evidence that academic macroeconomics is in a bad way ...

                                          Posted by on Thursday, July 10, 2014 at 10:53 AM in Economics, Unemployment | Permalink  Comments (12)


                                          Fed Explores Overhaul of Its Target Interest Rate

                                          Robin Harding reports:

                                          Fed explores overhaul of key rate: The US Federal Reserve is exploring an overhaul of the Federal funds rate – a benchmark that underlies almost every financial transaction in the world – as it prepares for an eventual rise in interest rates. ...
                                          According to people familiar with the discussions, the Fed is could redefine its main target rate so that it takes into account a wider range of loans between banks, making it more stable and reliable.  ...
                                          In particular, the Fed is looking at redefining the Fed funds rate to include eurodollar transactions – dollar loans between banks outside the US markets – as well as traditional onshore loans between US banks. Other closely related rates that it could include are those on transactions for bank commercial paper and wholesale certificates of deposit between banks.

                                            Posted by on Thursday, July 10, 2014 at 10:52 AM in Economics, Monetary Policy | Permalink  Comments (1)


                                            Fed Watch: QEInfinity Not

                                            Tim Duy:

                                            QEInfinity Not, by Tim Duy: The Federal Reserve released the minutes of the June FOMC meeting today, but the contents had little in the way of groundbreaking news. Most interesting was that Fed officials tired of being pestered about the "October or December" question regarding the end of the QE and decided to more or less commit to the earlier date:
                                            Some committee members had been asked by members of the public whether, if tapering in the pace of purchases continues as expected, the final reduction would come in a single $15 billion per month reduction or in a $10 billion reduction followed by a $5 billion reduction. Most participants viewed this as a technical issue with no substantive macroeconomic consequences and no consequences for the eventual decision about the timing of the first increase in the federal funds rate--a decision that will depend on the Committee's evolving assessments of actual and expected progress toward its objectives.
                                            In other words, who cares about that last $5 billion? The Fed's answer was to take away the mystery:
                                            In light of these considerations, participants generally agreed that if incoming information continued to support its expectation of improvement in labor market conditions and a return of inflation toward its longer-run objective, it would be appropriate to complete asset purchases with a $15 billion reduction in the pace of purchases in order to avoid having the small, remaining level of purchases receive undue focus among investors.
                                            with, of course, the usual "data dependent" caveat. Thus the predictions of QE Infinity come to an end. In other news, the Fed fretted over market complacency:
                                            However, participants also discussed whether some recent trends in financial markets might suggest that investors were not appropriately taking account of risks in their investment decisions. In particular, low implied volatility in equity, currency, and fixed-income markets as well as signs of increased risk-taking were viewed by some participants as an indication that market participants were not factoring in sufficient uncertainty about the path of the economy and monetary policy.
                                            I find this somewhat irritating. What is "sufficient" uncertainty? I find it especially irritating given that, as Josh Zumbrun at the Wall Street Journal reports, Fed officials themselves appear to have less uncertainty regarding the outlook:

                                            BN-DP809_dwindl_G_20140709142508

                                            If the Fed has a well-communicated reaction function, and there is little uncertainty about the outlook, why should there be uncertainty about the path of monetary policy? The Fed's unease about complacency seems misplaced. The goal of the communications strategy should be to limit uncertainty regarding the path of monetary policy by clearing defining the objective function. The only residual uncertainty will be economic uncertainty. And even that arguably is reduced by establishing a well-communicated reaction function.
                                            In any event, the Fed concluded that even if complacency is a problem, there is not much they can do about it:
                                            They agreed that the Committee should continue to carefully monitor financial conditions and to emphasize in its communications the dependence of its policy decisions on the evolution of the economic outlook; it was also pointed out that, where appropriate, supervisory measures should be applied to address excessive risk-taking and associated financial imbalances. At the same time, it was noted that monetary policy needed to continue to promote the favorable financial conditions required to support the economic expansion.
                                            Very similar to Federal Reserve Chair Janet Yellen's recent comments:
                                            Taking all of these factors into consideration, I do not presently see a need for monetary policy to deviate from a primary focus on attaining price stability and maximum employment, in order to address financial stability concerns. That said, I do see pockets of increased risk-taking across the financial system, and an acceleration or broadening of these concerns could necessitate a more robust macroprudential approach.
                                            If the Fed wants to increase uncertainty and, presumably, reduce potential financial instability, they could do so by changing the reaction function in a hawkish direction. The Fed, however, is not yet sufficiently concerned about complacency to attempt to gain more financial stability at the cost of economic growth.
                                            Inflation remains well below target:

                                            INF070914

                                            But the Fed believes we have seen the lows:
                                            Readings on a range of price measures--including the PCE price index, the CPI, and a number of the analytical measures developed at the Reserve Banks--appeared to provide evidence that inflation had moved up recently from low levels earlier in the year, consistent with the Committee's forecast of a gradual increase in inflation over the medium term. Reports from business contacts were mixed, spanning an absence of price pressures in some Districts and rising input costs in others. Some participants expressed concern about the persistence of below-trend inflation, and a couple of them suggested that the Committee may need to allow the unemployment rate to move below its longer-run normal level for a time in order keep inflation expectations anchored and return inflation to its 2 percent target, though one participant emphasized the risks of doing so. In contrast, some others expected a faster pickup in inflation or saw upside risks to inflation and inflation expectations because they anticipated a more rapid decline in economic slack.
                                            Seems like broad agreement that inflation rates bottomed out, but less agreement on where they head from here. Toward target, to be sure, but at what speed? That question, like all the forecasts, feeds into future policy decisions:
                                            Some participants suggested that the Committee's communications about its forward guidance should emphasize more strongly that its policy decisions would depend on its ongoing assessment across a range of indicators of economic activity, labor market conditions, inflation and inflation expectations, and financial market developments. In that regard, circumstances that might entail either a slower or a more rapid removal of policy accommodation were cited. For example, a number of participants noted their concern that a more gradual approach might be appropriate if forecasts of above-trend economic growth later this year were not realized. And a couple suggested that the Committee might need to strengthen its commitment to maintain sufficient policy accommodation to return inflation to its target over the medium term in order to prevent an undesirable decline in inflation expectations. Alternatively, some other participants expressed concern that economic growth over the medium run might be faster than currently expected or that the rate of growth of potential output might be lower than currently expected, calling for a more rapid move to begin raising the federal funds rate in order to avoid significantly overshooting the Committee's unemployment and inflation objectives.
                                            Is there any new information here? I think not. The current expected path of rates is data dependent, and as that data changes, so too will the expected rate path. The pattern of rate forecasts in the Summary of Economic Projections largely reflects differing forecasts rather than differing reaction functions. As the data evolves, the pattern of rate forecasts will converge as one of the paths becomes more obvious.
                                            My own view is:
                                            1. The existing mix of data and forecasts suggest the first rate hike in the second quarter of 2015 with a gradual increase in rates thereafter. This is my baseline.
                                            2. If unemployment continues to drop at the same rate as recent months, bring forward the rate hike to the first quarter but continue to assume a gradual increase.
                                            3. If core-PCE inflation exceeds 2.25% and wage growth is accelerating , expect first quarter liftoff and a steeper path of rate hikes.

                                            Obviously, the data could suggest a delay in the first rate hike, but I do not believe the risks are weighted in that direction. I think the risks are weighted toward tighter than expected policy.

                                            Bottom Line: Fairly straightforward minutes. Policy is data dependent. The Fed, like all of us, are simply waiting to see how that data evolves.

                                              Posted by on Thursday, July 10, 2014 at 12:24 AM in Economics, Fed Watch, Monetary Policy | Permalink  Comments (2)


                                              Links for 7-10-14

                                                Posted by on Thursday, July 10, 2014 at 12:06 AM in Economics, Links | Permalink  Comments (157)


                                                Wednesday, July 09, 2014

                                                Note

                                                I am on the road and have a long travel day ahead of me, the second in a row, so probably not much more blogging until much later, if at all (I'm headed to UT Austin to teach a four week class beginning next Monday).

                                                  Posted by on Wednesday, July 9, 2014 at 09:48 AM in Economics, Travel | Permalink  Comments (4)


                                                  Adam Smith as Malthusian: 'The Surplus Population'

                                                  Brad DeLong quotes Adam Smith:

                                                  Adam Smith as Malthusian: “The Surplus Population”, by Brad DeLong: ...Adam Smith: Smith: Wealth of Nations, Book I, Chapter 8: “Is this improvement in the circumstances of the lower ranks of the people…

                                                  …to be regarded as an advantage or as an inconveniency to the society? The answer seems ... abundantly plain. Servants, abourers and workmen of different kinds, make up the far greater part of every great political society. But what improves the circumstances of the greater part can never be regarded as an inconveniency to the whole. No society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable. It is but equity, besides, that they who feed, cloath and lodge the whole body of the people, should have such a share of the produce of their own labour as to be themselves tolerably well fed, cloathed and lodged.

                                                  Poverty… seems even to be avourable to generation. A half-starved Highland woman frequently bears more than twenty children…. Luxury in the fair sex, while it enflames perhaps the passion for enjoyment, seems always to weaken and frequently to destroy altogether, the powers of generation. But poverty… is extremely unfavourable to the rearing of children…. It is not uncommon… in the Highlands… for a mother who has borne twenty children not to have two alive…. In civilized society it is only among the inferior ranks of people that the scantiness of subsistence can set limits to the further multiplication of the human species… by destroying a great part of the children which their fruitful marriages produce. The liberal reward of labour, by enabling them to provide better for their children, and consequently to bring up a greater number, naturally tends to widen and extend those limits…. The liberal reward of labour, therefore, as it is the effect of increasing wealth, so it is the cause of increasing population. To complain of it, is to lament over the necessary effect and cause of the greatest public prosperity.

                                                  ItIt deserves to be remarked, perhaps, that it is in the progressive state, while the society is advancing to the further acquisition, rather than when it has acquired its full complement of riches, that the condition of the labouring poor, of the great body of the people, seems to be the happiest and the most comfortable. It is hard in the stationary, and miserable in the declining state. The progressive state is in reality the cheerful and the hearty state to all the different orders of the society. The stationary is dull; the declining melancholy…

                                                  And then Brad remarks:

                                                  Two things are worth noting here:

                                                  The first is that even as early as 1776 economics had already acquired the utilitarian bias toward an equal distribution of income: feeding, clothing, and lodging the working class “tolerably well” contributed much more to the flourishing and happiness of society then would devoting the same resources to further increasing the luxury of the rich. We are in the world of Jeremy Bentham, where any claim that we cannot make interpersonal comparisons of utility between rich and poor is dismissed with a laugh.

                                                  The second is that Adam Smith is, in the longest run and in the last analysis, a Malthusian: economies are headed for a stationary–or, worse, a declining–state, and that stationary state is not a good one: “the condition of the… great body of the people… is hard in the stationary, and miserable in the declining state…” But there is no sense that we should not grab for the boom as long as we can, and as long as we are in the boom period, Adam Smith says, we should not complain about population growth

                                                  The liberal reward of labour… is the effect of increasing wealth… [and] the cause of increasing population. To complain… is to lament over the necessary effect and cause of the greatest public prosperity…

                                                    Posted by on Wednesday, July 9, 2014 at 09:22 AM in Economics, History of Thought, Income Distribution | Permalink  Comments (7)


                                                    'Lifting the Veil on the U.S. Bilateral Repo Market'

                                                    Via the Liberty Street Economics blog at the NY Fed, should we worry as much about the bilateral repo market as we do about the tri-party market (which played a key role in the financial crisis and remains vulnerable to another "run on the shadow banking system")?:

                                                    Lifting the Veil on the U.S. Bilateral Repo Market, by Adam Copeland, Isaac Davis, Eric LeSueur, and Antoine Martin, Liberty Street Economics: The repurchase agreement (repo), a contract that closely resembles a collateralized loan, is widely used by financial institutions to lend to each other. The repo market is divided into trades that settle on the books of the two large clearing banks (that is, tri-party repo) and trades that do not (that is, bilateral repo). While there are public data about the tri-party repo segment, there is little to no information on the bilateral repo segment. In this post, we update a methodology we developed earlier to estimate the size and composition of collateral posted for bilateral repos, and find that U.S. Treasury securities are the dominant form of collateral for bilateral repos. This new finding implies that the collateral posted for bilateral repos is of higher quality than the collateral posted for tri-party repos. ...

                                                      Posted by on Wednesday, July 9, 2014 at 09:21 AM in Economics, Financial System, Regulation | Permalink  Comments (5)


                                                      Fed Watch: When The Fed Starts Raising Rates

                                                      Tim Duy:

                                                      When The Fed Starts Raising Rates, by Tim Duy: Via Twitter, modest proposal summarizes my last post:
                                                      Shorter @TimDuy, short the front end not the 10 year because the Fed will tighten before inflation is a problem http://t.co/1a0xRNueEO
                                                      — modest proposal (@modestproposal1) July 7, 2014
                                                      This made me think about the last tightening cycle. For those that hope to use tighter monetary policy to bolster the case against equities, recall that patience may be required:

                                                      FedTight1

                                                      For those making the bear case against long bonds, recall that initially long rates fell, and over the entire cycle rose just (roughly) 50bp:

                                                      FedTight2

                                                      The short end of the curve suffered, and the yield curve inverted:

                                                      FedTight3

                                                      How does this compare to now? If we consider last December's taper the beginning of this tightening cycle (the Fed does not; they prefer to think of it at reducing financial accommodation), stocks continue to power higher:

                                                      FedTight4

                                                      The 10 year bond initially fell on the taper talk and the yield curve steepened through the 10 year. But that steepening ended when the taper began:

                                                      FedTight5

                                                      More interesting is the flattening of the very long end after the taper began:

                                                      FedTight6

                                                      It looks like rates are signalling that the Fed will act to contain activity such that the economy does not overheat. Which, assuming the Fed maintains its current reaction function, tends to support modest porposal's interpretation - favor the long end of the curve over the short end.
                                                      I think the flattening of the yield curve should be a concern to the Fed. It suggests that while we frequently hear Janet Yellen described as a dove, the expectation is that her actual policy approach will be cautious bordering on hawkish. Not good if you think like Andy Harless:
                                                      I will consider Yellen's tenure a failure if the economy does not overheat.
                                                      — Andy Harless (@AndyHarless) July 5, 2014
                                                      I am sympathetic to this view. I would be a little more optimistic that the Fed would have more room to maneuver in the next recession if the long-end of the yield curve was signalling that the Fed was a little behind instead of a little ahead. And for more on why that is important, see Brad DeLong and his 17 tweet bear case for inflation.

                                                        Posted by on Wednesday, July 9, 2014 at 12:24 AM in Economics, Fed Watch, Monetary Policy | Permalink  Comments (20)


                                                        Links for 7-09-14

                                                          Posted by on Wednesday, July 9, 2014 at 12:06 AM in Economics, Links | Permalink  Comments (91)


                                                          Tuesday, July 08, 2014

                                                          'The Unemployment Cost of Below-Target Inflation'

                                                          Carola Binder:

                                                          The Unemployment Cost of Below-Target Inflation: Recently, inflation in the United States has been consistently below its 2% target. The situation in Sweden is similar, but has lasted much longer. The Swedish Riksbank announced a 2% CPI inflation target in 1993, to apply beginning in 1995. By 1997, the target was credible in the sense that inflation expectations were consistently in line with the target. From 1997 to 2011, however, CPI inflation only averaged 1.4%. In a forthcoming paper in the AEJ: Macroeconomics, Lars Svensson uses the Swedish case to estimate the possible unemployment cost of inflation below a credible target...

                                                          The unemployment rate would be about 0.8% lower if inflation averaged 2% (and presumable lower still if inflation averaged slightly above 2%). ...

                                                          Svensson concludes with policy implications:

                                                          "I believe the main policy conclusion to be that if one wants to avoid the average unemployment cost, it is important to keep average inflation over a longer period in line with the target, a kind of average inflation targeting (Nessén and Vestin 2005). This could also be seen as an additional argument in favor of price-level targeting...On the other hand, in Australia, Canada, and the U.K., and more recently in the euro area and the U.S., the central banks have managed to keep average inflation on or close to the target (the implicit target when it is not explicit) without an explicit price-level targeting framework.  
                                                          Should the central bank try to exploit the downward-sloping long-run Phillips curve and secretly, by being more expansionary, try to keep average inflation somewhat above the target, so as to induce lower average unemployment than for average inflation on target?...This would be inconsistent with an open and transparent monetary policy."

                                                          [See the full post for more details.]

                                                            Posted by on Tuesday, July 8, 2014 at 01:46 PM in Economics, Inflation, Monetary Policy, Unemployment | Permalink  Comments (9)


                                                            Is Wage Growth a Problem?

                                                            Josh Bivens:

                                                            Is Wage Growth the Problem or the Solution?, by Josh Bivens, WSJ Think Tank: Lots of talk has percolated recently about whether a sudden burst of rapid wage growth would force the Fed’s hand in pulling back monetary stimulus... Some who, like me, do not see any evidence of an imminent wage take-off have argued that the Fed should wait for some evidence of wage inflation before hitting the brakes.
                                                            These arguments essentially treat a pickup of wage growth as a problem to be guarded against. But the most conspicuous failure in the U.S. economy over the past generation, by far, has been too slow wage growth for the vast majority of American workers. ...
                                                            So one part of the “how much slack” debate that too often goes unaddressed is that there is not only a lack of evidence that wages are about to start growing rapidly but also that it wouldn’t be a big problem if they did. In fact, it would be a good thing.

                                                              Posted by on Tuesday, July 8, 2014 at 12:33 AM in Economics, Income Distribution, Inflation, Monetary Policy | Permalink  Comments (53)


                                                              FRBSF Economic Letter: Slow Business Start-ups and the Job Recovery

                                                              Liz Laderman and Sylvain Leduc:

                                                              Slow Business Start-ups and the Job Recovery, by Liz Laderman and Sylvain Leduc: Employment growth during the current recovery has been weak compared with past recoveries. It has taken nearly five years since the beginning of the economic expansion for nonfarm employment to return to its pre-recession peak. One factor that may have contributed to this tepid job growth is slower-than-normal employment growth at new businesses, or “start-ups.” Because start-ups generate jobs at a much faster pace than older businesses during recoveries, they account for a significant proportion of job growth in the economy, even though their share of overall employment is quite small. Therefore, even modest slowdowns in start-up growth could result in significant drops in overall employment growth. 
                                                              Employment at start-ups was particularly hard-hit during the Great Recession, suffering a much steeper decline in growth compared with more mature businesses and compared with start-ups in previous recessions. One issue may have been financing. Because personal assets are an important source of funding for start-ups, the tumble in house prices during the downturn may have weakened start-up activity. Since house prices remained depressed early in the recovery, this Economic Letter examines whether start-up employment growth also remained depressed. We further consider whether the slower growth may have been a significant factor behind the weak job recovery. 
                                                              We show that, compared with the recovery from the deep downturn of 1981–82, start-up employment grew significantly less in the year following the Great Recession. Our analysis suggests that between March 2010 and March 2011, lower employment growth at start-ups may have subtracted as much as 0.7 percentage point from total job growth, translating into roughly 760,000 fewer jobs. 
                                                              Despite the weakness thus far in the recovery, recent increases in home values may bring better news, translating into greater financing opportunities for start-ups and, in turn, contributing to faster employment growth. ...

                                                                Posted by on Tuesday, July 8, 2014 at 12:24 AM in Economics | Permalink  Comments (4)


                                                                'Why Hasn't the Yen Depreciation Spurred Japanese Exports?'

                                                                Mary Amiti, Oleg Itskhoki, and Jozef Konings:

                                                                Why Hasn't the Yen Depreciation Spurred Japanese Exports?, by Mary Amiti, Oleg Itskhoki, and Jozef Konings, Liberty Street Economics: The Japanese yen depreciated 30 percent from its peak in the fourth quarter of 2011 against its trading partners. This was expected to boost its exports as the lower yen makes Japanese goods more competitive on global markets. Instead, the volume of Japanese exports of goods actually fell by 0.6 percent over this same period, as can be seen in the chart below. Weaker external demand surely contributed to this poor export performance. Yet over the same period, U.S. goods exports grew by more than 6 percent, which suggests that other factors are also at play. In this post, we draw on our recent paper “Importers, Exporters, and Exchange Rate Disconnect” that highlights another channel to help explain these puzzling developments. In that study, we show that a key to understanding why there is low pass-through from exchange rates into export prices is that large exporters are also large importers, so they face offsetting exchange rate effects on their marginal costs. In the case of Japan, the connection between the yen and production costs has been made stronger since the country replaced nuclear power with imported fuels in the aftermath of the 2011 earthquake.
                                                                It has been well established that exchange rate changes are not fully passed through to export prices in foreign currency terms; that is, a 10 percent depreciation in the yen results in a less than a 10 percent fall in Japanese export prices and, thus, a relatively smaller boost to export quantities in response to a depreciation. This low pass-through has generally been attributed to “local currency pricing” and to “pricing-to-market.” If firms choose to invoice their exports in foreign currency terms, then prices are “sticky” in that currency, so exchange rate changes mechanically translate into changes in the exporter’s markup, with a weaker yen increasing the profit margin of exporters. A local currency pricing study shows that Japanese exporters to the United States generally invoice in U.S. dollars. In addition, exporting firms often tend to adjust their markups in response to an exchange rate depreciation, even if they do not invoice in the foreign currency, with the size of this adjustment depending on demand conditions in each export market.
                                                                The new finding in our study is that the incomplete pass-through is the most pronounced for exporters with large import shares—each additional 10 percentage points of imports in total variable costs reduces exchange rate pass-through by over 6 percentage points. We also show that large exporters are import-intensive, have high foreign market shares, set high markups, and actively move them in response to changes in their marginal costs. Thus, the prices of the largest firms, which account for a disproportionate share of trade, are insulated from exchange rate movements both through the hedging effect of imported inputs and through active offsetting markup adjustment in response to cost shocks. ...

                                                                  Posted by on Tuesday, July 8, 2014 at 12:15 AM in Economics, International Trade, Monetary Policy | Permalink  Comments (13)


                                                                  Links for 7-08-14

                                                                    Posted by on Tuesday, July 8, 2014 at 12:06 AM in Economics, Links | Permalink  Comments (79)


                                                                    Monday, July 07, 2014

                                                                    'The Myth of America’s Golden Age'

                                                                    Joe Stiglitz:

                                                                    ...the American dream—the notion that we are living in the land of opportunity—is a myth. The life chances of a young American today are more dependent on the income and education of his parents than in many other advanced countries, including “old Europe.”...
                                                                    Today, inequality is growing dramatically..., and the past three decades or so have proved conclusively that one of the major culprits is trickle-down economics... But it has taken us far too long as a country to understand this danger. ...
                                                                    Only with a vibrant middle class can the economy fully recover and grow faster. The more inequality, the slower the growth—a conclusion now endorsed even by the IMF. ...
                                                                    None of this is the outcome of inexorable economic forces, either; it’s the result of policies and politics... If our politics leads to preferential taxation of those who earn income from capital; to an education system in which the children of the rich have access to the best schools, but the children of the poor go to mediocre ones; to exclusive access by the wealthy to talented tax lawyers and offshore banking centers to avoid paying a fair share of taxes—then it is not surprising that there will be a high level of inequality and a low level of opportunity. And that these conditions will grow even worse.
                                                                    And now it’s also clear that ... the richer you are, the more you are able to influence the political process and the economic decisions that stem from it, and to rig it all in favor of the 1 percent. Is it any wonder the rich keep getting richer?

                                                                      Posted by on Monday, July 7, 2014 at 11:46 AM in Economics, Income Distribution, Politics | Permalink  Comments (17)


                                                                      Paul Krugman: Beliefs, Facts, and Money

                                                                      "Faith-based economics":

                                                                      Beliefs, Facts and Money, by Paul Krugman, Commentary, NY Times: ...On the eve of the Great Recession, many conservative pundits and commentators — and quite a few economists — had a worldview that combined faith in free markets with disdain for government. Such people were briefly rocked back on their heels by the revelation that the “bubbleheads” who warned about housing were right, and the further revelation that unregulated financial markets are dangerously unstable. ...
                                                                      Above all, there were many dire warnings about the evils of “printing money.” ... Reality, however, declined to cooperate. Although the Fed continued on its expansionary course ... inflation stayed low...which was exactly what economists on the other side of the divide had predicted would happen. ...
                                                                      So those who got it wrong went back to the drawing board, right? Hahahahaha.
                                                                      In fact, hardly any of the people who predicted runaway inflation have acknowledged that they were wrong... Some have offered lame excuses; some, following in the footsteps of climate-change deniers, have gone down the conspiracy-theory rabbit hole, claiming that we really do have soaring inflation, but the government is lying about the numbers (and by the way, we’re not talking about random bloggers or something; we’re talking about famous Harvard professors.) Mainly, though, the currency-debasement crowd just keeps repeating the same lines, ignoring its utter failure in prognostication.
                                                                      You might wonder why monetary theory gets treated like evolution or climate change. Isn’t the question of how to manage the money supply a technical issue, not a matter of theological doctrine?
                                                                      Well, it turns out that money is indeed a kind of theological issue. Many on the right are hostile to any kind of government activism... — if you concede that the Fed can sometimes help the economy by creating “fiat money,” the next thing you know liberals will confiscate your wealth and give it to the 47 percent. Also, let’s not forget that quite a few influential conservatives, including Mr. Ryan, draw their inspiration from Ayn Rand novels in which the gold standard takes on essentially sacred status.
                                                                      And if you look at the internal dynamics of the Republican Party, it’s obvious that the currency-debasement, return-to-gold faction has been gaining strength even as its predictions keep failing.
                                                                      Can anything reverse this descent into dogma? A few conservative intellectuals have been trying to persuade their movement to embrace monetary activism, but they’re ever more marginalized. ... When faith — including faith-based economics — meets evidence, evidence doesn’t stand a chance.

                                                                        Posted by on Monday, July 7, 2014 at 01:57 AM in Economics | Permalink  Comments (159)


                                                                        Fed Watch: Inflation Hysteria Redux

                                                                        Tim Duy:

                                                                        Inflation Hysteria Redux, by Tim Duy: I am in general agreement with Calculated Risk on this point:

                                                                        I also think the economy is picking up, and I agree that as slack diminishes, we will probably see real wage growth and an uptick in inflation.

                                                                        Moreover, note that this is largely consistent with the Federal Reserve's outlook as well. Recall St. Louis Federal Reserve President John Williams from April, via Bloomberg:

                                                                        Williams, who forecast the Fed will start raising interest rates in the second half of next year, said inflation has “bottomed out” and will gradually accelerate to the central bank’s 2 percent target. He said prices have been held down by temporary forces such as a slowdown in health care costs.

                                                                        The Federal Reserve has consistently predicted higher inflation, and consistently been surprised that that inflation has not yet arrived despite rapidly falling unemployment rates. It would appear, however, that their forecasts are finally coming true. Hence, I also agree with Calculated Risk when he says:

                                                                        On inflation: I'm sympathetic to people like Joe Weisenthal at Business Insider who is looking for signs of inflation increasing; I'm starting to look for signs of real wage increases and inflation too. I just think inflation isn't a concern right now (Weisenthal was correct on inflation over the last several years in contrast to the people who were consistently wrong on inflation).

                                                                        It is enough to simply say that inflation is coming. That in and of itself is insufficient. Any inflation call needs to be placed in the context of magnitude and expected monetary policy response. Regarding both, follow Calculated Risk's warning:

                                                                        Monetary policy can't halt the violence in Iraq or make it rain in California - and this is why it is important to track various core measures of inflation.

                                                                        The Fed doesn't target core inflation. They target headline inflation. But they also believe that headline inflation will revert to core, and as such tend to be more concerned with core inflation in excess of 2%. Consider the history of core inflation since 1985:

                                                                        INFLATION2

                                                                        I included a 25pb "forecast error" band around the Federal Reserve stated 2% target for PCE inflation; no one believes they can consistently hit 2% in the short-term, hence it is a medium term target. The most obvious feature is that for the last twenty years, core measures of inflation have more often than not been at or below the the upper range of the Fed's error band, especially for core-PCE inflation. Average core-PCE inflation: 1.7%. Average core-CPI inflation: 2.2%. Indeed, if core-PCE were the target, it is fairly clear that the Fed would have been on average undershooting its objective for the past two decades.
                                                                        It is simply difficult for me to become too worried about inflation given the history of the past twenty years - twenty years in which the US economy was at times substantially outperforming the current environment no less. Underlying inflation simply has not be a problem.
                                                                        It was not a problem because the Federal Reserve tightened policy multiple times to preempt inflation. Expect the same during this cycle as well - the Fed will begin to gradually raise interest rates sometime next year, and they will maintain a gradual pace of tightening as long as they believe core-PCE will consistently average 2.25% or less. Currently, I anticipate the first rate hike will occur in the second quarter of 2015. If the unemployment rate falls to 5.5% by the end of this year, I would expect the first hike to be in the first quarter of 2015.
                                                                        What about headline inflation? Headline inflation is at the mercy of the Middle East and the weather, leaving it more volatile than core:

                                                                        INFLATION

                                                                        Average PCE inflation since 1994: 1.9%. Average CPI inflation since 1994: 2.4%. Arguably a pretty good track record. It is really no wonder that it is so difficult to motivate the inflation lectures in Principles of Macroeconomics. All the students are twenty or less years old. They simply have no experience with inflation as a troubling 1970s-style phenomenon.
                                                                        How will headline inflation influence monetary policy? If you combine headline inflation well in excess of 2.25% (I suspect something more like 3%) with tight labor markets and rapid wage/unit labor cost growth, I think the Fed will accelerate the pace of tightening (indeed, the second two conditions alone would probably do the trick). If we experience high headline inflation in the context of weak wage growth, expect the gradual pace of tightening to continue. Under those circumstances, the Fed will believe that headline inflation will depress demand and lessen inflationary pressures endogenously.
                                                                        Bottom Line: If you are making a short-term bet on higher headline inflation, primarily you are making a bet on energy and food. That bet is about the Middle East and weather, not monetary policy. I don't have an opinion on that bet. If you are betting on inflation over the medium-term, primarily you are making a bet on higher core inflation. More to the point, you are betting against the Fed. You are essentially betting that the Fed will not do what it has done since Federal Reserve Chair Paul Volker - tighten policy in the face of credible inflationary pressures. I would think twice, maybe three times before making that bet.

                                                                          Posted by on Monday, July 7, 2014 at 01:25 AM in Economics, Fed Watch, Inflation, Monetary Policy | Permalink  Comments (26)


                                                                          Links for 7-07-14

                                                                            Posted by on Monday, July 7, 2014 at 12:06 AM in Economics, Links | Permalink  Comments (60)


                                                                            Sunday, July 06, 2014

                                                                            'Keynesian Yellen versus Wicksellian BIS'

                                                                            Gavyn Davies:

                                                                            Keynesian Yellen versus Wicksellian BIS, by Gavyn Davies: The Bank for International Settlements (BIS) caused a splash last weekend with an annual report that spelled out in detail why it disagrees with central elements of the strategy currently being adopted by its members, the major national central banks. On Wednesday, Fed Chair Janet Yellen mounted a strident defence of that strategy in her speech on “Monetary Policy and Financial Stability”. She could have been speaking for any of the major four central banks, all of which are adopting basically the same approach [1].
                                                                            Rarely will followers of macro-economics have a better opportunity to compare and contrast the two distinct intellectual strands in the subject...
                                                                            Paul Krugman correctly points out that the BIS has been wrong in the past about the threat of inflation. Furthermore, their supply-led analysis of the real economy probably underestimates the pervasive importance of demand shocks during most economic cycles (see Mark Thoma). But the risk of financial instability is another matter entirely. It is optimistic to believe that macro-prudential policy alone will be able to handle this threat. The contrasting needs of the real economy and the financial sector present a very real dilemma for monetary policy.
                                                                            The BIS was right about the dangers of risky financial behaviour prior to the crash. That caused the greatest demand shock for a century. Keynesians, including the Chair of the Federal Reserve, should be more ready to recognise that the same could happen again.

                                                                            Inadequate demand calls for low interest rates to try to stimulate spending, but does the threat of financial instability necessarily call for higher rates? If so, which should prevail? As I see it (1) lack of demand is the bigger threat right now, (2) if financial instability looks like the bigger problem at some point in the future, then macroprudential policy targeted at the specific problem should be the first line of defense, (3) and, if it is "optimistic to believe that macro-prudential policy alone will be able to handle this threat," that is, if macroprudential policy alone is not enough to eliminate the threat, then, and only then, should interest rates by raised beyond where they would be given the state of aggregate demand.

                                                                            As I said a few days ago:

                                                                            "I think the macroprudential approach is correct. Using interest rates to deal with pockets of financial instability is too blunt of an instrument, e.g. it hits all industries, not just the ones where the instability is suspected and it may not directly address the particular problem generating the instability. It's much better to target the sectors where the problems exist, and to shape the policies to directly address the underlying problem(s)."

                                                                            But let me conceded one point. If we wait until we can be sure that a dangerous bubble exists, and to see if macroprudential policy will be sufficient, it may be too late to raise interest rates to try to pop the bubble -- it may be past the point of no return. But I still prefer pricking the bubble with targeted policy rather than raising interest rates and causing a slowdown in a wide variety of markets, almost all of which are not a threat to the economy.

                                                                              Posted by on Sunday, July 6, 2014 at 10:55 AM in Economics, Financial System, Regulation | Permalink  Comments (17)


                                                                              'Slump Stories and the Inflation Test'

                                                                              Does evidence matter?:

                                                                              Slump Stories and the Inflation Test: Noah Smith has another post on John Cochrane’s anti-Keynesian screed... All the anti-Keynesian stories (except “uncertainty”, which as Nick Rowe points out is actually a Keynesian story but doesn’t know it) are supply-side stories; Cochrane even puts scare quotes around the word “demand”. Basically, they’re claiming that unemployment benefits, or Obamacare, or regulations, or something, are reducing the willingness of workers and firms to produce stuff.
                                                                              How would you test this? In a supply-constrained economy, the kind of monetary policy we’ve had, with the Fed quintupling the size of its balance sheet over a short period of time, would be highly inflationary. Indeed, just about everyone on the right has been predicting runaway inflation year after year.
                                                                              Meanwhile, if you had a demand-side view, and considered the implications of the zero lower bound, you declared that nothing of the sort would happen...
                                                                              It seems to me that the failure of the inflation predicted by anti-Keynesians to appear — and the fact that this failure was predicted by Keynesian models — is a further big reason not to take what these people are saying seriously.

                                                                              In a "supply-constrained economy" the price of inputs like labor should also rise, but that hasn't happened either.

                                                                                Posted by on Sunday, July 6, 2014 at 09:52 AM in Economics, Macroeconomics | Permalink  Comments (24)


                                                                                'The Productivity Puzzle'

                                                                                The opening lines of a relatively long discussion from Robin Harding at the FT of "the productivity puzzle":

                                                                                US economy: The productivity puzzle, by Robin Harding: To glimpse the miracle of productivity growth there is nowhere better to look than the ... US Corn Belt. A hundred years ago, an army of farmers toiled to produce 30 bushels an acre; now only a few hands are needed to produce 160 bushels from the same land.
                                                                                The rise of modern civilisation rested on this trend: for each person to produce ever more. For the past 120 years, as if bound by some inexorable law, output per head of population increased by about 2 per cent a year. That is, until now.
                                                                                There is a fear – voiced by credible economists such as Robert Gordon... – that 2 per cent is no law but a wave that has already run its course. According to Prof Gordon’s analysis, 2 per cent could easily become 1 per cent or even less, for the next 120 years. ...
                                                                                Yet there are also techno-optimists, such as Erik Brynjolfsson and Andrew McAfee..., whose faith in new discoveries is such that they expect growth to accelerate, not decline.
                                                                                Then there are more phlegmatic economists, whose answers are less exciting but also less speculative – and come in a bit below 2 per cent for growth in output per head.
                                                                                The productivity question is of the greatest possible consequence for the US economy...

                                                                                  Posted by on Sunday, July 6, 2014 at 09:41 AM in Economics, Productivity | Permalink  Comments (40)


                                                                                  Links for 7-06-14

                                                                                    Posted by on Sunday, July 6, 2014 at 12:06 AM in Economics, Links | Permalink  Comments (63)


                                                                                    Saturday, July 05, 2014

                                                                                    'The Intellectual Property Strategy'

                                                                                    Joshua Gans:

                                                                                    Another choice: The Intellectual Property Strategy, by Joshua Gans: Over the past two weeks, I have been outlining broad strategic options for entrepreneurs of which a disruption strategy is just one choice. The concept is that a given entrepreneurial idea can be commercialised in many different ways. The key to entrepreneurial strategy is to identify the feasible set of choices available to start-ups and to write a business plan for each. After all, you can’t have a strategic choice without actually having a choice and I maintain that entrepreneurs often have many more choices than they think at the outside.
                                                                                    Thusfar, I have considered two options that have in common that they are focused on execution. Recall that being focused on execution means that a start-up embraces potential and on-going competition and formulates a plan to continually beat that competition by developing and continually re-investing in capabilities that allow the venture to beat the next wave of competition on quality, cost or some combination of the two. However, in choosing to focus on execution, a start-up can choose whether to be oriented towards competition (and building out a new value chain in competition with established firms) or to be oriented towards cooperation (and work within existing value chains). These two strategies were termed disruption and value chain respectively and each might be the appropriate one to be matched with an entrepreneurial idea.
                                                                                    Today I want to turn to strategies that are based on investing in control rather than execution. ...

                                                                                      Posted by on Saturday, July 5, 2014 at 04:24 PM in Economics | Permalink  Comments (43)


                                                                                      Links for 7-05-14

                                                                                        Posted by on Saturday, July 5, 2014 at 12:06 AM in Economics, Links | Permalink  Comments (105)


                                                                                        Friday, July 04, 2014

                                                                                        Responses to John Cochrane's Attack on New Keynesian Models

                                                                                        The opening quote from chapter 2 of Mankiw's intermediate macro textbook:

                                                                                        It is a capital mistake to theorize before one has data. Insensibly one begins to twist facts to suit theories, instead of theories to fit facts. — Sherlock Holmes

                                                                                        Or, instead of "before one has data," change it to "It is a capital mistake to theorize without knowledge of the data" and it's a pretty good summary of Paul Krugman's response to John Cochrane:

                                                                                        Macro Debates and the Relevance of Intellectual History: One of the interesting things about the ongoing economic crisis is the way it has demonstrated the importance of historical knowledge. ... But it’s not just economic history that turns out to be extremely relevant; intellectual history — the history of economic thought — turns out to be relevant too.
                                                                                        Consider, in particular, the recent to-and-fro about stagflation and the rise of new classical macroeconomics. You might think that this is just economist navel-gazing; but you’d be wrong.
                                                                                        To see why, consider John Cochrane’s latest. ... Cochrane’s current argument ... effectively depends on the notion that there must have been very good reasons for the rejection of Keynesianism, and that harkening back to old ideas must involve some kind of intellectual regression. And that’s where it’s important — as David Glasner notes — to understand what really happened in the 70s.
                                                                                        The point is that the new classical revolution in macroeconomics was not a classic scientific revolution, in which an old theory failed crucial empirical tests and was supplanted by a new theory that did better. The rejection of Keynes was driven by a quest for purity, not an inability to explain the data — and when the new models clearly failed the test of experience, the new classicals just dug in deeper. They didn’t back down even when people like Chris Sims (pdf), using the very kinds of time-series methods they introduced, found that they strongly pointed to a demand-side model of economic fluctuations.
                                                                                        And critiques like Cochrane’s continue to show a curious lack of interest in evidence. ... In short, you have a much better sense of what’s really going on here, and which ideas remain relevant, if you know about the unhappy history of macroeconomic thought.

                                                                                        Nick Rowe:

                                                                                        Insufficient Demand vs?? Uncertainty: ...John Cochrane says: "John Taylor, Stanford's Nick Bloom and Chicago Booth's Steve Davis see the uncertainty induced by seat-of-the-pants policy at fault. Who wants to hire, lend or invest when the next stroke of the presidential pen or Justice Department witch hunt can undo all the hard work? Ed Prescott emphasizes large distorting taxes and intrusive regulations. The University of Chicago's Casey Mulligan deconstructs the unintended disincentives of social programs. And so forth. These problems did not cause the recession. But they are worse now, and they can impede recovery and retard growth." ...
                                                                                        Increased political uncertainty would reduce aggregate demand. Plus, positive feedback processes could amplify that initial reduction in aggregate demand. Even those who were not directly affected by that increased political uncertainty would reduce their own willingness to hire lend or invest because of that initial reduction in aggregate demand, plus their own uncertainty about aggregate demand. So the average person or firm might respond to a survey by saying that insufficient demand was the problem in their particular case, and not the political uncertainty which caused it.
                                                                                        But the demand-side problem could still be prevented by an appropriate monetary policy response. Sure, there would be supply-side effects too. And it would be very hard empirically to estimate the relative magnitudes of those demand-side vs supply-side effects. ...
                                                                                        So it's not just an either/or thing. Nor is it even a bit-of-one-plus-bit-of-the-other thing. Increased political uncertainty can cause a recession via its effect on demand. Unless monetary policy responds appropriately. (And that, of course, would mean targeting NGDP, because inflation targeting doesn't work when supply-side shocks cause adverse shifts in the Short Run Phillips Curve.)

                                                                                        On whether supply or demand shocks are the source of aggregate fluctuations, Blanchard and Quah (1989), Shapiro and Watson (1988), and others had it right (though the identifying restriction that aggregate demand shocks do not have permanent effects seems to be undermined by the Great Recession ). It's not an eithor/or question, it's a matter of figuring out how much of the variation in GDP/employment is due to supply shocks, and how much is due to demand shocks. And as Nick Rowe points out with his example, sorting between these two causes can be very difficult -- identifying which type of shock is driving changes in aggregate variables is not at all easy and depends upon particular assumptions. Nevertheless, my reading of the empirical evidence is much like Krugman's. Overall, across all these papers, it is demand shocks that play the most prominent role. Supply shocks do matter, but not nearly so much as demand shocks when it comes to explaining aggregate fluctuations.

                                                                                          Posted by on Friday, July 4, 2014 at 10:16 AM in Economics, Macroeconomics, Methodology | Permalink  Comments (31)


                                                                                          'Freedoms Can Be Lost'

                                                                                          I would be interested in seeing a discussion in comments about all of the ways in which our freedom and liberty has been curtailed in recent years. It is prompted by this commentary in the local paper:

                                                                                          Between your picnicking and fireworking, today would be a good day to contemplate how freedom can be taken from a nation.
                                                                                          While we’re being horrified by brutal dictators far away, we must remember there’s another way freedoms can be lost — by persuasion. If people become convinced they need protection, they will sacrifice their freedoms. ...

                                                                                          It seems to me that the examples given can be improved upon. For example, the NSA isn't even mentioned. What would your list include?

                                                                                            Posted by on Friday, July 4, 2014 at 10:08 AM in Economics, Politics | Permalink  Comments (71)


                                                                                            Paul Krugman: Build We Won’t

                                                                                            Why has public investment collapsed?:

                                                                                            Build We Won’t, by Paul Krugman, Commentary, NY Times: You often find people talking about our economic difficulties as if they were complicated and mysterious, with no obvious solution. ... The basic story of what went wrong is, in fact, almost absurdly simple: We had an immense housing bubble, and, when the bubble burst, it left a huge hole in spending. Everything else is footnotes.
                                                                                            And the appropriate policy response was simple, too: Fill that hole in demand. In particular, the aftermath of the bursting bubble was (and still is) a very good time to invest in infrastructure. ... Since 2008,... our economy has been awash in unemployed workers ... and capital with no place to go (which is why government borrowing costs are at historic lows). Putting those idle resources to work building useful stuff should have been a no-brainer.
                                                                                            But what actually happened was exactly the opposite: an unprecedented plunge in infrastructure spending. ... In policy terms, this represents an almost surreally awful wrong turn; we’ve managed to weaken the economy in the short run even as we undermine its prospects for the long run. Well played!
                                                                                            And it’s about to get even worse. The federal highway trust fund ... is almost exhausted. Unless Congress agrees to top up the fund..., road work all across the country will have to be scaled back just a few weeks from now. If this were to happen, it would quickly cost us hundreds of thousands of jobs, which might derail the employment recovery that finally seems to be gaining steam. And it would also reduce long-run economic potential.
                                                                                            How did things go so wrong? As with so many of our problems, the answer is the combined effect of rigid ideology and scorched-earth political tactics. The highway fund crisis is just one example of a much broader problem. ... The collapse of public investment was ... a political choice.
                                                                                            What’s useful about the looming highway crisis is that it illustrates just how self-destructive that political choice has become. It’s one thing to block green investment, or high-speed rail, or even school construction. I’m for such things, but many on the right aren’t. But everyone from progressive think tanks to the United States Chamber of Commerce thinks we need good roads. Yet the combination of anti-tax ideology and deficit hysteria (itself mostly whipped up in an attempt to bully President Obama into spending cuts) means that we’re letting our highways, and our future, erode away.

                                                                                              Posted by on Friday, July 4, 2014 at 12:24 AM in Economics, Fiscal Policy, Politics | Permalink  Comments (128)


                                                                                              Links for 7-04-14

                                                                                                Posted by on Friday, July 4, 2014 at 12:06 AM in Economics, Links | Permalink  Comments (109)


                                                                                                Thursday, July 03, 2014

                                                                                                'An Interview with Dr. Mark Thoma'

                                                                                                I was interviewed (via email):

                                                                                                An Interview with Dr. Mark Thoma

                                                                                                  Posted by on Thursday, July 3, 2014 at 11:25 AM in Economics | Permalink  Comments (16)


                                                                                                  Fed Watch: June Employment Report

                                                                                                  Tim Duy:

                                                                                                  June Employment Report, by Tim Duy: The BLS reported solid numbers for the labor market in June, although there may be somewhat less acceleration than meets the eye. On net, the ongoing rapid fall in the unemployment rate nudges forward my expectation of when the Fed makes history and begins to lift rates from the zero bound. Still, there does not appear to be sufficient reason yet to believe the Fed will steepen the pace of increases.
                                                                                                  Nonfarm payrolls rose by 288k, ahead of expectations for 211k. Job growth was broad-based and earlier months were revised higher. The three-month average for job growth is at its highest since 2011 while the 12-month average is slowly crawling up and now stands above 200k:

                                                                                                  EMPDAYd070314

                                                                                                  It is worth remembering that in order to maintain constant percentage changes over time, the absolute change has to increase. Indeed, the acceleration in percentage terms over the past year looks less than impressive:

                                                                                                  EMPDAYb070314

                                                                                                  Still somewhat below that experienced at the height of the housing bubble, clearly weaker then the late 1990s, and note in particular the acceleration in the early 1990's. It was that kind of acceleration that caught the Fed's attention. We are not seeing anything like that yet.
                                                                                                  Also note that while hours worked has recovered from the winter doldrums, it too is not growing at some blockbuster pace:

                                                                                                  EMPDAYh070314

                                                                                                  EMPDAYc070314

                                                                                                  In short, in some sense the excitement over the recent improvement in absolute job growth says less about an acceleration in actual activty and more about our diminished expectations for this recovery.
                                                                                                  The persistent decline in the unemployment rate will undoubtedly cause consternation among the more hawkish FOMC members:

                                                                                                  EMPDAYf070314

                                                                                                  Recall St. Louis Federal Reserve President James Bullard recent warning:
                                                                                                  The Federal Open Market Committee is closer to its goals for full employment and low and stable inflation than many investors realize, Bullard said. He predicted the pace of economic growth will accelerate to 3 percent this year after an unexpectedly deep first-quarter contraction.
                                                                                                  “Inflation is picking up now. It is still below target but it has been moving up in recent months,” he said in response to a question at a forum organized by the Council on Foreign Relations. “I don’t think financial markets have internalized how close we are to our ultimate goals, and I don’t think the FOMC has internalized how close we are.”
                                                                                                  Bullard's story in a picture:

                                                                                                  EMPDAYg070314

                                                                                                  As the Fed closes in on its traditional policy goals, the pressure from the hawks, and even the center, for a rate increase will increase. Still, the doves are not without a defence. Federal Reserve Chair Janet Yellen's measures of underemployment are still underwhelming:

                                                                                                  EMPDAYa070314

                                                                                                  In particular, wage growth has stalled, adding additional credence to the argument that substantial labor market slack remains despite the decline in the unemployment rate:

                                                                                                  EMPDAYe070314

                                                                                                  Also note that there is nothing here yet to challenge the more general consensus among policymakers that equilibrium interest rates are lower than in past cycles.
                                                                                                  Bottom Line: The jobs report is generally good news, albeit I would argue there remains room for substantial improvement. That room for improvement continues to restrain the Fed from dramatically tighter policy. My expectations for the first rate hike center around the middle of next year. On net, this report drags my expectations forward somewhat and suggests a higher probability of a hike before June than after June. Score one for the FOMC hawks. But I also see little here yet to suggest the need for any dramatic tightening; I doubt FOMC's expectation of a long, gradual tightening cycle is much altered. That's one for the doves.

                                                                                                    Posted by on Thursday, July 3, 2014 at 11:22 AM in Economics, Fed Watch, Monetary Policy, Unemployment | Permalink  Comments (10)


                                                                                                    'The Financial Instability Argument for Raising Rates'

                                                                                                    Simon Wren-Lewis responds to calls to raise interest rates to promote financial stability:

                                                                                                    The financial instability argument for raising rates: ... Let’s call the proposition that we should raise rates now to avoid financial instability the BIS case, after the Bank of International Settlements who have been making this argument ever since the recession began. ...
                                                                                                    I want to begin by conceding a point. Suppose, as a monetary policymaker, you believe a financial crisis is possible, and that by raising rates you may be able to prevent it. Assume, crucially, that there is nothing else you can do to help prevent the financial crisis. In that case, you will consider raising rates, even if inflation is below target. ...
                                                                                                    However that is not the end of the story. If you raise rates to prevent financial instability when inflation is below target, inflation will remain below target or may fall even further. You cannot ignore that. So if interest rates are raised today to head off a financial crisis, they will have to be lower in the future to deal with the lower inflation or even deflation you have caused. ... So by raising rates by a modest amount today we might prevent financial instability, but at the cost of delaying the recovery. ...
                                                                                                    As Ryan Avent says, we can avoid all these difficulties by adding an extra instrument, which is macroprudential regulation. ... Now, as R.A. notes, those taking the BIS position counter that such measures are untested and may not be effective. Here is a typical example in the FT, where it is stated that “macroprudential policies will fail to stop investors taking irrational risks”.
                                                                                                    So we must raise interest rates, and delay the recovery, because nothing else can stop some in the financial system taking excessive risks. To which I can only say, summoning all my academic gravitas, what audacity, what impudence! Not only have we had to suffer the consequences of the Great Recession because of excessive risk taking within a largely unregulated financial system, we now have to cut short our main means of getting out of that recession because they might do it again. I do not know what planet these people are on, but if its mine, can they please get off and play their games elsewhere.

                                                                                                    Jane Yellen on how to deal with financial instability:

                                                                                                    ... Well, I think my main theme here today is that macroprudential policies should be the main line of defense, and I think the efforts that we’re engaged in in the United States but all countries coordinating through the — through Basel, through the Financial Stability Boards — the efforts that we are taking to globally strengthen the resilience of the financial system: more capital, higher quality capital, higher liquidity buffers, stronger and — arrangements for central clearing of derivatives that reduce interconnectedness among systemically important financial institutions, strengthening of the architecture of payments and clearing system dealing with risks we see in areas like tri-party repo. ...
                                                                                                    I would also put resolution planning which we’re engaging in actively as among those measures. And, you know, as I mentioned, I think cyclical policies and sector-specific policies that we’re seeing many emerging markets take steps that can be used, particularly when we see problems developing in housing or a particular sector. These are really promising.
                                                                                                    I don’t think we yet understand how they work. When they can be effective, how we should use them. I hope this will be an area for the IMF and for us of active research so we can better deploy those tools, capital — countercyclical capital charges.
                                                                                                    But I think importantly, I’ve not taken monetary policy totally off the table as a measure to be used when financial excesses are developing because I think we have to recognize that macroprudential tools have their limitations. ... So to me, it’s not a first line of defense, but it is something that has to be actively in the mix. ...

                                                                                                    Paul Krugman says "It’s about sadomonetarism, not stability."

                                                                                                    I think the macroprudential approach is correct. Using interest rates to deal with pockets of financial instability is too blunt of an instrument, e.g. it hits all industries, not just the ones where the instability is suspected and it may not directly address the particular problem generating the instability. It's much better to target the sectors where the problems exist, and to shape the policies to directly address the underlying problem(s).

                                                                                                      Posted by on Thursday, July 3, 2014 at 11:21 AM in Economics, Financial System, Regulation | Permalink  Comments (13)