June 30, 2005
BusinessWeek Has No Point To Miss
[Update: PGL at Angry Bear offers his comments.]
[Update: Once again, thanks to Michael Mandel for provoking thought. There are some very good books on what constitutes a valid school of economic thought and when recogonition of such schools advances our understanding of important economic principles. Arbitrary slices don’t cut it.]
Fed Watch: Not Ready to Say “Uncle”
Recent data suggest that the solid pace of spending growth has slowed somewhat, partly in response to the earlier increases in energy prices. Labor market conditions, however, apparently continue to improve gradually. Pressures on inflation have picked up in recent months and pricing power is more evident. Longer-term inflation expectations remain well contained.
But from today’s statement:
Although energy prices have risen further, the expansion remains firm and labor market conditions continue to improve gradually. Pressures on inflation have stayed elevated, but longer-term inflation expectations remain well contained.
The failure to characterize spending growth as slowing is, I believe, the notable shift in the policy outlook. Of course, with the upward revision in Q1 GDP growth, there exists a solid argument for the shift.
I did anticipate maintaining the terms “accommodative” and “measured” which signal that they are not prepared to stop raising rates. I thought, however, that the FOMC would acknowledge the downside risks (weak manufacturing surveys and underlying durable goods numbers, for example), and I was off base here (in contrast to William Polley’s comments to my last post). In short: The thinking in the FOMC remains more optimistic on growth compared to the view of many market participants. FOMC members do not believe they have entered the ninth inning. The FOMC intends to continue raising rates, and likely do not have an end target in mind.
New Environmental Economics Blog
GOP: Doing Nothing is Not an Option
Approval of president's Social Security efforts dips, By Richard Wolf, USA Today: Americans disapprove of the way President Bush is handling Social Security by a ratio of more than 2-to-1, a new low … Opposition to Bush is greatest among seniors, women, and people with lesser incomes and levels of education. Democrats disapprove by … more than 20-to-1, but Republicans back Bush's performance on the issue by a 2-to-1 ratio. … Seven in 10 Americans say Bush has not been clear or specific enough ... Nearly eight in 10 say the same thing about Republicans in Congress. More than eight in 10 say Democrats haven't been clear.
House GOP Pledges Fall Vote on Soc. Sec, By David Espo, AP: … Republican leaders announced Wednesday the House would vote by fall on legislation to establish individual accounts under Social Security. … As drafted, the House GOP plan omits steps to extend the program's solvency, despite Bush's insistence that changes are needed. … One lawmaker said GOP leaders had ultimately decided that doing nothing was not a realistic option. …
My uncle, who drinks a bit, once told me that when his time comes they’ll have to beat his liver to death with a stick. That’s how I feel about private accounts.
June 29, 2005
WSJ Commentary: Monetary Policy Does Not Affect Core Inflation
The Fed's Crude Policy, By Alan Reynolds, The Wall Street Journal (subscription): … It is commonly assumed that the Fed "leans against" inflation -- raising interest rates when inflation accelerates and lowering rates when inflation slows. Yet the graph nearby (free) proves it is difficult to discover any coherent relationship between the funds rate and the "core" deflator for personal consumption expenditures (PCE), or any other measure of inflation not distorted by energy prices. … The only way to link the fed-funds rate to inflation is to assume the Fed suffered from "energy illusion" -- focusing on fluctuating energy prices rather than the impressive stability of other consumer prices. Perhaps the best way to show this is to look at the consumer price index with and without energy, so there can be no doubt that food prices (which are also excluded from core inflation) were irrelevant…
Here’s the problem with this "analysis." Suppose that monetary policy perfectly controlled inflation. What would a graph of inflation over time look like (note that the author only shows a few years in the graph)? It would be a flat line with no variation from its target value whatsoever, and it would be uncorrelated with any other variable. The fact that there is no correlation between inflation and the ff rate would be an indication of the success of the policy, not that inflation and monetary policy are unrelated. Looking at such raw correlations tells us nothing at all about causal relationships. This is a very well known fallacy in the literature surrounding monetary policy and anyone who purports to write as an expert on monetary policy ought to be aware of this.
As for the other part of the argument, there are sound theoretical reasons for looking at core inflation rather than total inflation that I won’t detail here. But suppose that core inflation is the target of monetary policy. Then core inflation would flat line but total inflation would not, and a measure of inflation including energy prices could show a correlation with the ff rate as claimed in the article.
But the conclusion is exactly the opposite of what the author claims. Finding a correlation between the ff rate and inflation including energy prices means, if policy is successful, that policy does not target energy prices, not that it does.
Monetary policy does not affect prices and inflation? This does not belong in the Wall Street Journal.
June 28, 2005
What We Don’t Know Can’t Hurt My Lobbyists
Salmon: Protect the evidence, Seattle Post-Intelligencer: Sen. Larry Craig ... The Idaho Republican … is trying to eliminate scientific evidence of what is happening to fish in the Columbia River system. A Senate appropriations bill includes report language intended to kill … collecting data on the survival of salmon in the Columbia and Snake rivers. ... Craig and others are angry about recent federal court rulings protecting endangered fish. … Craig also has raised the idea of using the appropriations process to undo the court decisions, an extremely bad idea both in principle and practice. Congress must preserve the … integrity of the courts. The Senate should not try to undo the … science needed to protect threatened creatures and the environment …
This needs to stop.
We Can't be Trusted With Your Money
There's a better solution to a congress that can't control itself.
The School of “Hairshirt” Economics
Alan Greenspan, Wizard or Villian (sic)?, By Christopher Farrell, BusinessWeek Online: Remember when Federal Reserve Board Chairman Alan Greenspan held sway over the American economy -- and imagination? … No more. Greenspan-bashing is now a popular sport ... One reason is that the 10-year economic expansion came to an end with the dot-com bust and subsequent recession. Another is that Greenspan's standing as the Monetary Maestro was overhyped during ... the 1990s. And the third is that his fallibility as a central banker was overemphasized during the difficult economy of the early 2000s. Indeed, the chairman has never recovered his lost luster.
No mention of his support for the 2001 tax cuts?
Still, Greenspan's most vehement critics go a lot further than this. They're convinced he has made a fundamental error as a monetary economist. Call it the hairshirt economists vs. the cheerleaders for growth-is-good. The hairshirts believe that for the health of the economy to be restored, the inevitable bust that follows a boom must be at least as great as the boom. Growth proponents -- and there's none greater than Greenspan -- believe that it's better to limit the fallout of a bust and get the economy growing again as quickly as possible.
Hairshirt economists? What school is that? Though he makes reference to Schumpeter's evolutionary view of cycles (recesssions are good because they weed out the inefficient firms and workers) later it becomes evident he means classical economists, so why not just say that? And the Growth proponents – most of us would call them Keynesians. More on this shortly, but there are two fundamental confusions here. The first is to call the monetarists interventionists. The second is to confuse short-run stabilization policy with policies to promote long-run growth.
… To the hairshirts' way of thinking, the great mistake Greenspan made was … to drive rates to a 45-year low to limit the damage from the recession. The Fed then nurtured the recovery by keeping money policy loose … The result: today's "low saving rates, the housing bubble, high debt loads, and a runaway current account deficit," writes Stephen Roach, chief economist at Morgan Stanley … The critics say Greenspan has transformed the economy into a giant bubble ... The longer he delays the day of reckoning, the worse the fallout will be when the bubble pops. That's a severe indictment -- but not necessarily a valid one. A problem with the anti-Greenspan mindset is that hairshirt economics was largely discredited during the Great Depression. The most infamous proponent … was Andrew Mellon, President Herbert Hoover's Treasury Secretary. He called for letting the Depression run its course without government interference …
In case you missed it, that’s an endorsement of Keynesian economics and a claim that the Great depression invalidated classical economic policy (the monetarist, hands-off, laissez faire position), as he now notes
… Mainstream economists of all schools, from Keynesianism to monetarism, turned away from hairshirt economics after the Great Depression. They realized that the government could play a positive role in counteracting contractionary forces in the economy. …
This is really confused. How did Keynesians turn away from hairshirtism after the Great Depression? Keynesian economics didn’t even exist prior to the depression. What he’s trying to say is that the forced interventionist experiment caused by World War II was credited with ending the Great Depression leading to an endorsement of Keynesian economics over the classical hands-off position. And it’s just wrong to say that monetarists advocated government intervention. There was this long discussion, called the Keynesian-Monetary debate, on this issue.
… Case in point: The chairmanan (sic) came under heavy criticism during the 1990s for not "taking the punchbowl away" ... The fear among most economists was that inflation would take off as the economy heated up. But Greenspan gambled … The bet paid off handsomely. American productivity has been running at an average annual rate of 3% since 1995, about double the pace of the previous two decades. Productivity is what economists really care about, because its growth rate is the foundation of higher living standards. … Indeed, most economists systematically overestimate the limits to growth …
This is another fundamental misunderstanding. There are two distinct sets of economic policies, one set is about stabilizing the economy around the natural rate, whatever it might be, the other is about making economic growth as strong as possible. Long-run economic growth depends upon real, not monetary factors in almost all mainstream economic models. Monetary policy is designed to stabilize the economy around the natural rate, but it does not change the natural rate itself. Technology, growth in human and physical capital, growth in the labor force, etc. are the sources of growth. Monetary policy is not a large factor. It affects growth in the short-run, but not the long-run.
… Perhaps there is a bubble in the housing market. … But a record 70% of American households now own their own homes. And growth is also persuading business leaders to invest … Greenspan is no economic wizard … He has made his share of mistakes ... But what should be defended is the economics of growth. Remember, not all price increases are bubbles, booms are better than busts, and growth is not only good -- it's vital.
So, Greenspan is a monetarist interventionist Growth proponent following Keynesian short-run policies to promote long-run growth.
Hare-brained hairshirt economics.
[PGL at Angry Bear comments here.]
No Change in The CBOT's Fed Funds Rate Target Probabilities
CBOT Fed Watch - June 29 Market Close - Based upon the June 29 market close, the CBOT 30-Day Federal Funds futures contract for the July 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 3 percent to 3 1/4 percent at the FOMC meeting on June 30.
In addition, the CBOT 30-Day Federal Funds futures contract is pricing in a 4 percent probability of a further 25-basis point increase in the target rate to 3-1/2 percent (versus a 96 percent probability of just a 25-basis point rate increase).
June 23: 96% for +25 bps versus 4% for +50 bps. June 24: 96% for +25 bps versus 4% for +50 bps June 27: 96% for +25 bps versus 4% for +50 bps June 28: 96% for +25 bps versus 4% for +50 bps. June 29: 96% for +25 bps versus 4% for +50 bps
June 30: 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 3.25%, and a 4% chance it will increase an additional .25% to 3.50%.
[Update: June 29 - No change.]