This site has moved to
The posts below are backup copies from the new site.

April 30, 2005

WSJ: Fed Sees Inflation as Biggest Threat

Tim Duy, a colleague of mine, offers his thoughts on this WSJ column (Sub. only). Before coming to the UO, Tim was an International Economist at Treasury and a Fed Watcher for The G7 Group, a private consulting firm. First, the WSJ article:

Fed Sees Inflation As Bigger Threat Than a Slowdown (Sub. only), More Boosts in Rates Likely Despite Signs of Cooling; Debating Use of 'Measured,' By Greg Ip , The Wall Street Journal, April 29, 2005; Page A1

Despite signs that economic growth is slowing, the Federal Reserve sees signs of an upward creep in inflation as a bigger threat -- and is likely to keep raising interest rates in the months ahead to curb it.

On Tuesday, the Fed likely will raise the target for its key short-term interest rate to 3% from 2.75%. … Fed increases are likely to continue at subsequent meetings unless the economy slows much more than it already has. But officials are debating the wisdom of continuing to signal their intentions for interest rates as they have been.

… the timing of Mr. Greenspan's retirement could be a factor in Fed deliberations now … "Any central banker would rather risk a little bit weaker economy than a little bit higher inflation as part of your legacy," … Greenspan's fellow policy makers, meanwhile, "want to make sure his personal credibility as an inflation fighter stays with the institution," …

In the statement following its March 22 meeting … the Fed cited concerns about inflation for the first time in four years, suggesting it had lowered the bar for raising rates in larger, half-point increments. Since then, the economy's apparent loss of momentum has taken half-point increases off the table … But … it would take several more months of sub-par growth before they consider a pause in rate increases. … In speeches, Fed officials have continued to emphasize their inflation focus. …

The debate at next week's meeting likely will center on whether to continue to say rates will rise at a "measured" pace -- not over the rate change itself. … Minutes for the March meeting show some officials pressed to drop the word. … Some officials worry continued use of the word "measured," … could lead investors to think the Fed is more certain of its rate plans than it is ... However, removing the word "measured" could prompt some investors to think the Fed is about to raise rates by a half-percentage point. ... Whether officials stick with "measured" next week likely will depend in part on how they think markets will react. …

A related issue is how much longer the Fed will describe the federal-funds rate as "accommodative," that is, below some neutral level that neither stimulates nor restrains spending. Fed officials have said a neutral funds rate is somewhere between 3% and 5%, and by next week, the rate is expected to be in that range. But no Fed official has yet suggested that rates are close to neutral, which would imply the Fed was almost finished raising them.

Tim says:

1. It was almost certainly placed by Greenspan. You don't go front page with a piece like that unless you are sourced from the top.

2. On balance, FOMC members want to drop the term "measured." They do not want to step up the pace of rate increases. They want instead to have more flexibility about policy. This has always been a problem with the statement - it is often difficult to back off of a critical catch phrase.

3. If market participants take this column well, the odds of dropping the term "measured" rise.

4. The Fed is trying to dissuade investors from concluding that the Q1 growth slowdown is significant enough to dissuade their rate rising campaign. Critics will claim the Fed is ignoring potentially disastrous underlying economic imbalances, and that rising rates threaten to trigger a financial crisis (see DeLong's piece on hard-landings). But the Fed is always behind the curve. I would be surprised to see any shift in the course of policy prior to the Q2 GDP release in July.

April 29, 2005

Probability of a 50 Basis Point Increase in FF Target Increases Slightly

After recent news concerning prices and output, the probability of a 50 basis point change in the FOMC's federal funds target rate, as indicated by the CBOT's 30-Day Federal Funds futures contract, rose slightly today:
CBOT Fed Watch - April 29 Market Close

Summary Table: April 26: 95% for +25 bps versus 5% for +50 bps. April 27: 95% for +25 bps versus 5% for +50 bps. April 28: 95% for +25 bps versus 5% for +50 bps. April 29: 93% for +25 bps versus 7% for +50 bps.

May 3: FOMC decision on federal funds target rate.

Thus, according to the CBOT 30-Day Federal Funds futures contract there is a 100% chance the target rate will increase .25% to 3.00%, and a 7% chance it will increase an additional .25% to 3.25%.

Has Fed Policy Been Less Accommodating than is Widely Believed?

Institutional Economics discusses a paper by John H. Makin where Makin argues that the equilibrium real interest rate has fallen recently and because of this, monetary policy has not been as accommodating as is widely believed:
It is beginning to appear as though the current rate of 2.75 percent is at or above neutral. If so, that would be about a full percentage point below what many were guessing. ... A number of exogenous events have combined to produce what probably amounts to a reduction in the neutral real fed funds rate. … the price of oil in April 2005 is 50 percent higher than it was a year earlier. … the impact of oil prices on growth and inflation suggests that higher energy prices operate on the economy with a lag of about one year. … the global economy has slowed sharply over the past four to six weeks … The simultaneous slowdown of the economies of the United States, Europe, and Japan virtually guarantees a global economic slowdown. …China, the perennial wild card, has moved toward a less growth-oriented stance … The other problem plaguing the United States… is the persistence of inflation pressures already in the pipeline. ... Such a stagflationary environment pulls the central bank in two directions. The slowing economy says to stop raising interest rates while rising inflation says to continue raising them. … interest rate increases have been more than sufficient to slow growth. … The Federal Reserve … faces a difficult task. Higher energy prices will probably seep through and produce higher core inflation approaching a 2.5-percent rate by fall. If ... the real economy and markets fail to recover ... the Fed will need to give serious consideration to holding the fed funds rate around 3 percent and allowing a slowing global economy to ease the upward pressure on energy prices. That said, a sharp drop in stock prices or the housing market should not result in a Fed easing, since even more inflation pressures… from energy and resurgent asset markets, would only require a disruptive resumption of rate increases in the near future.
How has the real interest rate behaved in recent years? Let’s look at some data. Here is the federal funds rate minus the CPI less food and energy inflation rate, a measure of the ex-post real federal funds rate along with NBER dated contractions. The data are monthly and begin in 1957:
Click on Graph for a Larger and Clearer Version
Notice the evolution of the real rate since the beginning of the 1980’s. There is a consistent decline until around 1986 followed by a period of tightening. However, the period of tightening is brief and the real rate declines consistently until it hits zero around 1992. In 1992 the real rate begins rising and continues to rise until mid 1990’s where the increase flattens considerably. Then in the recession beginning in 2001 the real rate drops to near zero quickly and has remained at that level ever since. By this measure, the ex-post real rate is low by historical standards. It has only been this low once before since 1980, in 1992, and the low real rate is more persistent this time than in 1992. However, it has been this low prior to 1980 and it is interesting to note the similarity in the real rate movements in the mid 1970's to recent movements in the real rate. But the ex-post real rate is not what matters for policy or for economic decisions. The ex-post real rate is measured using actual rather than expected inflation and thus it fails to fully capture information about future economic conditions. For example, if the expected inflation rate is lower than the actual rate, then this measure of the ex-ante real rate, the variable we want to know about, will be too low. I believe that inflationary expectations are anchored. If so, then it is difficult to get much mileage out of arguments that separate actual from expected inflation in either direction in the near future. These data have made me question my past advocacy for increases in the federal funds rate. Could Makin be correct? Has the equilibrium real interest rate fallen, and if so is it enough to make policymakers think twice about an aggressive response to recent price data? Even after seeing these data I still believe that any noteworthy price pressure must be dealt with through appropriate monetary tightening.

GOP: Reduce Social Security Benefits and Taxes on Wealthy

While the president was preparing his remarks outlining how Social Security benefits would be cut for wealthy individuals, congress was, in effect, proposing to give the money back by cutting their taxes:
Budget Deal Sets Stage for Arctic Drilling And Tax Cuts, Washington Post

…The budget also makes way for $106 billion in tax cuts over five years, about what Bush had requested. Of that, $70 billion would be shielded from a Senate filibuster, enough to ensure that all expiring tax cuts can be extended, including the 2003 cuts to capital gains and dividend tax rates and last year's deduction for state and local sales taxes.

The cost of those tax-cut extensions would more than nullify the savings from the spending cuts, allowing Democrats to charge that the budget agreement actually leaves the federal deficit worse than it would be without a deal. … Indeed, the budget instructs lawmakers to raise the federal government's statutory debt limit this fall by $781 billion, to $8.96 trillion. The government's borrowing limit will then have climbed by $3 trillion since Bush took office.

NYT, WP, LAT, or Fox: Which Headline is Which?Bush Recasts His Message on Social Security Bush Recasts His Message on Social Security

[I just noticed the title. It's not what I intended, but fixing it now changes the permalinks. Oh well...] Here are four headlines from tonight's press conference from the web sites of the NY Times, The Washington Post, The Los Angeles Times, and Fox News. Can you match the headlines to the news agency?
Bush Social Security Plan Would Cut Benefits

Bush Recasts His Message on Social Security

Bush Cites Plan That Would Cut Social Security

Doing What is Right

The last one has a different headline, Bush Clarifies Social Security, Energy Plans, when the link on the main page is followed (the headline on the main page may disappear or change, it changed from "Let's Do Our Duty" earlier, and the LA Times headline changed as well). The others have the same headline in both places. The answer is in the comments (or just use mouseover). [Update at 10:41 a.m. on 4/29: The last headline, "Doing What is Right" is no longer on the main web page - instead a smaller headline on the right-hand side of the page now reads "Staying on Course."]

April 28, 2005

Bush to Shift Focus to Solvency

[Update: The press conference didn't offer any new details over those described below except to name Robert Pozen as the architect of the plan they are endorsing. Here's a summary of the president's remarks from Reuters. The main change from the current system is to reduce benefits for higher income individuals as a means of achieving solvency.] [Update #2: From Fox News: "I know some Americans have reservations about investing in the stock market, so I propose that one investment option consist entirely of treasury bonds, which are backed by the full faith and credit of the United States government,..." My question is if these will have a 3% clawback. The details weren't clear from the report. If so, under this safe option, returns could be negative. I assume there's no clawback on this part, but don't know. Does anyone? I'll update this if I find out. Brad DeLong addresses (and answers) this here.] According to a Bloomberg report, President Bush will shift the focus to solvency in his press conference tonight, but he's still insisting that personal accounts be part of the solution. Even so, it’s looking more and more as though personal accounts won’t make it out of committee. However, even if this does happen, that does not mean personal accounts are dead. They can be added later and put to a vote on the floor on the senate. Here’s the report from Bloomberg:
Bush to Outline Social Security Options, Aide Says (Update1), April 28 (Bloomberg) -- President George W. Bush plans to shift the focus of Social Security overhaul to solvency solutions for the fund and away from the personal accounts he has been promoting for the past three months, a White House official involved in the issue said. Possibly as early as tonight's scheduled press conference, Bush will indicate he's amenable to ... greater benefit cuts for high-income individuals, raising the retirement age, and reduced incentives for early retirement, this official, speaking on condition of anonymity, said. The administration also favors a minimum Social Security benefit for the poor, the aide said. Bush isn't expected to go beyond what he has already said on any tax increase; he has ruled out raising the payroll tax rate but would consider raising the amount of income subject to Social Security taxes. … Opinion polls show declining support for accounts and Bush's handling of Social Security. Democrats are demanding the White House present a specific plan to make Social Security solvent before any negotiation can begin. … Bush will maintain his position that "personal accounts must be part of the solution,'' … calling for congressional passage of the plan this year. …"Democrats have reason to be suspicious,'' said Norm Ornstein, a congressional scholar at the American Enterprise Institute in Washington. Bush and Senate Republicans have "regularly'' used "bait- and-switch'' tactics on Democrats, convincing them to support policies by promising to cooperate on the final details and then they "find themselves frozen out of the conference committee,'' said Ornstein. …

Interest Rate Spreads and Recessions

CNN Money points to the flattening of the yield curve:
The yields on the longer-term treasuries … have not seen much in the way of gains over the past year, even as shorter-term rates … steadily gained ground. The condition is known as a flattened yield curve … it is a warning sign for the economy that economists take seriously. History tell us that as the two types of interest rates get closer, slower economic activity is almost sure to occur. If short-term rates overtake longer-term rates, a recession is virtually always in the offing. The last time that happened was from July through November 2000.
There is some truth to this assertion. Here is a graph of the interest rate spread between 10 year notes and 3 month T-Bills as discussed in the article along with recessions (peak to trough) as identified by the NBER. The sample period is from April 1953 through March 2005:
(Click on graph for larger and clearer version)
It is not inevitable that a recession follows a negative spread, but there is an association. A good counter example is the mid 1960's where the spread was negative but no recession occurred. In the other direction the spread was positive (but near zero) prior to the 1990-91 recession. The data in the graph are monthly and end in March 2005. The last value of the spread in the sample is 1.75. Data for 4/18/05 through 4/22/05 give spreads of 1.42, 1.36, 1.41, 1.5, 1.39. This is not yet in what appears to be the danger zone, recessions generally follow spreads that are between zero and one or negative in the graph, but the spread is certainly headed in that direction. Even though there are more sophisticated approaches to predicting the movement of output over time involving more variables than just the spread, as we wonder about the probability and timing of hard versus soft landings, this is a variable to watch.

The Oregonian: Social Security Straw Man

It rains once in awhile in Oregon. The Oregonian has learned to see through the clouds:
Social Security straw man: The Senate panel's hearing begins on a disappointing note, Wednesday, April 27, 2005, Editorial, The Oregonian

A few weeks ago, Sen. Charles Grassley made a lot of Americans cringe by asserting that the Social Security trust fund was only "a mirage." Scary words, those, from the all-powerful chairman of the Senate Finance Committee.

On Tuesday, the Iowa Republican said something equally as cringe-worthy, not to mention untrue, as his "mirage" remark. He blasted Democrats and other critics of President Bush's Social Security privatization plan for failing to offer ideas of their own on how to keep the system from falling apart.

"Doing nothing is not an option," he fumed at some who appeared before the 20-member committee Tuesday.

Trouble is, not a single critic of the Bush plan favors "doing nothing." Opponents of diverting Social Security payments into private investment accounts have been pointing out all sorts of responsible reforms that can put the popular social insurance program back on the path to solvency -- something that even Bush admits his proposal does not do.

"We've had months of sparring and skirmishing," one committee member, Sen. Ron Wyden, D-Ore., noted on the eve of the hearing. "Tuesday," he added, "is Round One of getting into the substance."

So true. Which made it all the more disappointing to see Chairman Grassley pull out the old straw-man ploy right at the get-go. If he allows that kind of political posturing to continue in this important hearing, true Social Security reform will indeed be a mirage.

Economic News Does Not Alter Federal Funds Target Probabilities

Today's economic news did not change the Chicago Board of Trade’s calculation of the probabilities of changes in the FOMC's federal funds target rate, as indicated by the CBOTs 30-Day Federal Funds futures contract:
CBOT Fed Watch - April 28 Market Close

Summary Table: April 26: 95% for +25 bps versus 5% for +50 bps. April 27: 95% for +25 bps versus 5% for +50 bps. April 28: 95% for +25 bps versus 5% for +50 bps.

May 3: FOMC decision on federal funds target rate.

Thus, as for the previous two days, according to the CBOT 30-Day Federal Funds futures contract there is a 100% chance the target rate will increase .25% to 3.00%, and a 5% chance it will increase an additional .25% to 3.25%.

The Evolution of Central Banking in the United States

A very nice history of central banking in the United States from Federal Reserve Vice Chairman Roger W. Ferguson, Jr. with comparisons to the introduction of the Euro and the European Central Bank. If you are interested in monetary policy and history, this is worth reading:
The Evolution of Central Banking in the United States, Vice Chairman Roger W. Ferguson, Jr., The European Central Bank, Frankfurt, Germany, April 27, 2005 …I would like to discuss the evolution of central banking in the United States, with particular reference to currency, relations between the regions and the center, mandates, and communication. Along the way, I will compare our experience with that of the ECB…

April 27, 2005

Samuelson's One-Sided Scissors

Robert Samuelson, in his Washington Post column today, excused the U.S. from any responsibility for the current account deficit. He says:

Washington Post, The Global Savings Glut, By Robert J. Samuelson, April 27, 2005

We are all taught that saving is good … But what if the problem of today's global economy is that people elsewhere … are saving too much and spending too little? Former Princeton University economist Ben Bernanke argues that this is precisely the case. He calls it "the global savings glut."

… Bernanke's global savings glut is just such a notion. It helps explain (a) the huge U.S. trade deficits; (b) the weakness of the current economic recovery (now 3 1/2 years old); and (c) the difficulty of doing anything about (a) and (b).

… the flow of surplus global savings to the United States has caused Americans to spend more and save less. In recent speeches, Bernanke … has shown how. In the 1990s, some of the savings surplus went into the hot U.S. stock market, boosting prices further. Feeling wealthier -- because their stock portfolios had fattened -- Americans decided they could save less and shop more.

…Americans' low saving and high consumption offset foreigners' high saving and low consumption. The huge U.S. trade deficits result …

… Foreigners may tire of investing in the United States; the dollar may drop on foreign exchange markets, as it already has against some currencies. But if countries with savings surpluses didn't consume or invest more at home, world growth would suffer. Or the U.S. recovery could falter. Trade deficits certainly help explain its precariousness. There's a constant drag on job creation, as rising imports divert production abroad.

Like others, Bernanke warns that these trade imbalances -- our huge deficits, their huge surpluses -- seem dangerous. His contribution is to show that their main causes lie outside the United States. To say a country has surplus saving is simply another way of saying that it lacks good investment opportunities at home …

Whatever the problems, Americans can't fix them. The common view that our budget deficits (which Bernanke correctly thinks should be reduced) cause our trade deficits is simply wrong. The two are only loosely connected. That unconventional conclusion is also inconvenient, because it measures our powerlessness.

The argument is that high foreign saving caused low U.S. saving. Quoting Samuelson “… the flow of surplus global savings to the United States has caused Americans to spend more and save less.” High foreign saving caused low domestic saving? But isn’t it equally logical (which is to say it isn't logical at all) to argue the reverse, that the low saving rate, particularly public saving (the deficit) in the U.S. caused funds to flow in from abroad? Would that then mean, under Samuelson's definition, that the main cause lies within the U.S.? Does that mean, playing off Samuelson't conclusion, that whatever the problems, America can fix them?

The supply of funds is not enough. There must be a demand as well. As Marshall reminded us long ago in a slightly different context, “We might as reasonably dispute whether it is the upper or the under blade of a pair of scissors that cuts a piece of paper ...”

Yes, the high foreign saving rate played a role, but that is only one side of the scissors. The U.S. public and private saving rates played a role as well.

Congressional Research Service: Texas Private Accounts a Bad Deal for Most

Yesterday John Tierney used the story of a single individual to characterize the entire Social Security privatization experience in Chile and as noted in this post, he leaves a very misleading impression about the success of the system.

President Bush, campaigning in Galveston yesterday does the same thing. He focuses on two hypothetical workers rather than the system as a whole. From The Los Angeles Times:

…He said a Galveston County worker earning $25,000 a year who retired after 37 years would receive a monthly benefit of $1,250, compared with $669 from Social Security.

A higher-wage worker earning $75,000 would do better, he said, receiving $3,600 a month from private accounts instead of what he said would be $1,300 a month from Social Security…

But a study by the nonpartisan Congressional Research Service reached different conclusions for two workers similar to those that were the focus of Bush’s sales effort, conclusions supported by independent analysis of the Government Accountability Office and the Social Security Administration:

The congressional study … prepared by Boxer's staff with help from the nonpartisan Congressional Research Service, cited different comparisons and reached different conclusions.

It calculated that a hypothetical married worker who retired last year after earning a median annual income of $34,442 would receive a monthly payment of $1,568 under Galveston's plan, compared with an initial benefit of $1,818 under Social Security.

A high-wage worker earning $87,900 a year would fare better, receiving a monthly benefit of $3,012 from his or her private account instead of a Social Security benefit of $2,841, the study found.

But even that initial advantage would disappear after several years because the payment provided by the Galveston plan would be fixed, while Social Security benefits would be adjusted upward to keep pace with inflation…

…Boxer's study was based on a number of assumptions, which could be challenged by advocates of personal accounts, about years of participation and rates of return on past contributions and future annuity payments.

But the general conclusion that low-wage workers would fare worse than higher-paid employees is consistent with the findings of previous studies of the Galveston plan by the Government Accountability Office and the Social Security Administration…

As in Chile, as in Britain, as in Ohio, and as in Texas, privatization is a bad deal for most workers.

Congress Likely to Approve Budget Adding $125 Billion to the Deficit

As this post notes, the headlines don’t necessarily tell the story, and as Brad DeLong notes,the story may not tell the story either. Here are the headlines on the opening of hearings on Social Security reform:
At Social Security Hearing, Bush's Fight Looks Largely Uphill (NY Times) GOP May Be Splintering on Plan (Washington Post) Clashes Growing Between Bush and GOP Moderates(LA Times) Top Senator questions personal accounts(CNN) Deep divide marks Social Security debate(MSNBC) Dems Rebuff GOP Pleas on Social Security(AP)
However, while the focus is on Social Security, there are other budget issues in the news that should not escape attention. This editorial notes that some key decisions will be made in the next day or so:

In Search of Budget Moderates, Editorial, April 27, 2005: Unless a handful of moderate Republicans can inject some common sense and human kindness into the process, Congress is likely to approve a budget blueprint this week that manages to be profligate and mean-spirited at the same time… the budget nearing final consideration is in fact a Republican document that is expected to add at least $125 billion to the federal budget deficit in the next five years… calls for generous tax cuts for investors … and for harsh spending cuts for the needy …

the aim is to ensure that spending on Medicaid and other programs for the poor will be cut by $17 billion over five years … the House bid up the Senate's cuts for the poor, while the Senate increased the House's gifts to the rich. The result is expected to guarantee the passage of tax cuts that would cost $70 billion over the next five years … Those cuts are all but certain to include the extension of low tax rates for dividends and capital gains, which almost entirely benefit people who make more than $200,000 a year.

… There is still time in the next day or so to fix this dreadful bill. Earlier this year, seven Republican senators joined forces to eliminate the Medicaid cuts that are about to be reinstated by the conference. Four of the seven - Gordon Smith, Susan Collins, Arlen Specter and Norm Coleman - are in the strongest position politically to stand firm against further cuts. The pressure is great. Fairness and fiscal sanity hang in the balance.

While hearings are being conducted to consider Social Security reform due to solvency concerns, congress is considering increasing the deficit by $125 billion over the next five years (around 1 trillion over 75 years). Add that to the $290 billion estimated cost over ten years for the repeal of the estate tax and the 10-year $1.35 trillion tax cut in 2001, and that's roughly 1.765 trillion in just 10 years. Over a 75 year horizon, it would be far more than that. And this is just three items, it is not an exhaustive list of ways in which the administration and congress have increased the deficit.

Think about the size of the tax cuts and who benefited from the estate tax, income tax, and other changes, think about the size of the cuts in government programs for the poor, then listen to the magnitude of the numbers being talked about in the Social Security reform hearings. After comparing the two numbers, the source of the insolvency issues in Social Security will be evident.

The CBOT's Fed Funds Rate Target Probabilities

Following up on David Altig’s post at macroblog yesterday, here is the Chicago Board of Trade’s calculation of the probabilities of changes in the FOMC's federal funds target rate, as indicated by the CBOT 30-Day Federal Funds futures contract:
CBOT Fed Watch - April 26 Market Close - Based upon the April 26 market close, the CBOT 30-Day Federal Funds futures contract for the May 2005 expiration is currently pricing in a 100 percent probability that the FOMC will increase the target rate by at least 25 basis points from 2-3/4 percent to 3 percent at the FOMC meeting on May 3. In addition, the CBOT 30-Day Federal Funds futures contract is pricing in a 5 percent probability of a further 25-basis point increase in the target rate to 3-1/4 percent (versus a 95 percent probability of just a 25-basis point rate increase). April 26: 95% for +25 bps versus 5% for +50 bps. May 3: FOMC decision on federal funds target rate.
Thus, according to the CBOT 30-Day Federal Funds futures contract, there is a 100% chance the target rate will increase .25% to 3.00%, and a 5% chance it will increase an additional .25% to 3.25%.

April 26, 2005

Tierney on Social Security Privatization: Seeing the Tree

John Tierney looks at the case of a single individual and concludes that privatization in Chile is a success. Success stories are easy to find when the focus is on a single individual, in this case an economist at the University of Chile:
The Proof's in the Pension, NY Times, April 26, 2005, By John Tierney … What would Pablo Serra do? … he and I were friends in second grade at a school in Chile. He remained in Chile and became the test subject; I returned to America as the control group. … Pablo, who grew up to become an economist … called up his account on his computer and studied the projected retirement options for him …"I'm very happy with my account," he said to me after comparing our pensions. He was kind enough not to gloat. When I enviously suggested that he could expect not only a much heftier pension than mine, but also enough cash to buy himself a vacation home at the shore or in the country, he reassured me that it would pay for only a modest place…
But what if we look at the whole forest, not just a single tree? This is a post from earlier in April:
In Chile: A Safety Net With Some Holes, By Monte Reel, Washington Post Foreign Service, Monday, April 11, 2005; Page A11 ...Given the pace of contributions, more than half of the workers who retire in the next 30 years will not have enough money in their plans to receive the minimum payout...
According to this report, the forest is much less healthy than the single tree Tierney examined. [Here's a link to a Washington Post story about privatization in Britain where "... 75 percent of private plans have contribution rates that fall below the level needed to provide adequate pensions." Another link on shortfalls in the Chilean system - thanks to Jennifer and anne.]

What Did Greenspan Say and When Did He Say It?

Yesterday, in this post, I discussed a Washington Times editorial attempting to absolve Alan Greenspan of responsibility for playing a role in promoting tax cuts that led to the current budget deficit. Quoting from the editorial:
Mr. Greenspan told Mr. Sarbanes that the charge was "frankly unfair" because it neglected the Fed chairman's unambiguous endorsement of "trigger" mechanisms during the same testimony. "I advocated tax cuts" in 2001, Mr. Greenspan acknowledged Thursday, "but I also advocated triggers in the same testimony."
Did he advocate triggers? While that term is not used directly in his testimony, it is used in a CBS report noted below, the only report I could find explicitly discussing spending restraint mechanisms, and Greenspan does say:
… In recognition of the uncertainties in the economic and budget outlook, it is important that any long-term tax plan, or spending initiative for that matter, be phased in. Conceivably, it could include provisions that, in some way, would limit surplus-reducing actions if specified targets for the budget surplus and federal debt were not satisfied. Only if the probability was very low that prospective tax cuts or new outlay initiatives would send the on-budget accounts into deficit, would unconditional initiatives appear prudent. … Indeed, the current economic weakness may reveal a less favorable relationship between tax receipts, income, and asset prices than has been assumed in recent projections. … But the risk of adverse movements in receipts is still real, and the probability of dropping back into deficit as a consequence of imprudent fiscal policies is not negligible. But let me end on a cautionary note. With today's euphoria surrounding the surpluses, it is not difficult to imagine the hard-earned fiscal restraint developed in recent years rapidly dissipating. We need to resist those policies that could readily resurrect the deficits of the past and the fiscal imbalances that followed in their wake.
In my view, he does add quite a bit of caution regarding slipping back into large deficits, cautions that, as noted below, were not reported widely in the press. So, as far as it goes, the Washington Times editorial is correct. He did talk about mechanisms to restrain spending and warned about the return of deficits. However, it is also my view that this does not absolve him of responsibility. Consider the following quote:
…But continuing to run surpluses beyond the point at which we reach zero or near-zero federal debt brings to center stage the critical longer-term fiscal policy issue of whether the federal government should accumulate large quantities of private (more technically nonfederal) assets. … I believe, as I have noted in the past, that the federal government should eschew private asset accumulation because it would be exceptionally difficult to insulate the government's investment decisions from political pressures. Thus, over time, having the federal government hold significant amounts of private assets would risk sub-optimal performance by our capital markets, diminished economic efficiency, and lower overall standards of living than would be achieved otherwise.
Based upon this reasoning that the government should not accumulate large sums of private sector assets (held as loans to the public made through financial intermediaries), the Social Security Trust Fund was allowed to lapse. Greenspan talks throughout his testimony of a zero debt target. He does realize that the Trust Fund assets will need to be present, but he does not believe the government should hold them. Instead, he advocates private accounts. However, if privatization is not in place, he states:
… Short of some privatization, it would be preferable in my judgment to allocate the required private assets to the social security trust funds, rather than to on-budget accounts. To be sure, such trust fund investments are subject to the same concerns about political pressures as on-budget investments would be. The expectation that the retirement of the baby-boom generation will eventually require a drawdown of these fund balances does, however, provide some mitigation of these concerns…
The question I have is why he allowed the Trust Fund to vanish without public comment. Why didn't we hear more from him as this was happening? He knew that a zero budget target without Trust Fund assets in place elsewhere would create deficit problems in the future, but he did not protest. That is hard to understand unless it was part of a broader strategy to force privatization. The press bears responsibility in this as well. From the time of Greenspan’s testimony on January 25, 2001 until now, the press has missed what Greenspan was really talking about. He was afraid of a large surplus building up and the effect that would have on the private market when the government invested the large surplus in the private sector. To avoid this problem, his solution was to accumulate the Trust Fund surplus in private accounts so that individuals rather than the government would participate in the private market, and to cut taxes. At the time, Krugman stated in a column in the NY Times:
Some people — including, alas, Alan Greenspan — have made it seem as if any purchase of private-sector assets by the trust funds would instantly politicize the financial markets and undermine the foundations of the free-enterprise system. But that's ideology, not analysis; people who have looked seriously at the issue think that these concerns are vastly overblown. There are well-established techniques for protecting government investment accounts from political meddling, such as legal requirements that the funds buy a broad index. Are these techniques imperfect? Maybe — but who would argue that rather than running some slight risks of politicizing the markets, we should squander the money that was supposed to pay for our retirement? Only a politician with an irresponsible tax cut to sell.
However, when the economy began slipping into deficit and the Trust Fund assets were evaporating, Greenspan did not protest, and importantly, neither did the press. Here are the headlines from the time. Note that only CBS News talks about trigger mechanisms and very few of the stories mention any caution regarding deficits. None talk about the Trust Fund assets and Greenspan’s remarks in that regard. Here are the headlines:

Greenspan Endorses Tax Cuts

WASHINGTON, Jan 25, 2001 (AP Online via COMTEX) -- Federal Reserve Chairman Alan Greenspan gave a major boost Thursday to President Bush's plan for across-the-board cuts in taxes …

GOP Raves at Greenspan's Tax Views January 26th

WASHINGTON (AP) - President Bush, in office less than a week, has scored an early triumph in his campaign for a $1.6 trillion tax cut, winning Federal Reserve Chairman Alan Greenspan's support for tax relief…

In Policy Change, Greenspan Backs A Broad Tax Cut

RICHARD W. STEVENSON (NYT) January 27, 2001

… it should not be so big that it would plunge government back into deficit if federal budget surplus fails to materialize as projected …

Greenspan eyes tax cuts

January 25, 2001: 2:09 p.m. ET

WASHINGTON (CNNfn) - Federal Reserve Chairman Alan Greenspan gave his broadest endorsement of tax cuts to date Thursday… Greenspan said that if it became clear that politicians might be tempted to use the money for major spending initiatives, it would be better to cut taxes. "It is far better, in my judgment, that the surpluses be lowered by tax reductions than by spending increases," the Fed chairman said.

Greenspan supports tax cut plan

By Gerard Baker in Washington site; Jan 25, 2001

Alan Greenspan, chairman of the US Federal Reserve, on Thursday threw his weight behind proposals for a large tax cut, giving a powerful boost to the centerpiece of President George W. Bush's economic policy…

That created the real risk that, if budget surpluses continued, the US government would begin to acquire a growing portion of the nation's private financial assets - which would create serious inefficiencies….

Greenspan quick to move with times

By Gerard Baker in Washington site; Jan 26, 2001

…Alan Greenspan … found himself repeatedly echoing Keynes's defence …as he explained his remarkable U-turn...

… At that point the government could literally buy back all the outstanding publicly held debt and still have several billion dollars left over. It is this situation Mr. Greenspan is anxious to avoid, since the government will then in effect be holding net private assets…


Financial Times; Jan 26, 2001

Alan Greenspan's sudden endorsement of President George W. Bush's tax cutting plans looks like smart politics rather than sound economics… Mr Greenspan worries that in six to seven years this debt will have been repaid and the government will be forced either to acquire private assets or go on a spending spree…

Greenspan Gets Mixed Reviews

CBS News, WASHINGTON, Jan. 26, 2001

… Greenspan urged caution, suggesting that Congress consider some type of trigger to trim government spending or tax cuts if the budget surpluses aren't as large as currently estimated…

Greenspan on tax-cut bandwagon

Chicago Tribune - US FT Abstracts; Jan 26, 2001

Federal Reserve chairman Alan Greenspan told the senate budget committee yesterday that … he is ready to support reduced tax rates.

Greenspan backs tax cuts as way to trim surplus

Los Angeles Times - US FT Abstracts; Jan 26, 2001

Federal Reserve Chairman Alan Greenspan gave his endorsement for President Bush's ambitious tax cut program yesterday, citing the expanding budget surplus as reason for lower taxes.

Editorial: Interpreting Mr. Greenspan

The New York Times - US FT Abstracts; Jan 26, 2001

Alan Greenspan's approval of tax cuts in his Congressional testimony yesterday should not be misconstrued by Bush as an endorsement of his $1.6 trillion tax cut offer. … Congress should therefore move carefully toward tax cuts…

In policy change, Greenspan backs a broad tax cut

The New York Times - US FT Abstracts; Jan 26, 2001

Federal Reserve Chairman Alan Greenspan has given his blessing for a substantial tax cut … but he did warn that any cut should not be so big that it plunged the government into deficit should the federal budget fail to materialize as projected…

Greenspan, in about-face, backs tax cuts

The Wall Street Journal - US FT Abstracts; Jan 26, 2001

In a dramatic departure from a long-held view, Federal Reserve Chairman Alan Greenspan yesterday lent his support to the federal government's tax cut package…

Zeal and doubt follow tax-cut blessing

The Boston Globe - US FT Abstracts; Jan 26, 2001

The Federal Reserve's Alan Greenspan lent his support to the Republican's plan for a tax-cutting initiative yesterday …

Economic Realities Drove Greenspan

The Washington Post. Washington, D.C.: Jan 26, 2001. pg. A.4

[FROM ABSTRACT]…Alas, said [Alan Greenspan], it's not that simple. The moment the target is reached and the government stops using its annual surpluses to pay down the national debt, it faces a problem … What to do with the extra cash piling up at the Treasury? …

Bush's Hand Greatly Strengthened

Glenn Kessler. The Washington Post. Washington, D.C.: Jan 26, 2001

[FROM ABSTRACT]… [Alan Greenspan] dispelled the notion that [Bush]'s plan to cut taxes might be reckless, dangerous or even massive, as former vice president Al Gore charged ...

Greenspan did warn about large deficits. But he didn’t warn about the bigger problem, congress allowing the Trust Fund assets to vanish. Because he failed to protest as the Trust Fund assets were used to fund deficit spending in other parts of government, he is not absolved of all responsibility for our current predicament.

Bloomberg: U.S. April Consumer Confidence Index Falls to Five Month Low

Consumer confidence fell from 103 to a five month low of 97.7 in April:
U.S. April Consumer Confidence Index Falls to 97.7 From 103 April 26 (Bloomberg) -- U.S. consumer confidence fell to a five-month low in April as record gasoline prices and doubts about job prospects threatened to slow the world's largest economy, a private survey showed…
The article notes that:
...a decline in confidence doesn't always mean lower consumer spending, which accounts for more than two-thirds of gross domestic product...
However, if there was no relationship between confdence and spending, the index would not tell us anything useful. It often does mean lower spending, and a fall in confidence is unlikely to increase spending, so this is not encouraging news.

Cleveland Fed President: The Power of Price Stability and Public Pressure

Sandra Pianalto, President and CEO, Federal Reserve Bank of Cleveland, explains the advantages of inflation targeting when there are budget and current account deficits. In addition, she discusses the appropriate monetary policy response in both soft and hard landing scenarios. She states a clear commitment to inflation targeting and to gradually allowing interest rates to rise to their equilibrium level in the near future. The exception is a hard landing where an immediate infusion of liquidity might be necessary to avoid systemic market failure. She also notes that the public can help the Federal Reserve with its job. She says “... it goes without saying that our job is made easier if the public expects that the fiscal authorities will address budgetary imbalances in a timely and effective fashion.” Thus, by exacting a political price for high and persistent deficits the public can help to stabilize the economy. This is an important point. If the public does not expect or demand that politicians attend to budgetary issues, then they will have no incentive to undertake the difficult task of balancing the books. Here are President Pianalto’s remarks:
The Power of Price Stability,Sandra Pianalto, President and CEO, Federal Reserve Bank of Cleveland, The Levy Economics Institute of Bard College, Annandale-on-Hudson, NY, April 21, 2005 The economy has been expanding for the past few years, but many people seem to think that … the economy could face some challenges from fiscal and trade deficits. Today, I would like to explain how I think central banks can best meet those challenges and promote economic prosperity - by maintaining price stability, or low and stable rates of inflation. … …Let me turn now to the issue of whether large budget deficits may undermine central banks' success in maintaining low and stable inflation rates. In the United States, current budget deficits, as well as prospective deficits over the immediate horizon, seem to be well within the boundaries of historical experience. … the United States … face[s] demographic changes where we see entitlement liabilities growing faster than the tax base available to support them… … resolving fiscal imbalances is not the job of monetary policymakers, but that does not mean that we can ignore their consequences. The stance of monetary policy - that is, whether a specific setting of the federal funds rate target is determined to be "tight," "easy," or "neutral" - depends on the level of what economists usually refer to as the "equilibrium real interest rate." … It is not unreasonable to expect that persistent government deficits will eventually yield upward pressure on the equilibrium real interest rate. … central banks … will need to respond to this pressure with corresponding movements in their policy rates. … But… large and persistent fiscal deficits introduce another risk-namely, that they could be the source of inflationary pressures. However, there is no need for deficits to be inflationary. The prospect of inflation arises only if the central bank ignores or, even worse, tries to resist any rise in real interest rates. By doing so, the central bank would keep its policy rates too low and inadvertently ease monetary policy. Of course, the real risk of an excessively stimulative monetary policy is that inflation expectations may eventually become unanchored. History shows that once inflation expectations become unstable, more stringent policy actions might be required. …I believe that the FOMC is trying very hard to preserve its credibility by being clear and unwavering in its commitment to low and stable inflation. However, it goes without saying that our job is made easier if the public expects that the fiscal authorities will address budgetary imbalances in a timely and effective fashion. Now I would like to discuss how monetary policy can best contribute to resolving the challenges brought by external account imbalances. … I think everyone agrees that these levels are unsustainable, and that a reversal is inevitable, even if the timing and pace of the adjustment are uncertain. Some people envision a soft landing. As we all know, a return to current account balance will ultimately require that U.S. households consume less and save more of their incomes. Households could become concerned about having enough money for future consumption and step up their saving, even at today's interest rates. The more commonly expected scenario, though, is that foreign savings coming into the United States could become less plentiful over time, driving up interest rates. Then, households might be induced to save more and spend less. If a substantial turnaround in U.S. current account deficits results in higher equilibrium real interest rates, the FOMC would most likely need to adjust its federal funds rate target accordingly to prevent a change in its policy stance. It is also possible that a decline in the exchange value of the dollar could result in temporary upward pressure on the price level, due to rising import prices and the prices of import-competing goods. The first responsibility of the central bank is to ensure that these price pressures do not feed into higher inflation expectations in the long run. … … of course, there are those who believe that the landing might not be so soft - and that the reversal of our large current account deficits will be sudden and disruptive. … In these circumstances, it is difficult to predict what the specific course of monetary policy ought to be, but the usual answer to financial market crises is for the central bank to provide enough liquidity to short-circuit systemic market failure. How, then, should monetary policy deal with current account imbalances today? I do not think that the FOMC should take preemptive measures to address these imbalances. However, I do think that the Committee should continue to bring the federal funds rate target to a level that is consistent with maintaining price stability in the long run. If we achieve that, then we will be in a position of strength to address whatever challenges arise.

Grassley Open to Focusing on Solvency, Dropping Private Accounts

This would be encouraging, but I don't think the GOP is ready to decouple solvency and privatization:
CNN Money: Retirement debate to heat up in Senate ... Grassley, according to USA Today, said he would be open to coming up with a bill that focuses on solvency and puts aside individual accounts for now...
The fact that there is an emerging recognition that solvency and privatization are separate issues is, however, a step in the right direction. [Update: CNN has more here.]

April 25, 2005

Greenspan Defends 2001 Comments on Tax Cuts, Says Calls for Budget Constraints Ignored

From a Washington Times editorial, quotes from Alan Greenspan defending his comments on cutting taxes in January 2001. Greenspan notes that he also called for “triggers” in the same testimony to restrain spending by congress:
Washington Times Editorial, Greenspan and the Democrats' spin, April 25, 2005 …there is little evidence that the Bush administration and Congress have any viable plans to meet the president's commitment to slice the deficit in half over any reasonable period of time. It was in this atmosphere that Federal Reserve Chairman Alan Greenspan testified before the Senate Budget Committee Thursday, declaring, "The federal budget deficit is on an unsustainable path." Mr. Greenspan emphatically warned: "Unless that trend is reversed, at some point these deficits would cause the economy to stagnate or worse." As he has done repeatedly in past congressional testimony, Mr. Greenspan implored the senators to re-adopt budget procedures from the 1990s that provided a modicum of discipline to fiscal policy. Those procedures included discretionary spending caps and so-called PAYGO requirements... "Reinstating a structure like the one provided by the [1990] Budget Enforcement Act would signal a renewed commitment to fiscal restraint and help restore discipline to the annual budgeting process," the Fed chairman told the senators. …Mr. Greenspan was recommending the use of "triggers" -- and not for the first time… Democratic senators have pursued a revisionist strategy that attempts to place much of the blame for the burgeoning budget deficits on the Fed chairman… Mr. Greenspan told Mr. Sarbanes that the charge was "frankly unfair" because it neglected the Fed chairman's unambiguous endorsement of "trigger" mechanisms during the same testimony. "I advocated tax cuts" in 2001, Mr. Greenspan acknowledged Thursday, "but I also advocated triggers in the same testimony." …"In recognition of the uncertainties in the economic and budget outlook," Mr. Greenspan said in his prepared remarks in January 2001, "it is important that any long-term tax plan, or spending initiative for that matter, be phased in. Conceivably, it could include provisions that, in some way, would limit surplus-reducing actions if specified targets for the budget surplus and federal debt were not satisfied." … "What if," he asked more than four years ago, "the forces driving the surge in tax revenues in recent years begin to dissipate or reverse in ways that we do not now foresee?" That is precisely what happened… the triggers he advocated "never passed, never got any real interest, and as you point out, that's unfortunate, because we would have found that a number of things would have occurred differently. One of the real problems we had was allowing PAYGO to lapse in September 2002, and were we to still be under a PAYGO regime, which I thought worked very well, I think we'd have fewer problems now."

S&P Economist: Easter Caused Prices to Hop in 1st Quarter

Now that Easter is over, pressure on prices to increase should abate according to an S&P economist:
BusinessWeek, April 22, 2005, Joseph Lisanti, Inflation and the Moveable Feast The Easter bunny came early this year. Did he bring higher prices with him? … Standard & Poor's economist Beth Ann Bovino notes that some of the increase could be attributed to an early Easter in 2005. Because the holiday fell in the first quarter this year, the extra spending it generated came in March... some of the strongest price increases in the March CPI report were in transportation services, hotels, and apparel. Some could have been holiday related: As Americans bought airline tickets for holiday visits, and as they shopped the apparel stores for their spring wardrobes, prices may have been boosted by higher demand. Also, a weaker dollar may have increased foreign travel to the U.S., giving hotels and airlines more pricing power…

Hearings on Social Security Reform Legislation Begin This Week

The Social Security reform battleground shifts this week. The first steps to draft Social Security legislation begin Tuesday with hearings on potential options for reform. Krugman's column "The Oblivious Right" makes it clear that the likelihood that congress will pass a bill despite public opinion to the contrary should not be underestimated. As Krugman notes:
...Mr. Bush doesn't understand their concerns. He was sold on privatization by people who have made their careers in the self-referential, corporate-sponsored world of conservative think tanks. And he himself has no personal experience with the risks that working families face. He's probably never imagined what it would be like to be destitute in his old age, with no guaranteed income...
As this Washington Post story makes clear, the congress and administration are determined to pass private-accounts legislation despite polls showing seven in ten Americans say they're uneasy about his approach to the issue:
Washington Post, Jonathan Weisman, April 24, 2005 - Panel to Start Writing Social Security Bill Five months after President Bush launched his drive to overhaul Social Security, the difficult, if not impossible, task of drafting legislation begins Tuesday when the Senate Finance Committee holds the first hearing on options to secure Social Security's future …, Senate Finance Committee Chairman Charles E. Grassley (R-Iowa) said last week he will move forward with Social Security legislation, hoping to push a private-accounts plan out of his committee this summer -- on a party-line vote if necessary … Supporters and opponents of the president's ideas say Grassley's determination will help the White House cause, by ramping up pressure for compromise …

April 24, 2005

Hundreds of Thousands of Poor to Lose Medicaid Coverage in Coming Months

From the Los Angeles Times (thanks to anne for the heads-up), news that hundreds of thousands of poor will lose Medicaid coverage in coming months as state legislators try to reign in budgets. Given Krugman's recent column, the long-run cost effectiveness of this policy outcome is debatable. As Krugman notes, the uninsured will still need and receive care after losing coverage, so in the end this may just shift costs to other people and other institutions that are less efficient at providing services:
States Rein In Health Costs By Stephanie Simon Times Staff Writer April 24, 2005 Hundreds of thousands of poor people across the nation will lose their state-subsidized health insurance in the coming months as legislators scramble to hold down the enormous … cost of Medicaid … Lawmakers say they feel for those who will lose coverage. But they say also that they have no alternative…Prenatal checkups, care in nursing homes and other health services for the poor and disabled account for more than 25% of total spending in many states. Medicaid is often a state's single biggest budget item, more expensive even than K-12 education. And the price of services, especially prescription drugs and skilled nursing for the elderly, continues to soar. The federal government helps pay for Medicaid, but in the coming fiscal year, the federal contribution will drop by more than $1 billion because of changes in the cost-share formula. President Bush has warned of far deeper cuts to come; he aims to reduce federal spending on Medicaid by as much as $40 billion over the next decade. "It's frightening a lot of governors," said Diane Rowland, executive director of the Kaiser Commission on Medicaid and the Uninsured. ...The Republican lawmakers who have been leading the Medicaid overhaul drive say such criticism distorts their goals. The cuts are not just about balancing this year's budget, they say. They're about steering Medicaid back to its original purpose: to serve as safety net for citizens who are too young, too old, or too ill to help themselves. Turning Medicaid into a welfare program for poor but able-bodied adults risks jacking up the costs so high, they say, that the entire system could go bust... "Government is not here to do everything for everybody," said state Rep. Jodi Stefanick, a Republican representing suburban St. Louis. "We have to draw the line somewhere." Medicaid was enacted in 1965 as a joint federal-state program to provide basic care for poor children, pregnant women and people with disabilities. States administer the program and pay 20% to 50% of the total costs. The federal government funds the remainder. (The federal contribution varies from state to state, with the poorest states receiving the largest amounts.) …Medicaid now covers 53 million Americans. The program pays the bills for nearly 60% of all nursing home residents and finances 37% of all births. Because most states have added prescription drug benefits, Medicaid covers the hefty pharmacy bills for many patients with AIDS, many transplant recipients and many senior citizens on dialysis or undergoing chemotherapy. The program also covers the more mundane medical expenses of low-income working families. …For most states, Medicaid expenses are often the single largest line item on the budget, exceeding K-12 education. States spending the most on Medicaid as a percentage of fiscal 2004 budgets: Tennessee... 33.3% Missouri ...30.7 Pennsylvania ...29.5 Maine ...29.0 New York ...28.3 Illinois... 28.1 Vermont ...27.5 New Hampshire... 26.4 Mississippi... 26.3 Rhode Island ...25.5 Who receives Medicaid • 25 million children • 13 million low-income adults, including pregnant women • 15 million seniors and people with disabilities Medicaid benefits By federal law, states must provide certain benefits for Medicaid recipients, including: • Inpatient and outpatient hospital services • Physician, psychiatrist and nurse practitioner visits • Nursing home and home healthcare for adults • Family-planning services and supplies • Lab and X-ray services • Transportation to medical appointments

Fed Governor Kohn on the Chance of a Hard versus Soft Landing; Says Fed Should Not Hesitate to Increase Interest Rates

Here are remarks by Federal Reserve Board Governor Donald L. Kohn concerning how the imbalances in the U.S. economy came about, the chance of a hard versus soft landing, and the role of monetary policy in the coming months. At the end he makes it clear that the Fed should not hesitate to increase interest rates to contain inflationary pressure:
But, in the same vein, we should not hesitate to raise interest rates to contain inflation pressures just because it might set off a retrenchment in housing prices, just as we were willing to keep rates unusually low as house prices rose rapidly. Nor should we hesitate to raise rates because higher rates mean higher debt-servicing burdens for the current account, the fiscal authority, or households. In my view, our role is to anticipate as best we can the macroeconomic effects of imbalances and their correction and to respond to unexpected changes in asset prices and spending propensities as they occur. It is through such actions that we aim to achieve our objective of economic stability.
This, taken together with Greenspan’s remarks that there is little sign of stagflation make it increasingly likely that the Fed will raise interest rates in coming months. If there are signs of price instability, a .50 percent increase appears possible, though new data showing accelerating inflation would likely be required, particularly since Governor Kohn describes the Fed's posture as measured. But the posture described by Governor Kohn is more aggressive towards raising interest rates than I have described recently. This emerging vigilance towards inflation has arisen as the Fed has detected underlying strength in economic growth from recent reports on the economy. Here is a longer version of Governor Kohn's remarks, and a link to a transcript of the entire speech. Calculated Risk also discusses this speech and highlights the comments regarding current account imbalances and the housing market. Dave Altig's discussion of hard and soft landings in his series of posts here, here, and here at macroblog is also worth reading:
Imbalances in the U.S. Economy Remarks by Governor Donald L. Kohn At the 15th Annual Hyman P. Minsky Conference, The Levy Economics Institute of Bard College, Annandale-on-Hudson, New York April 22, 2005 ... I must emphasize that these views are my own and not necessarily those of my colleagues on the Federal Open Market Committee … …The United States has been doing well over the past few years by most measures of overall economic performance ... To be sure, the rise in energy prices seems to have taken a toll on consumer confidence and spending most recently. But … most forecasters expect growth to remain solid. Excluding food and energy, the rate of inflation has fluctuated around 1-1/2 percent over the past few years... Core inflation has been running somewhat faster more recently, in part because of the increases in the prices of energy, commodities, and imports that began last year. Nevertheless … core and headline inflation rates should moderate later this year. Buttressing this view, long-run inflation expectations have been, on balance, fairly stable in the face of these price gyrations. …[S]ome aspects of the current situation might be viewed as worrisome. In particular…the ... [current account] imbalance … has risen to a record level, both in absolute terms and as a ratio to GDP. Moreover, the cumulative value of past current account deficits … is also at a record high, again both in absolute terms and as a ratio to GDP. The growing current account deficit has been associated with a pronounced decline in the saving proclivities of both the private and public sectors… … [W]ith probably limited economic slack remaining, such a pronounced imbalance between national saving and domestic investment would have placed substantial upward pressure on interest rates. One also might have expected real interest rates to be high at a time when we are experiencing rapid productivity growth. But, as you know, nominal and real yields on both short-term and long-term Treasury securities are low by historical standards… …Low interest rates have, in turn, been a major force driving the phenomenal run-up in residential real estate prices over the past few years, and the resultant boost to net worth must be one of the reasons households have felt comfortable directing so little of their current income to saving. However, whether low interest rates and other fundamental factors can fully explain the current lofty level of housing prices is the subject of substantial debate. This situation raises some difficult questions. Can the aforementioned spending imbalances and possible asset-price anomalies continue without threatening macroeconomic stability? And if they cannot be sustained, how will they unwind? Will the transition be relatively benign, or will it be a rocky adjustment with deleterious effects on economic growth, inflation, and other factors? And finally, what role will government policies play in influencing the path of adjustment? On the question of sustainability, it is worth noting that these sorts of imbalances are not new ... But, the magnitude of these imbalances is increasingly moving into unfamiliar territory…The sustainability of these large and growing imbalances has become especially suspect because it would require behavior that appears to be inconsistent with reasonable assumptions about how people spend and invest … Similar considerations apply to the current low rate of household saving... given average life expectancies and the typical number of working years, a sustained saving rate of less than 2 percent is too low for households to accumulate enough wealth to maintain their standard of living after retirement--unless, of course, those households are lucky enough to receive outsized capital gains on their homes and other assets. Although many households have received such windfalls over the past few years, such gains are not likely to be continually repeated in the future … The current imbalances will ultimately give way to more sustainable configurations of income and spending ... Ideally, the transition would be made without disturbing the relatively tranquil macroeconomic environment that we now enjoy. But the size and persistence of the current imbalances pose a risk that the transition may prove more disruptive. ...I think we can identify several factors that have played an important role in the emergence of these imbalances, and in so doing gain some insight into their likely resolution. A rise in the net supply of saving in other countries, the perception that dollar assets are a relatively favorable vehicle in which to place that saving … the increased willingness of the rest of the world to hold U.S. assets, along with the jump in our productivity growth, contributed to a sharp increase in U.S. equity valuations. And the associated capital gains, in turn, caused the net worth of U.S. households to soar relative to their income and induced a reduction in personal savings rates. Then, in 2000 and 2001, ... In the United States and elsewhere, monetary and fiscal policies turned stimulative to bolster demand and to stave off unwelcome disinflation. The size of the stimulus required to accomplish our macroeconomic objectives in the United States was further increased by the sluggish economic growth of our trading partners and by continued demand for dollar assets, which further exacerbated our trade imbalance… ...What can we say about the likely path by which these spending imbalances will resolve themselves and about the effects those resolutions will have on the broader economy? … The federal funds rate appears to be below the level … consistent with the maintenance of stable inflation and full employment over the medium run, and, if growth is sustained and inflation remains contained, we are likely to raise rates further at a measured pace. By increasing the return to saving and by damping the upward momentum in housing prices, rising interest rates should induce an increase in the personal savings rate, and thereby lessen one of the significant spending imbalances we have noted. ...We do not understand all the reasons for recent low personal saving rates, and the rise in the saving rate could exceed the increase that results from likely movements in interest rates and house prices--especially as households contemplate the adequacy of their retirement income. And fiscal policymakers do seem to be more aware of the need to change the medium-term trajectory of the federal budget. To the extent that current spending behavior is built on realistic expectations … the transition should be relatively orderly ... But if current expectations are badly distorted, then the way forward may not be so smooth... Are expectations substantially distorted? …risk premiums on private securities are low by historical standards …[and] yields reflect … low actual and expected inflation … and the market's belief that … the federal funds rate will move up only gradually as the expansion proceeds… [S]ubdued expectations may reflect a belief that underlying global demand will remain damped and that the world will continue to be willing to invest heavily in the United States. A second observation concerns the housing market … Prices have gone up far enough since then relative to interest rates, rents, and incomes to raise questions … [that] the recent trend of price increases …[can] continue. Even so, such a distortion would most likely unwind through a slow erosion of real house prices, rather than a sudden crash … … Finally, there is the exchange rate … In all likelihood, adjustments toward reduced imbalances in the United States and globally will be handled well … provided … that the Federal Reserve reacts appropriately to foster price and economic stability… … [W]e cannot rule out sudden shifts in expectations, whether or not they are unreasonable to begin with, and asset prices may change suddenly... Moreover, we cannot rule out governments engaging in unwise policies… … A permanent correction to the spending imbalances must involve the restoration of fiscal discipline and long-run solutions to the financing problems of Social Security, Medicare, and Medicaid..Adjustment of global current-account imbalances could also be aided by changes over time in the policies of our trading partners… …Finally, there is the role that monetary policy plays in reacting to these imbalances and their inevitable unwinding... [A]nything that has the potential to threaten the stability of output and prices is of concern to us... we should take into account the claim on resources implied by the federal budget, ... the effect that housing wealth has on consumer spending and the economy more broadly. We should note the implications of changes in the exchange rate or borrowing rates by U.S. corporations that result from shifts in global investor sentiment. But ... we should not hesitate to raise interest rates to contain inflation pressures just because it might set off a retrenchment in housing prices, just as we were willing to keep rates unusually low as house prices rose rapidly. Nor should we hesitate to raise rates because higher rates mean higher debt-servicing burdens for the current account, the fiscal authority, or households. In my view, our role is to anticipate as best we can the macroeconomic effects of imbalances and their correction and to respond to unexpected changes in asset prices and spending propensities as they occur. It is through such actions that we aim to achieve our objective of economic stability.
[Update: William Polley notes his approval of the Fed's recent signs of inflation fighting resolve here.]

Bloomberg: China Will Accelerate Currency Reform, Welcomes Pressure

From Bloomberg, news that China will accelerate currency reform. It appears from this report that international pressure is part of the reason for the acceleration. A central bank governor says such pressure is welcome because it helps to bring about needed reform. However, he also says, "We have a very clear target in this regard, but we have our own sequence."
China Will Accelerate Foreign Exchange Reform (Update4) April 24 (Bloomberg) -- China will accelerate foreign exchange reform, a regulatory official said, a day after the central bank governor said the country may speed preparations to loosen the tie between its currency and the U.S. dollar. China should undertake “step-by-step'' reforms, Wei Benhua, deputy director of the State Administration of Foreign Exchange… “We will positively, but prudently, accelerate the process of reform of the renminbi exchange rate,'' Wei said. Yesterday, central bank Governor Zhou Xiaochuan said pressure from outside China could force the country to speed reforms …. It's “probably time,'' but first “we need to see what the impact will be on neighboring countries.'' …Zhou said China welcomes international pressure because it will force the nation to speed up needed financial reforms. Still, “we don't see that the pressure is that strong right now,'' he said.

...The G-7's sharper rhetoric marked a shift in the group's efforts to coax the world's fastest-growing major economy into ending the peg. Some investors said the strategy might backfire, making China less likely to revalue because its leaders won't want to be seen as bowing to outside influence.

"We have a very clear target in this regard, but we have our own sequence,'' Zhou said at the forum, a two-day gathering of regional leaders. "We are doing some preparation, for example the reform of the financial sector, to enlarge the role of the foreign-exchange market.''

A complete liberalization of the country's foreign exchange system would take "several decades'', Wei said today, adding that China is about halfway to achieving this.

[Update from The Financial Times: Yen and Chinese forwards leap on US pressure, By Steve Johnson in London, April 22 2005 17:30

The yen and forward contracts based on the non-tradeable Chinese renminbi both jumped sharply on Friday amid mounting speculation that Beijing may be ready to ease its decade-long dollar peg...]

Statistical Releases and Fed Speeches This Week

From US News and World Report, a list of speeches and statistical releases to note for the coming week. There are key reports on consecutive days throughout the week. The existing home sales release on Monday will be important given last week’s disappointing economic news and the fall in housing starts in March. Then, with consumer confidence, durable goods, GDP, and consumer sentiment reports on consecutive days starting on Tuesday, it will be an interesting week to watch. By the end of the week we should have a bit better idea about the underlying strength or weakness in the economy. The Fed speeches by Pianalto, Gramlich, Ferguson, and Hoenig are also on the watch list:

Monday, April 25:

EXISTING HOME SALES: Last week, a government report indicated that housing starts fell an unexpected 18 percent in March. Today, the National Association of Realtors is scheduled to release a separate report on existing home sales last month. If existing home sales fell significantly, it could lead to a new round of concerns about the housing market.

FEDSPEAK: Sandra Pianalto, president of the Federal Reserve Bank of Cleveland, is scheduled to deliver a speech in Akron, Ohio.

Tuesday, April 26:

CONSUMER CONFIDENCE: The Conference Board is scheduled to release the latest findings of its closely followed consumer confidence index. It has declined for two consecutive months and many economists are expecting another slight drop.

Wednesday, April 27:

DURABLE GOODS: How worried are consumers about the health of the economy? One way to tell is to consider trends in durable goods—big-ticket items that consumers don't absolutely need but tend to purchase when times are flush. The government is slated to release March durable goods orders this morning.

FEDSPEAK: Federal Reserve Board governor Edward Gramlich is scheduled to speak about predatory lending in an address in Philadelphia. Meanwhile, Fed Vice Chairman Roger Ferguson is expected to talk about the Federal Reserve system in a speech in Frankfurt, Germany.

Thursday, April 28:

GDP: The Commerce Department will release a preliminary assessment of first-quarter economic growth. As recently as a few weeks ago, some economists were predicting first-quarter gross domestic product growth of nearly 4 percent. But in light of recent data showing a somewhat weaker economy, many now believe GDP grew 3.5 percent at the start of the year.

The New York Times: Private Accounts and the Priorities of Economic Advisers

This opinion piece from the New York Times speaks for itself. It's worth reading it its entirety:
Private Accounts, and Priorities ECONOMIC VIEW By MATT MILLER April 24, 2005 WHATEVER you think of President Bush's proposal to let people divert a third of their Social Security payroll taxes into new private accounts, one thing seems a mystery. If the White House and its allies think that private accounts are such a good idea, why don't they propose paying for the fiscal hole that the payroll tax diversion creates, rather than borrowing a fresh $200 billion or so each year for a few decades? Why isn't the idea of paying for the accounts - through spending trims elsewhere, or, more likely, through some new tax stream - even part of the debate? As Republican economists and former presidential advisers like Michael J. Boskin, N. Gregory Mankiw and R. Glenn Hubbard take to the op-ed pages to defend the president's idea, they never mention options other than borrowing, focusing instead on a defense of why outsized borrowing is nothing to fear. It wasn't always this way… [link to article]

April 23, 2005

Social Security as Insurance vs. Welfare vs. Saving Once Again

Deinonychus antirrhopus, in this post, revisits the "Is Social Security saving, welfare, and/or insurance question" following up on this post on the site two days before (my response to the earlier post is here). The vehicle generating the discussion is this post from my comment on a Robert Samuelson column. My response to the latest post at Deinonychus antirrhopus is in the comments. Brad DeLong also commented on my Samuelson post here. In addition, Angry Bear weighs in nicely here on social insurance.

Harris Poll: Medicare and the Budget Deficit Are Not Big Problems

Here are some interesting data from the The Harris Poll on April 14. The question asked was "What do you think are the two most important issues for the government to address?" The percentage of people choosing Social Security fell between February and April from 37% to 31%. Over the same time period, the number choosing oil prices increased from 1% to 9%, worry over the deficit fell from 10% to 6% which surprises me both because it fell and because the percentage is so small, and worry over Medicare was unchanged at 3%, a smaller percentage than I would have predicted. Healthcare was a larger worry than Medicare at 14%, and it was also unchanged from February to April. These data indicate that the message that Medicare and the overall budget deficit, not Social Security, constitute the difficult problems to solve is not resonating with the public. One surprise to me was how large and often the percentages can change as attention shifts to new issues. Here is part of Table 11:
‘96 ‘97 ‘98 ‘99 ‘00 ‘01 ‘02 ‘03 ‘03 ‘04 ‘04 ‘04 ‘05 ‘05
Apr May Jan Feb Aug Dec Dec Jun Oct Feb Aug Oct Feb Apr
% % % % % % % % % % % % % %
Social Security X 6 6 24 16 3 2 4 2 2 5 4 37 31
The war X X X X X 12 18 8 18 13 24 35 30 23
Healthcare (not Medicare) 16 10 11 12 15 5 10 14 13 16 17 18 14 14
The economy (non-specific) 14 8 9 7 5 32 34 25 30 31 32 28 11 13
Energy/Oil prices X X X X X X X 1 1 * 1 1 1 9
Education 14 15 14 21 25 12 11 13 11 11 9 7 7 9
Federal budget surplus/deficit 22 20 12 5 4 1 1 4 5 5 2 2 10 6
Employment 9 5 3 4 4 7 8 8 12 16 10 10 6 6
National security X X X 2 2 6 3 6 7 4 6 5 4 4
Medicare 3 4 5 5 6 1 1 4 3 2 3 3 3 3
Foreign policy (non-specific) 3 3 5 4 3 2 4 2 4 6 2 3 3 3
Welfare 13 14 8 4 2 1 1 3 2 2 1 * 1 2
Crime/violence 16 19 13 8 10 1 2 3 1 3 1 1 * 2
Drugs 4 8 6 2 5 2 3 3 3 3 2 * * *
Ethics in government * * * * * 1 1 1 1 1 * 1 * -
* = Less than 0.5%.
X = Not mentioned as specific issue.
Some rows and earlier years are omitted for brevity. There are more tables at the link given above.