October 31, 2005
Krugman: Ending the Fraudulence
Ending the Fraudulence, by Paul Krugman, NY Times: Let me be frank: it has been a long political nightmare. ... So is the nightmare finally coming to an end? Yes, I think so. ... I don't share fantasies that Dick Cheney will be forced to resign; even Karl Rove may keep his post. One way or another, the Bush administration will stagger on... But its essential fraudulence stands exposed... What do I mean by essential fraudulence? Basically, I mean the way an administration with an almost unbroken record of policy failure has nonetheless achieved political dominance through a carefully cultivated set of myths. The record of policy failure is truly remarkable. It sometimes seems as if President Bush and Mr. Cheney are Midases in reverse: everything they touch ... turns to crud. Even the few apparent successes turn out to contain failures at their core: for example, real G.D.P. may be up, but real wages are down. ... The administration has ... built its power on myths ... Take away those myths, and the administration has nothing left. Well, Katrina ended the leadership myth... Pundits may try to resurrect Mr. Bush's reputation, but his cult of personality is dead - and the inscription on the tombstone reads, "Brownie, you're doing a heck of a job." Meanwhile, the Plame inquiry ... has ended the myth of the administration's monopoly on patriotism... Apologists can shout all they like that no laws were broken, ...or whatever. The fact remains that officials close to both Mr. Cheney and Mr. Bush leaked the identity of an undercover operative for political reasons. Whether or not that act was illegal, it was clearly unpatriotic. And the Plame affair has also solidified the public's growing doubts about the administration's morals. ...
But the nightmare won't be fully over until two things happen. First, politicians will have to admit that they were misled. Second, the news media will have to face up to their role in allowing incompetents to pose as leaders and political apparatchiks to pose as patriots. It's a sad commentary on the timidity of most Democrats that even now, ... it's hard to get leading figures to admit that they were misled into supporting the Iraq war. Kudos to John Kerry for finally saying just that last week. And as for the media: these days, there is much harsh, justified criticism of the failure of major news organizations ... to exert due diligence on rationales for the war. But the failures that made the long nightmare possible began much earlier, during the weeks after 9/11, when the media eagerly helped our political leaders build up a completely false picture of who they were. So the long nightmare won't really be over until journalists ask themselves: what did we know, when did we know it, and why didn't we tell the public?
I was motivated to post this shortened version of Krugman’s comments because what he says about the media applies equally well to reporting on economics. The press is no less guilty here of the lapses Krugman identifies and economic myths have been among those that have flourished (link to “Better Press Corps” from Brad Delong). Journalists need to go beyond Krugman’s three questions, “what did we know, when did we know it, and why didn't we tell the public?” and ask themselves how to do a better job of presenting objective analysis on economic matters rather than the opinions of pundits from both sides. That’s a lot harder than grabbing the usual talking heads who say the usual things, it will require digging in and doing research, seeking out and talking to the real experts in the field, and understanding the issues before reporting on them. But unless things change, the public will continue to be ill-served by the press.
Halloween Special: Return of the Dead Proposal
In the link above Bush says he was advised not to talk about Social Security, but gosh darn it, he's going to talk about it anyway. He says the same thing in another speech a few days earlier, but adds the claim that he no longer has trouble with that "fuzzy math" stuff:
An issue that I've been talking about for quite a while is one that, oh, some said you probably shouldn't talk about. But I didn't come here not to deal with major problems. .... And the reason I've been talking about it is because I understand the mathematics of Social Security.
Do you think Bush will end up looking like a knight in shining armor defending Social Security's future despite the difficulties posed by a partisan congress and opposition from advisers, party members, pundits, and so on, or is this just another case of Bush ignoring good advice and forging ahead anyway?
Buteo Jamaicensis Bernakus
Bond Firms Say Bernanke Will Be a Fed Inflation Hawk (Update1), Bloomberg: Wall Street's biggest bond-trading firms say Ben Bernanke will be as zealous in fighting inflation as Alan Greenspan... ''Bernanke's nomination does not change our outlook,'' said Lewis Alexander, chief economist at Citigroup in New York. ''The Fed has been hardening its rhetoric in response to emerging inflation risks. They are not ready to pause.'' ... [A]ll the dealers surveyed said the central bank will raise the target rate to 4 percent from 3.75 percent... They also said the Fed will reiterate that it will continue to lift rates at a ''measured'' pace... The Federal Open Market Committee will meet again five more times before July. None of the dealers believe policy makers will lift rates at every one of those meetings, the survey shows. ... The following are the results of the survey, conducted from Oct. 25 to Oct. 28.
Drop Dec. 31 March 30 June 30 Firm Measured? Target Target Target ABN Amro No 4.25% 4.50% 5.00% BNP Paribas N/A 4.25% 4.25% 4.25% Banc of Amer No 4.25% 4.75% 4.75% Barclays Cap No 4.25% 4.75% 4.75% Bear Stearns No 4.25% 4.75% 5.00% CIBC World Mkts N/A 4.00% 4.00% 4.00% Citigroup No 4.25% 4.50% 4.50% Countrywide No 4.25% 4.50% 4.50% CSFB No 4.25% 4.50% 4.75% Daiwa No 4.00% 4.25% 4.50% Deutsche Bank No 4.25% 4.75% 4.75% Dresdner No 4.25% 4.50% 4.50% Goldman Sachs No 4.25% 4.75% 5.00% HSBC No 4.00% 4.00% 4.00% JPMorgan Chase No 4.25% 4.50% 4.50% Lehman Brothers No 4.25% 4.75% 4.75% Merrill Lynch No 4.25% 4.50% 4.50% Mizuho No 4.25% 4.25% 4.25% Morgan Stanley N/A 4.25% 4.50% 4.50% Nomura No 4.00% 4.25% 4.50% RBS Greenwich No 4.25% 4.75% 5.00% UBS Securities No 4.25% 4.25% 4.25%
Using Monetary Aggregates to Overcome Model and Data Uncertainty
Money in an uncertain World, by Professor Hermann Remsperger, Deutsche Bundesbank: Ladies and Gentleman, it is a pleasure for me to speak to you this evening on the role of money in an uncertain world. ... All the different types of uncertainty have been picked up by academic literature. ... I will focus on two of them, one is model uncertainty and the other data uncertainty. ... I would like to convey the key message of my talk without any further delay: The analysis of monetary aggregates can play and should play an important role to cope with these two challenges.
Model uncertainty and money As central bankers we need models to structure our thoughts and to estimate the impact of our decisions. However, there is no consensus about which model is ... appropriate... As a consequence, most central banks – including the ECB – use a wide range of models. ... I think that Ben McCallum is perfectly right in that the preferred policy rule should be one that works ‘reasonably well in a variety of plausible quantitative models’. By the way, this approach can also be applied to ... whether monetary policy decisions should be made by a committee or not: The variety of views ... should be larger in a committee. If the committee members agree on a decision that is acceptable for all of the different prevailing assumptions of the transmission mechanism, this could prevent monetary policy decisions which are optimal only in one specific model...
In order to determine ... a robust policy rule, we have to take two decisions: The first is on the set of models which should be taken into account. And the second is how to weigh the results these models present... As concerns the weighting problem, some argue that minimizing the maximum loss across models is appropriate. This would prevent extremely bad results. However, others argue that this method may give too much weight to implausible scenarios. ... The decision about which set of models to include in this decision process and which models to exclude also turns out to be highly important but difficult. The inclusion of an additional model, even if it has a low probability, may strongly influence the resulting decisions.
Concerning the models to be regarded in the decision making process, I think that at least one from the New-Keynesian school ... should be included. These models are designed to capture short-run fluctuations in output and inflation ... Depending on the exact model specification, money can play an explicit role in the determination of output and inflation. However, it usually plays only a passive role... Given this more or less unimportant role for money in New-Keynesian models, some observers already see money leaving the stage of the academic discussion on monetary policy. However, I think that a few qualifications are essential.
First of all, I would argue that there is an implicit key role for money in the basic New Keynesian Model. ... implementing a certain path of the short-term interest rate is only possible if the central bank can control the corresponding supply of base money. Second, taking New Keynesian Models with a minor role for money on board must not mean that we should leave aside other models with a key role for money. ... Models that capture this long-run relationship between monetary developments and inflation ... are ... the natural complements to models of short-run fluctuations in the toolbox of policy makers. ...
Data uncertainty and money ...I now want to make some comments on the role of money against the background of data uncertainty. One dimension of data uncertainty refers to the problem of measuring well-defined economic aggregates. ... monetary and financial data are far less affected by such measurement problems than data from the real economy. Monetary data are available very quickly. And they are available with a much smaller measurement error than other key variables. Therefore, money may serve as an important indicator of current economic activity. ... Measurement problems become even more severe if certain model variables are unobservable... Important examples include the output gap and the natural rate of interest. ... An empirical quantification of the output gap, for instance, is often based on more or less detailed assumptions about an underlying model structure. If ... policy ... depends crucially on such unobservable variables, errors in assessing the size of those variables may lead to large deviations from optimal policy. ...
Orphanides and others have shown that in the seventies and eighties, estimates of the US output gap have been subject to large and persistent measurement errors. On average, there has been a downward bias of this measure of economic activity which in turn led to a monetary policy of the Fed that - with hindsight - must be judged as too expansionary. As a consequence, the late 1970s and the early 1980s have been characterized by high inflation rates in the USA.
I believe that the Bundesbank managed to prevent this kind of problems. ...the Bundesbank did not assign an important role to the level of the output gap... Instead, we focused on deviations of money growth from target, on deviations of the inflation rate from the price norm and on deviations of the growth rate of real output from the growth rate of potential output. This approach is much less subject to measurement errors than one that uses the level of the output gap. Based on our previous research on “How the Bundesbank really conducted Monetary Policy” we have set up a new project on “Taylor Rules vs. Growth Rate Targeting” ... This follow-up project intends to answer the question whether, and if so why, responding to the inflation gap, to the change in the output gap and to monetary developments instead of putting a strong weight on the level of the output gap can be welfare improving in the presence of data uncertainty. ...
October 30, 2005
The Use of the Yield Curve as a Leading Indicator
The Yield Curve as a Leading Indicator, by Arturo Estrella, NY Fed: A broad literature originating in the late 1980s documents the empirical regularity that the slope of the yield curve is a reliable predictor of future real economic activity. Today, there exists a substantial body of evidence from which various useful stylized facts have emerged. This catalogue of some of the salient findings takes the form of answers to frequently asked questions. An extensive bibliography is also included. [FAQ Available in PDF] [Bibliography]
Frequently Asked Questions: Click on a question from the following list to go to the corresponding answer.
- What does the evidence say, in short?
- How and when were the relationships first identified?
- How long have these relationships existed, and do they still hold?
- Are formal models needed to extract the information content in the yield curve, or are there also rules of thumb?
- What statistical models have been formulated?
- Which interest rates to use: Treasuries, fed funds, Eurodollar, swap, corporate?
- What maturity combinations work best?
- Is it the level or the change in the spread that matters?
- Does it matter if changes are driven by the short or the long end?
- Is an inversion required for a signal?
- Does the signal have to be persistent?
- Is the evidence robust over time?
- How do binary models that predict recessions compare with models that forecast continuous dependent variables (e.g., real GDP, industrial production growth)?
- How does the yield curve compare with other indicators?
- How does the yield curve perform out of sample, and can it be supplemented with other indicators?
- How are predictions related to monetary policy?
- How are predictions related to market expectations of the economy?
- Is there causality from economic activity to the yield curve?
- Should we expect the predictive power of the term spread for real activity to persist?
Bernanke: Krugman is a Wonderful Scholar
Or perhaps we should take note that the Times didn’t give Bernanke an opportunity to go on the record about how he feels about having hired Krugman. We’ll use our imagination on that one.
No need to use our imagination, Bernanke is already on the record. As Brad DeLong says, let’s go to the tape:
Krugman came to Princeton from MIT and will teach both undergraduate and graduate courses in economics and the Wilson School, including ECO 102, according to economics department chair Ben Bernanke. "[Krugman] is a wonderful scholar, a great teacher and another star to add to our firmament," Bernanke said.
There’s not an economics department in the world that wouldn’t jump at the opportunity to have Krugman on the faculty.
There's Enough Froth for All of Us to Study
SciAm Observations: Not the Table of the Elements: People sometimes ask me, what is the value of particle physics? Why should we pay to build these huge accelerator installations? What practical benefit comes from it? And now I can tell them this: physicists have solved the wobbly table problem.
Do you always get the wobbly table at restaurants and cafes? Don't despair. A physicist has proved that, within reasonable limits, it is always possible to rotate the table to a position where all four legs stand solidly on the ground. Andre Martin was moved to study the problem because he was fed up with the wobbly tables at CERN ... in Geneva ... where he works on abstruse problems in high-energy physics. Anyone who drinks a cup of coffee on the terrace of the CERN cafeteria ... discovers that the tables usually have only three feet resting on the ground, so that the slightest touch spills your drink. Time after time, Martin would find himself rotating the table to look for a stable position. "I've always been able to find one," he says. "People are sometimes amazed that it works." More than ten years ago, Martin decided to see if he could find some proof that a stable state always exists. He believed that he'd found one ... in 1998, but ... discovered that ... it wasn't completely correct. Now Martin believes he has a more watertight case, and this time he has gone public. "I had the feeling that mathematicians were interested," he explains.
Nobel Committee, are you listening? This could qualify for either Physics or Peace, given all the aggravation this problem has caused.
The Opportunity Cost of Lost Opportunity
When Children Are Left Behind, the Economy Is, Too, by Hubert B. Herring, NY Times: ...[W]hat if our educational shortcomings could be put in strictly economic terms, instead of being part of a humanitarian debate? What, in short, does it cost the nation when a child drops out of high school? ... The answer is hundreds of billions of dollars. Looking at taxes alone, the researchers calculated that federal and state income tax receipts would be at least $50 billion higher each year if every high school dropout had graduated instead. And billions more are lost, the researchers figure, to added health costs and increased crime.
We are hiring a new Provost and I was at a meeting last week to decide on questions to ask the candidates. The registrar, admissions director, and others directly involved in the admissions process were at the meeting and access to education came up as a potential question area. This brought up a general discussion of the access issue and when you hear those on the front lines of the admission process describe the battles they go through to maintain access to higher education, the registrar was particularly passionate in his description of how things have changed during his long association with universities, you cannot help but be moved to action.
October 29, 2005
Oil Price Shocks and Inflation
Oil Price Shocks and Inflation, by Bharat Trehan, Research Adviser, SF Fed: Oil prices have risen sharply over the last year, leading to concerns that we could see a repeat of the 1970s, when rising oil prices were accompanied by severe recessions and surging inflation. ... This Letter ... argue[s] that oil shocks are sometimes assigned too large a role in the run-up in inflation during the 1970s because analysts tend to ignore the part played by inflation expectations and by monetary policy during this period. The implication is that the recent oil shock should not lead to as much inflation as the 1970s would suggest. Financial markets provide confirming evidence. ... there is little evidence to suggest that markets are expecting substantially higher inflation as a result of the run-up in oil prices since the beginning of the year. As discussed ..., this could be because the markets are expecting the Fed to respond vigorously to the run-up in oil prices. But a look at the fed funds futures markets reveals that markets are not expecting very large policy moves. ... Thus, financial market expectations do not appear to be out of line with the statistical analysis. Markets do not expect the recent substantial rise in oil prices to lead to a substantial increase in inflation, and they expect this result to occur without the kind of funds rate increases one saw in the 1970s...
Jim Hamilton is quoted making similar points. Alan Greenspan views the degree of pass through as an area of considerable uncertainty, but if this research holds up, it implies less pass through of oil shocks to core inflation than commonly assumed, and hence less need for tightening of interest rates to prevent an outbreak of inflation.
[Update: Brad DeLong comments.]
Is Bush Playing Pin the Social Security Tales on the Obstructionist Donkeys?
We ... have got to do something about Social Security and Medicare. As you know, I brought up the -- (applause.) They told me not to talk about it when I first got up here. (Laughter.) But I've been talking about it ever since I've been running for President and since I've been the President because I believe the job of a President is to confront problems and not pass them on to future Presidents and future Congresses. (Applause.) ... I'm going to continue to talk to the American people on this issue, and insist that Congress do the right thing and work together to save Social Security.
And here's John Snow:
Jon, from NY, NY writes: Why am I still left thinking there never was a social security crisis?
John Snow Well, Jon, that’s because the crisis is in the future – the President brought Social Security to the forefront of the Washington, DC policy agenda because there is a very serious looming crisis for the system. ... The problem you’ve heard so much about will begin as cash flows for the program turn negative in 2017, and the trust fund itself will be exhausted in 2041...
And this one is interesting:
daniel, from westport, ct writes: Can you tell me how much of the excess Social Security payroll taxes -- payroll taxes collected by the government but not spent on benefits -- have been spent on government operations in the past five fiscal years? And if Social Security is facing a crisis, why were those funds spent on government operations?
John Snow Thanks for this terrific question, Daniel. The total amount of Social Security surpluses that have been spent on other programs is at $1.7 trillion today. It’s a bad habit that government has, of borrowing money from the Social Security fund and writing itself “IOUs.” I think it’s time to put a stop to that, don’t you? That’s why the President wants to let younger workers put their Social Security dollars in personal accounts – the ultimate “lock box” for their hard-earned retirement dollars. We also need to make the program solvent. Progressive benefit growth, which would bring the program about 70 percent of the way to solvency, is another important element of the President’s proposed changes...
So is this an attempt at a revival? A resurrection of privatization? Habit persistence? An attempt to capture political gain by appearing concerned and unwilling to give up on the issue? That's my guess, that it's an attempt to capture political gain and revive the labeling of Democrats as obstructionists.
Note: Looking back at the last attempt at Social Security reform, how do you rate? If you are an orange state, the president visited you and gave a speech on Social Security:
The Economist: China's Risky Strategy for Financial Sector Reform
A great big banking gamble, The Economist: It is a staggering thought... At more than $66 billion following its initial public offering ... on October 27th, China Construction Bank (CCB) ... is the largest global flotation for four years, China's biggest and the biggest ever for a bank. ... This is quite a transformation for a bank that was technically insolvent less than two years ago and ... is still a government agency, plagued by bad debts and corruption... Beijing is encouraging this rush to market as the most fundamental step in reforming the economy since Deng Xiaoping opened China to the world in the late 1970s. Since then, the country's banks have been almost wholly responsible for channelling the population's sky-high savings into industry and investment. Given China's failure to develop healthy stock and bond markets, bank assets have ballooned ... Sadly the banks have been disastrous middlemen, lending on government instruction without a view to their profits. ... That is why overhauling its banks is so critical to securing the country's future growth. China's political leaders have an iron commitment to bank reform—a commitment backed with cash. ... Beijing realises ... that money alone will not do the trick. ... it has raised accounting, prudential and regulatory standards. ... The biggest change, though, has been the creation of a central regulator, the China Banking Regulatory Commission (CBRC)...
The restructuring has been helped by a benign environment. ... Strong revenue growth and offloading bad debts on to the government has inflated bank profitability. ... CCB looks much cleaner, ...has stronger reserves, .... Its listing prospectus says that loans to “new” customers ... are one-third as likely to go sour as those to older clients, suggesting regulations are working. ... Well, it would, if that were indeed ... true... Independent estimates put bad debts at 20-25%, far exceeding official figures. ... bad loans are rising, not falling ... If economic growth slows, a new wave of bad loans will hit. ... Chinese banks [do not have] the earnings power to absorb them... Two sobering conclusions follow. The first is that even a tiny deterioration in business conditions ... would wipe out earnings at China's banks. The second is that even if the economy remains good, the banks cannot generate enough internal capital to support their current levels of loan growth. ... To close that gap will take a fundamental transformation of how Chinese banks operate. The banks simply do not understand how to price risk or spot a dodgy borrower. Neither flexible interest rates nor loan classifications can help if credit officers cannot tell good loans from bad. The current boom has led loan officers to believe the value of collateral always goes up. The real battle for bank reform will be won or lost in the branches. ... These are massive organisations to turn around, after all. CCB alone has 14,250 branches and 304,000 employees. ...
Meanwhile, strategic foreign investors are supposed to bridge the gap—with money, but especially with skills in risk management and advanced financial products. ... given limited ownership rules, foreign banks can have only a modest influence on strategy or operations at their Chinese partners. ... To reform its banks properly, China must allow foreign takeovers. And its banks must be allowed to merge and fail. ... as banks in Poland and the Czech Republic discovered, preventing foreign takeovers simply delays bank reform and means more costly bail-outs. ... Instead, China is gambling on going it alone. By rushing poorly reformed banks to market and sucking in a bit of money and know-how ... from foreign investors, it hopes to improve them sufficiently and sufficiently rapidly before the economy runs into a headwind. The size of that gamble should not be underestimated.
Alice Rivlin is "Profoundly Worried" about the Policy Process
Former Fed Board vice chair: U.S. politics too polarized, by Peter Stevenson, Indiana Daily Student: A polarization of issues has caused inefficiency in American public policy, said a former vice chair of the Federal Reserve Board of Governors. ... "I am profoundly worried, even frightened, that our policy process will prove unequal to the task ahead," Rivlin said. "America appears polarized into non-communicating blocks that make us increasingly unable to engage in civil discourse" about important issues the government has to consider. Rivlin ... said ... the two major parties are not actually that far apart in ideology. She believes if politicians could get past the partisanship that is so prevalent in Washington, a lot more could be accomplished on major issues. ...
CBOT Fed Watch: Chance of 25 bps Rate Hike is 98%
CBOT Fed Watch: Based upon the October 28 market close, the CBOT 30-Day Federal Funds futures contract for the November 2005 expiration is currently pricing in a 98 percent probability that the FOMC will increase the target rate by at least 25 basis points from 3-3/4 percent to 4 percent at the FOMC meeting on November 1 (versus a 2 percent probability of no rate change). Summary:
October 25: 0% for No Change versus 100% for +25 bps. October 26: 2% for No Change versus 98% for +25 bps. October 27: 2% for No Change versus 98% for +25 bps. October 28: 2% for No Change versus 98% for +25 bps. October 31: 2% for No Change versus 98% for +25 bps. November 1: FOMC decision on federal funds target rate.
[Update: No change from 10/28 to 10/31. David Altig has more.]
October 28, 2005
Who Gets the Cookies?
Wages increased 2.3 percent in the third quarter from the same three months last year, the smallest year-over-year rise since record-keeping began in 1981... Total U.S. labor costs rose 0.8 percent in the third quarter after a 0.7 percent rise in the previous three months.
So the economic news is not unambiguously positive from labor's perspective.
Posted by Mark Thoma on Friday, October 28, 2005 at 09:26 AM in Economics
Greg Mankiw: Questions Bernanke Must Be Asking Himself
Questions for Ben Bernanke, by N. Gregory Mankiw, Commentary, WSJ: ...[S]enators and their staffs are busy compiling questions for Ben Bernanke. The most intriguing questions, however, are ... the questions that Mr. Bernanke must be contemplating quietly on this own. There should be no doubt in anyone's mind that Mr. Bernanke is superbly qualified for the job. I have known Ben for 20 years, and there is not a monetary economist alive who commands more respect among professional economists for his deep, broad intellect and rock-solid judgment. (OK, maybe Milton Friedman, but at the age of 93, he's probably not available.) ... Here are three questions he must be asking himself.
"How can I advance inflation targeting?" ...Mr. Bernanke has long advocated inflation targeting, under which a central bank sets a numerical target for the inflation rate. He will soon be in a position to put his monetary policy where his mouth is. This will not necessarily be easy. ... it is supported by many U.S. economists, but the support is not universal. Alan Greenspan has long been a skeptic. More importantly, so is Mr. Greenspan's close protégé Donald Kohn, who ... commands broad respect among the other members and the Fed staff. Some recent news reports have suggested that inflation targeting would mean a big change in policy from the Greenspan era. That is not right. Starting where we are today, a switch to inflation targeting is not so much a change in monetary policy as it is a change in the way the Fed communicates about monetary policy. ... As former Fed governor Laurence Meyer pointed out, anyone who doesn't know that Mr. Greenspan is aiming for a measured inflation rate of about 1% to 2% is just not paying attention. The evolution toward inflation targeting under Mr. Bernanke can, therefore, be very gradual. ...
"How broadly should I offer opinions?" Mr. Greenspan has not been shy, over the years, about expressing opinions on a broad range of economic issues. This proclivity has at times made some Fed staff cringe. The political independence of the Fed is among the institution's most basic values. Whenever the Fed chairman opines on a politically charged topic, he puts the Fed's independence at risk. It was created by Congress -- and it can be taken away by Congress. ... Mr. Bernanke must decide for himself how far he is willing to go. ... Here is my guess about what Mr. Bernanke will decide. He will be prepared to talk not only about monetary policy but also about issues related to financial stability, such as regulation of Fannie Mae. He will be willing to explain the views of professional economists when there is a consensus. ... But he will stay away from issues that are distant from monetary policy, controversial among economists and politically divisive. The repeal of the estate tax, for instance, is not an issue that the future Fed chairman is likely to comment on anytime soon.
"How high a profile should I adopt?" Alan Greenspan is a rock star, at least by the standards of the American Economic Association. ... Much of the general public may fail to understand how monetary policy functions, but they still know it is important -- and that Mr. Greenspan is the man. That is why the choice of his successor was anticipated so intensely. Yet the truth is that monetary policy is set not by a single person, but rather by a large committee supported by one of the most talented staffs of professional economists working in government. If the next Fed chairman accepts a lower public profile, the true nature of the Fed could be more widely appreciated -- and that would be a step in the right direction. Monetary policy is not so complex that we need an inscrutable wizard to do it well...
The most negative assessment I have ever heard about Ben Bernanke, from one of my colleagues, is that he is "a bit boring." For an economist, boring is an occupational hazard. For a central banker, however, it is just the ticket. The central bank's job is to create stability, not excitement. ...
Will Bernanke Speak Up?
Fed Nominee Says He Will Avoid Fray Of Politics, by Nell Henderson, Washington Post: Ben S. Bernanke urged Congress ... to reduce the federal deficit, cut government spending and make ... recent tax cuts permanent. Bernanke was speaking then on behalf of the president, as his top economic adviser... But was he also expressing his own views? ... Some lawmakers and interest groups quickly invoked Bernanke's recent comments in favor of extending the tax cuts as signs of the policy prescriptions he would offer as Fed chief. But Sen. Charles E. Schumer (D-N.Y.) said such assumptions are wrong. Bernanke assured Schumer ... he was speaking to the congressional committee as chairman of Bush's Council of Economic Advisers and that he hoped to avoid such policy debates during his confirmation process and at the Fed... Bernanke ... indicated that he would prefer to limit his future public comments mainly to Fed policy... "I told him he should rethink that," Schumer said. "I would encourage him to be a positive force for deficit reduction." ... Bernanke has said in the past that the Fed has a role in budget debates when the outcomes would affect the well-being of the national economy and financial markets. The Fed "has the responsibility to be a nonpartisan adviser on general matters of macroeconomic and financial stability," Bernanke said in a June 2004 interview published by the Fed bank of Minneapolis. "So to the extent that deficits and debt are threatening macroeconomic and financial stability, the central bank is one actor that can provide advice and counsel to the fiscal policymakers."
While that sounds reassuring, the qualifier "to the extent that deficits and debt are threatening macroeconomic and financial stability" is important. At what point does Bernanke believe the debt becomes threatening? My impression is that he does not believe the current debt level crosses that threshold. If so, where is his threshold? I also do not believe the Fed chair should be a "positive force for deficit reduction" per se. Deficits and fiscal policy should be discussed by the Fed chair only to the extent that they affect monetary policy. And finally, I'm not sure Bernanke's personal views are as important as implied in the article. When he says:
"the general approach of inflation targeting is fully consistent with any set of relative social weights on inflation and unemployment; the approach can be applied equally well by "inflation hawks," "growth hawks," and anyone in between."
The use of the term "relative social weights" is an indication of his recognition that the Fed is a steward of the public, business, and banking interests, not the personal interests of Ben Bernanke. For that reason, his personal views are less important than his views of how to best represent these interests using monetary policy and the Fed chair's pulpit.
Paul Krugman: New Fed Chairman Bernanke and the Bubble
Bernanke and the Bubble, by Paul Krugman, NY Times: ... Mr. Bernanke is actually an expert in monetary policy, as opposed to, say, Arabian horses.
And as noted here, Bernanke is not known to be partisan. Bernanke's colleagues at Princeton, and Krugman is one of them, knew very little about his politics:
Beyond that, Mr. Bernanke's partisanship, if it exists, is so low-key that his co-author on a textbook didn't know he was a registered Republican.
Should I be happy he has kept his politics to himself? What is it we don't know? Is he a very quiet raging ideologue?
The academic [work]... is apolitical. ... there's not a hint in his work of support for the right-wing supply-side doctrine. Nor is he a laissez-faire purist who believes that government governs best when it governs least. On the contrary, he's a policy activist who advocates aggressive government moves to jump-start stalled economies. For example, a few years back Mr. Bernanke called on Japan to show "Rooseveltian resolve" in fighting its long slump.
What about his allegiance to Bush? I'm worried about that. Bush appointed him as a Fed governor, as chair of the Council of Economic Advisers, and now the nomination to be Fed chair. Won't he owe Bush his allegiance?
...Mr. Bernanke has no personal ties to the Bush family. It's hard to imagine him doing something indictable to support his masters. It's even hard to imagine him doing what Mr. Greenspan did: throwing his prestige as Fed chairman behind irresponsible tax cuts.
Ben Bernanke was chair of the Princeton Economics Department when you were hired, so you know Bernanke pretty well. You've assured us he's qualified, apolitical, and independent. Sounds good. Should I stroll away confident in our economic future, or are there additional concerns?
This isn't a comment on Mr. Bernanke's qualifications, although there is one talent ... that Mr. Bernanke has yet to demonstrate ... Mr. Greenspan ... has repeatedly shown his ability to divine from fragmentary and sometimes contradictory data which way the economic wind is blowing. As an academic, Mr. Bernanke never had the occasion to make that kind of judgment. We'll just have to see whether he can develop an economic weather sense on the job.
Since I made the same point about Greenspan here, I'd have to agree. Let's hope Bernanke has this talent as well. But even if he does, you still seem concerned. Is it related to concerns about Bernanke's qualifications or abilities as Fed chair?
No, my main concern is that the economy may well face a day of reckoning soon after Mr. Bernanke takes office. And ... coping with that day of reckoning without some nasty shocks may be beyond anyone's talents. The fact is that the U.S. economy's growth over the past few years has depended on two unsustainable trends: a huge surge in house prices and a vast inflow of funds from Asia. Sooner or later, both trends will end, possibly abruptly.
But hasn't Bernanke said there is no housing bubble, and that the global savings glut explains the international trade imbalance and the dangers there aren't as large as many believe?
...Well, soothing words are expected from a Fed chairman. He must know that he may be wrong.
If he is wrong, what should he do? Does he have what it takes to handle such events?
If he is, the U.S. economy will find itself in need of the "Rooseveltian resolve" Mr. Bernanke advocated for Japan. We can safely predict that Mr. Bernanke will show that resolve. ...
It's reassuring to hear such praise for Bernanke. It sounds like monetary policy is in good hands.
But that may not be enough. When all is said and done, the Fed controls only one thing: the short-term interest rate. And it will be a long time before we have competent, public-spirited people controlling taxes, spending and other instruments of economic policy.
Update: Brad DeLong comments on Krugman.
The Variance of Output and Commodity Flows
In the figure, commodity flows appear to have less variability prior to 1984. This is noteworthy because since 1984, the volatility in output has been reduced considerably, by around 50% by some estimates. Yet according to this picture commodity flows have not realized a corresponding fall in variability, but have increased instead. This leads to the hypothesis that volatility on the output side has been traded for volatility on the input side. [Note: If you are interested in explanations for the decline in GDP volatility since 1984 such as good luck, good policy, and better technology (inventory management), a place to start is Ramey and Vine (2004).]
Posted by Mark Thoma on Friday, October 28, 2005 at 12:17 AM in Economics
October 27, 2005
Indifference to Restaurant Service
Me: The service in here is awful. This is making me really mad.
Son: Why? They're saving you money. Won't you just reduce the tip until you are indifferent?
I wanted a reason to be mad, not indifferent. I was hungry and pretty cranky, so I explained, curtly, how market failure in the food service industry made it so that reducing the tip would not fully compensate me for my losses. I was then told, in so many words:
Son: That's a dumb argument.
And it was. But don't tell him I admitted that. I did reduce the tip, and even though I didn't reduce it very much, I'd feel better now if I hadn't. I'll see if Mr. Smarty Pants can explain that.
Will the Fed Follow the Reserve Bank of New Zealand and Overshoot?
New Economist: RBNZ overshooting once again: New Zealand was the first central bank to introduce inflation targeting, so you would think they'd have got the hang of it by now. But no - even with Don Brash safely relegated to the Opposition benches, the Reserve Bank of New Zealand still manages to get it wrong. Today they raised the Official Cash Rate by another 25 basis points to 7.0%, the highest in the OECD (aside from Mexico). In today's statement Governor Bollard explained the rate hike thus:
...medium term inflation risks remain strong. Persistently buoyant housing activity and related consumption, higher oil prices and the risk of flow-through into inflation expectations, and a more expansionary fiscal policy are all of concern. While there has been a noticeable slowing in economic activity, and a particular weakening in the export sector, we have seen ongoing momentum in domestic demand and persistently tight capacity constraints. Hence, we remain concerned that inflation pressures are not abating sufficiently to achieve our medium term target, prompting us to raise the OCR today.
Bollard noted "the continuing strength of household spending, supported by a relentless housing market and rapid growth in mortgage lending", along with "a worsening current account deficit, now 8 per cent of GDP." For those hoping for some respite, he warned of "the prospect of further tightening" and added:
Certainly, we see no prospect of an easing in the foreseeable future if inflation is to be kept within the 1 per cent to 3 per cent target range on average over the medium term.
True, annual inflation is 3.4%, breaching the central bank's target band of 1%-3%. But the pick-up in inflation in large part reflects higher oil prices. The pace of economic growth has already slowed significantly, down from over 4% to around 2.5%, with June quarter private consumption growth the slowest in three years. Softer domestic demand will help ease medium-term inflation pressures. The RBNZ look like they are once again going to overshoot by raising rates more aggressively than they need to - just as inflation is peaking and the economy heads into sub-trend growth. Stephen Kirchner at Institutional Economics agrees...
There are those who worry that the Fed is on the measured path to the same mistake.
Grassley Gives Tax Reform Panel a Warning
Senior US Senator Foresees Opposition To Tax Panel Reform Proposals, by Mike Godfrey, Tax-News.com: Sen Charles Grassley (R - Iowa) has warned that the tax reform panel's recommendations on limiting mortgage and employer-provided healthcare tax breaks would make it "very difficult" for the Senate to pass a package of new legislation aimed at simplifying the US tax code. ... "When you start messing with sacred things like tax deductibility of health insurance and mortgage interest, particularly the latter, it's going to be very, very difficult to get that as part of a reform package," he stated. Grassley predicted that a tax reform package would be much more likely to be passed if these two provisions were dropped from the legislation.
The outlook for the proposal given in an editorial in the NY Times is grim:
The final report of President Bush's tax reform panel [is] due Tuesday... Popular discontent with advance word on its recommendations is sure to spook Congress into inaction in the coming election year, especially on proposals to limit the mortgage-interest deduction, abolish the deduction for state and local taxes, and reduce the write-off for employer-provided health insurance. ... That's fine with us. The panel's expected report deserves the death sentence that awaits it...
MarketWatch is equally grim with Dead on Arrival. There is the usual silliness from Senator DeMint:
Senators Plan Push To End Income Tax, by Meghan Clyne, NY Sun: Disappointed by the recommendations of President Bush's advisory panel on tax reform, Senator DeMint, a Republican of South Carolina, will introduce legislation this week that would replace America's tax code with a simpler, free-market alternative that would abolish personal and corporate income taxes in favor of a flat-rate levy on retail and business transactions. ... Under Mr. DeMint's plan, all personal income taxes and the attendant bevy of related taxes, deductions, and exemptions, including the estate tax and the alternative minimum tax, would be abolished. ... Instead, individuals would pay an 8.5% federal retail sales tax on all new goods and services. Corporate income taxes would be replaced by an 8.5% business transfer tax charged during purchases of supplies or equipment... the DeMint plan would harm certain sectors privileged by the current code, such as the home mortgage industry...
Echoes of Social Security. Here we go again.
President Gives Speech on His Economic Agenda
I encourage Congress to push the envelope when it comes to cutting spending. See, believe it or not, up here in Washington, there's a lot of programs that simply don't deliver results. (Laughter.) And if it doesn't deliver results, we ought to get rid of... the war on terror...
And the reason is:
That will help us meet our priorities ... helping the people down there in Katrina.
What about helping the people down there in Rita and Wilma too?
Greenspan on the Role of the Council of Economic Advisers
Receipt of the Truman Medal for Economic Policy, Remarks by Chairman Alan Greenspan, October 26, 2005: ...[P]art of Truman's importance derives from the fact that several key new governmental structures were established during his Administration. Among these were the Council of Economic Advisers (CEA) and the Joint Economic Committee of the Congress (JEC). These organizations were established by the Employment Act of 1946... Two ingredients seem to have been essential precursors of the Employment Act. The first was a deep concern that the problem of peacetime unemployment had not been solved. ...many feared that the economy would slip back into depression. The second element was the economic thinking of John Maynard Keynes. ... President Truman's memoirs make clear that both of these strands ... influenced his request to the Congress for full employment legislation in the fall of 1945. ... Early drafts of the Employment Act enshrined ... new processes and institutions, ... the CEA, the annual Economic Report of the President, and the JEC... The CEA consists of a chairman and two other members, ...Over the years, the CEA has provided objective and professional economic advice at the highest levels in the White House. ... A hallmark of the ethos of the CEA is the pride that its staff members take in providing objective analysis. ... Because the CEA has retained its small size over the years, it can be quick and nimble in ways that are difficult for some larger agencies. Moreover, because the CEA is viewed as a neutral agency without ties to any particular constituency, the CEA often has played an important role on interagency committees and working groups... Along those lines, perhaps the most important role of the CEA has been to scuttle many of the more adventuresome ideas that inevitably bubble up through the machinery of government. ... This role of the CEA is wholly unheralded--after all, who hears about the idea that never came to fruition--but it serves as an important check in the policymaking process. ... Of course, as chairman of the Council during President Ford's Administration, I was close to some of these debates and decisions. ...I began work at the CEA in September 1974. ... I found my time there quite rewarding, ... I will only highlight three themes that recurred during my tenure. First, economic modeling is as much art as science. ... Economic models provide a set of useful tools to frame future outcomes; but ... models can go off track in myriad ways. Objective and thorough analysis, as is the norm at the CEA, is the most effective counterweight to this challenge. Second, high-quality and timely data are crucial inputs to the process of making economic policy. ... Finally, as hard as this can be to achieve, economic policy should take the long view. Although pressures to use the government's tools of economic management to achieve one or another short-term aim are always present, the tools of government are, in fact, most appropriately used to create an environment in which private economic activity can flourish over the longer run...
What's left unstated, and the hard part of the statement at the end, is deciding what the "longer run" is, particularly in light of the long lags before monetary policy takes full effect. Obviously, the Fed cannot manage aggregate output hourly, daily, or even weekly. But what about monthly output? Quarterly? Annual? When there is a recession, a short-run event around the long-run trend the Fed, even Greenspan's Fed responds by lowering rates. Deciding whether an event is a short-term cyclical fluctuation of little concern to the Fed, or a medium term fluctuation that requires action is part of the art of policymaking Greenspan discusses. This task is made harder by having imperfect models of the economy and this explains his craving for more high-quality and timely data. Greenspan proved to be quite skilled at untangling more persistent fluctuations from more transitory ones and this is one reason for his success as Chair of the Fed.
October 26, 2005
Should FOMC Meetings be Televised?
Other possibilities for improved transparency may exist. Importantly, as we think about these, we should not simply take the view that more information is always better. Indeed, irrelevant or badly communicated information may create more noise than signal; and some types of information provision--an extreme example would be televising FOMC meetings--risk compromising the integrity and quality of the policymaking process itself. Rather, the key question should be whether the additional information will improve the public's understanding of the Fed's objectives, economic assessments, and analytical framework, thus allowing them to make better inferences about how monetary policy is likely to respond to future developments in the economy.
So he is not in favor of televising meetings, a sentiment repeated here in an interview with the Minneapolis Fed. I'm not as sure as he is that the public would be misled by listening in on the process. However, William Poole, president of the St. Louis Fed, agrees with Bernanke. He is also worried about misleading the public, but that is not his main worry since he believes only those who would understand the proceeding would be interested in tuning in. He has concerns about confidentiality issues, and he is also worried about how behavior changes when the cameras are watching, for instance the difficulty in talking about policy that might increase unemployment. I am not so sure. Hypotheticals can be clearly elucidated, and if the merits of a particlar policy proposal cannot be articulated publicly in an understandable manner, perhaps it needs to be thought through again. Wouldn't forcing people to tighten up their arguments due to increased public scrutiny be helpful?:
Consider the possibility of televising FOMC meetings, so all can observe the proceedings. One issue is the mismatch between the technical level of the meeting and the knowledge of the audience. ... Monetary policy needs to be conducted at the highest possible technical level; a general audience is more likely to be confused than enlightened by watching an FOMC meeting live. Most viewers would get little out of watching a discussion of technical econometric issues ... and might well misinterpret such discussion. Perhaps we shouldn't worry too much about this issue, as the audience for an FOMC meeting would probably be pretty small after a few such episodes. I do not think we would compete very successfully with daytime television! Of course, a televised FOMC meeting ... could not include discussion of information obtained under pledge of confidentiality. Information from individual firms does play a useful role in policymaking, and the Fed could not obtain such information without maintaining its confidentiality. Moreover, there is ample evidence that people in televised meetings behave differently ... Some participants might have a tendency to grandstand for the audience, and to avoid discussing difficult or controversial issues. ... It is particularly difficult to analyze unpleasant possibilities in public, such as that a particular policy action might have the effect of increasing the risk of recession. ... During the time I’ve been in St. Louis, my impression is that FOMC deliberations are extremely open and that issues are thoroughly explored. I do not think that disclosing the transcript with a five-year lag inhibits my discussion, and believe that to be the case for most other members as well. I also believe that the transcript provides a valuable record for scholars and I strongly support the current system of releasing lightly edited transcripts. ... The current system of releasing the FOMC transcript with a five-year lag works well.
I am sold on the confidentiality argument, but remain skeptical that the public cannot digest the information properly or that the behavioral changes televising the proceedings would have on participants are unambiguously negative. Following the lead on the transcripts, a "lightly edited" video of the meetings released as soon as possible after FOMC meetings could address confidentiality issues, so that objection seems manageable as well. But I suspect I will be the cheese that stands alone on this one and that most will feel the negatives of televising the proceedings outweigh the positives.
Ben Bernanke: We Cannot Practice Safe Popping
What about another concern regarding monetary policy recently, asset bubbles? Will Bernanke change the Fed's current view that managing asset prices is outside of its purview? This statement from an American Economics Review Papers and Proceedings volume from 2001 should help to clarify Bernanke's position:
Should Central Banks Respond to Movements in Asset Prices?, by Ben S. Bernanke and Mark Gertler: ...The inflation-targeting approach gives a specific answer to the question of how central bankers should respond to asset prices: Changes in asset prices should affect monetary policy only to the extent that they affect the central bank’s forecast of inflation. ... In use now for about a decade, inflation targeting has generally performed well in practice. However, so far this approach has not often been stress-tested by large swings in asset prices. [Author web page versions here and here.]
The stress testing he mentions, an indication his view on is not yet etched in stone, is now being performed and his hand will soon be on a key lever in the process, interest rates. But this doesn't explain why the Fed shouldn't respond. For more on that, here's a 2002 Fed speech from Bernanke. Once again, we see that his mind is not entirely made up on this issue, but he is persuaded by arguments that bubbles cannot be reliably identified in time to prevent them, and even if they could, monetary policy is too blunt an instrument to use if the intent is to prick individual bubbles:
Asset-Price "Bubbles" and Monetary Policy, by Ben Bernanke: ... My talk today will address a contentious issue, summarized by the following pair of questions: Can the Federal Reserve ... reliably identify "bubbles" in the prices of some classes of assets, such as equities and real estate? And, if it can, what if anything should it do about them? ... My suggested framework for Fed policy regarding asset-market instability can be summarized by the adage, Use the right tool for the job. ... The Fed ... has two broad sets of policy tools: It makes monetary policy, which today we think of primarily in terms of ... setting ... the federal funds rate. And, second, the Fed has a range of powers with respect to financial institutions, including rule-making powers, supervisory oversight, and a lender-of-last resort function ... The first part of the prescription implies that the Fed should use monetary policy to target the economy, not ... asset markets. ... [F]or the Fed to be an "arbiter of security speculation or values" is neither desirable nor feasible. ... The second part of my prescription is for the Fed to use its regulatory, supervisory, and lender-of-last-resort powers to protect and defend the financial system.
...[T]he framework just articulated is not universally accepted ... And, in my opinion, the theoretical arguments that have been made for the lean-against-the-bubble strategy are not entirely without merit. ... If we could accurately and painlessly rid asset markets of bubbles, of course we would want to do so. But ... the Fed cannot reliably identify bubbles in asset prices. ... [and] even if it could identify bubbles, monetary policy is far too blunt a tool for effective use against them. ... As a matter of logic, the fact that bubbles are difficult to identify with precision does not necessarily justify ignoring potential ones ..: Even if we can measure bubbles only imprecisely, is the optimal response of monetary policy to a perceived bubble literally zero? Shouldn't there be at least a bit of response, for "insurance" purposes? ... [But] Is it plausible that an increase of ½ percentage point in short-term interest rates, unaccompanied by any significant slowdown in the broader economy, will induce speculators to think twice about their equity investments? ... Although neither I nor anyone else knows for sure, my suspicion is that bubbles can normally be arrested only by an increase in interest rates sharp enough to materially slow the whole economy. In short, we cannot practice "safe popping," at least not with the blunt tool of monetary policy. ... One might as well try to perform brain surgery with a sledgehammer. ...
A far better approach, I believe, is to use micro-level policies to reduce the incidence of bubbles and to protect the financial system against their effects. I have already mentioned a variety of possible measures, including supervisory action to ensure capital adequacy in the banking system, stress-testing of portfolios, increased transparency in accounting and disclosure practices, improved financial literacy, greater care in the process of financial liberalization, and a willingness to play the role of lender of last resort when needed...
Things could change in the future under Bernanke as new ideas and new research on the Fed's role in managing asset price bubbles comes to light, but I don’t expect much, if any change in the Fed's hands-off policy regarding asset price management, and if there is change, it won't be immediate. One final note. I was struck in reading this speech how similar it is to very recent discussions emanating from FedSpeak on this issue, an indication of the influence Bernanke has within the Federal Reserve.
[Update: The Washington Post discusses this here.]
Robert Samuelson: Ben Bernanke is a Dedicated Inflation Fighter
The New Fed Chief Will Protect Us From Inflation By Robet J. Samuelson, The Washington Post (WSJ version used here): We have all the telltale signs of an inflation breakout: a big jump in oil and energy prices ... a low unemployment rate ... To anyone old enough to remember, the situation seems eerily reminiscent of the 1970s, when ... inflation reached peaks of 12.3% in 1974 and 13.3% in 1979. Well, folks, it ain't gonna happen this time. Here are three reasons: (1) The Federal Reserve won't let it happen -- and the nomination of Ben Bernanke to succeed Alan Greenspan as Fed chairman won't change that. The Fed would tolerate a recession before again permitting inflation to go bonkers. (2) The U.S. economy has become vastly more competitive since the 1970s. It's harder for companies to raise prices, because they face imports or low-cost domestic rivals. (3) Productivity has also improved since the 1970s, helping companies absorb some cost increases without raising their prices...
It's true that ... recent inflation news ... has been abysmal. .... But the overwhelming cause was the explosion of energy prices, not a general rise of most prices. Economist James Hamilton of the University of California at San Diego cites this revealing fact: even if no prices outside energy had increased, the CPI would still have risen 2.7%. ... "People make a mistake when they attribute inflation (mainly) to oil prices," says Mr. Hamilton. "It was what the Federal Reserve was doing before the oil shocks that made for inflation." What the Fed was doing was following easy money and credit policies. Countless economists, left and right, have concluded that oil prices were not the principal inflation culprit. The great continuity between Messrs. Greenspan and Bernanke is that both accept this basic analysis. ... The Fed's first job ... is to restrain inflation, because almost everything else depends on it. Probably most economists now believe this, but much of the public still clings to the myth that high oil prices caused high inflation. It's apparently indestructible. The truth is that the high inflation of the 1970s was mostly self-inflicted: the consequence of bad economic ideas. What prompted the Fed to follow easy-money policies was the belief -- then dominant among economists -- that there is a stable "trade off" between inflation and unemployment. In effect, you could juice the economy, and you'd get a big drop in unemployment and a slight rise in inflation. It seemed like a good deal. But the theoretical bargain didn't work in practice. ... Under Mr. Greenspan, the Fed buttressed its credibility by raising interest rates when necessary to suppress inflation, even at the risk of a short-term recession. The last thing Mr. Bernanke wants is to squander this hard-won reputation.
China's Growing Environmental Problems
Living Hand to Mouth, by Thomas L. Friedman, New York Times: ...Not only is China not a communist country anymore, but it may also now be the world's most capitalist country in terms of raw energy. ... But can anything stop Chinese capitalism? Yes, Chinese capitalism. Other than political breakdown, the biggest threat to China's growth is now the environment. ... China's leaders know this and have been taking steps to reverse deforestation and find alternatives to the coal-powered electricity plants ... But ... the legitimacy of the ruling Communist Party rests largely on its ability to keep raising living standards, it can't afford a recession ... officials will always choose raw growth. ... Tighter regulation alone won't save China's environment, or the world's. Since logging in most natural forests was banned here in 1998, China's appetite for imported wood has led to stripped forests in Russia, Africa, Burma and Brazil. China outsourced its environmental degradation. That is why you need an integrated solution. ... to produce a more sustainable form of development - so China can create a model for itself and others on how to do more things with less stuff and fewer emissions. That is the economic, environmental and national security issue of our day...
Whose Health is Wal-Mart Looking Out For?
Wal-Mart Memo Suggests Ways to Cut Employee Benefit Costs, by Steven Greenhouse and Michael Barbaro, NY Times: An internal memo sent to Wal-Mart's board of directors proposes numerous ways to hold down spending on health care and other benefits while seeking to minimize damage to the retailer's reputation. Among the recommendations are hiring more part-time workers and discouraging unhealthy people from working at Wal-Mart. ... the memorandum ... also recommends reducing 401(k) contributions and wooing younger, and presumably healthier, workers by offering education benefits. The memo voices concern that workers with seven years' seniority earn more than workers with one year's seniority, but are no more productive. To discourage unhealthy job applicants, [the memo] suggests that Wal-Mart arrange for "all jobs to include some physical activity (e.g., all cashiers do some cart-gathering)." ... The memo ... said that three top Wal-Mart officials ... had "received the recommendations enthusiastically." ... The memo noted, "The least healthy, least productive associates are more satisfied with their benefits than other segments and are interested in longer careers with Wal-Mart." ... "It will be far easier to attract and retain a healthier work force than it will be to change behavior in an existing one," the memo said. "These moves would also dissuade unhealthy people from coming to work at Wal-Mart." ...
So it appears this is about image, not worker health. Memo to self. Next time Wal-Mart does something that appears benevolent to its workers on the surface, look beneath the surface and ask why.
October 25, 2005
Will the Transparent Fed Open the Drapes a Little More?
Transparency Wins, Fed Leaks Lose, With Bernanke, Caroline Baum, Bloomberg: There were no fireworks in the financial markets yesterday, the way there were when Paul Volcker announced he was stepping down ... President George W. Bush's announcement yesterday that he was nominating former Fed governor Ben Bernanke ... to succeed Greenspan created no such jitters. Look how far we've come! Central banking has evolved ... to the point that investors understand that the institution is larger than any one person ... There will be some obvious changes at the Bernanke Fed --none of which will be quick as policy innovation moves at a glacial pace. What won't change is the central bank's commitment to price stability. "Ben has said that there is no inconsistency in the Fed's dual mandate'' of maximum sustainable economic growth and price stability, says Frederic Mishkin, professor of banking and finance at Columbia University's Graduate School of Business and a former research director at the New York Fed. Mishkin ... says there will be more "open discussion'' at the Fed ... "Ben is a listener and will build consensus,'' ... Unlike Greenspan, who resisted an explicit inflation target and ... Bernanke is likely to advance the cause and communicate clearly, Mishkin says. ...
There is something to be said for a rules-based policy as opposed to Greenspan's seat-of-the-pants approach, no matter how well one thinks it succeeded. If the central bank is precise about its goals, offering up a numerical inflation target ... takes the guesswork out of what constitutes price stability, which inflation measure expresses it best and how many exclusions (food and energy?) are legitimate. Just because a central bank has an explicit inflation target doesn't mean it has a playbook on how to achieve it. "An inflation target doesn't tell you how to set the policy instrument,'' Mishkin says, referring to the overnight federal funds rate...
In 2003, ... Bernanke advocated using forward- looking language to bring long-term rates down. His willingness to use verbal guidance ... suggests the prospective language included in the statement released following Fed meetings will remain for now. Two ... differences come to mind in contemplating how the Fed would differ under Bernanke. His focus on transparency suggests Greenspan's anointed Fed reporters may be out of luck, at least in terms of printing comments from unnamed Fed officials. It would be out of character for him to disseminate information in a way that opens the door to questions of who actually said and meant what. Second, Bernanke is apt to restrict himself to comments on monetary policy. He appeared uncomfortable enough commenting on the monthly employment report to the TV audience in his role as chairman of the President's Council of Economic Advisers. He's not likely to advocate or criticize specific fiscal policies (tax cuts, for instance) in his job as Fed chairman, other than to remind his congressional inquisitors that they need to put their house in order. In return, let's hope they stay out of his.
Yes, let's hope they do. But I do hope Bernanke will speak out when other parts of government take actions that have the potential to feedback upon and affect monetary policy.
Bernanke on Interest Rates, Monetary Aggregates, and How Monetary Policy Impacts the Economy
At the time the paper is published, there is a fairly active debate among those studying monetary policy concerning how to correctly measure monetary policy shocks, a debate that continues today. The traditional measures are derived from monetary aggregates such as M1, M2, the monetary base, and reserves, but interest rates such as the T-Bill rate and the federal funds rate, and interest rate spreads such as long-short spreads and the spread between the T-bill rate and the commercial paper rate are beginning to gain favor on both theoretical and empirical grounds. This table helped to push the profession away from aggregates and towards interest rates and interest rate spreads, with this paper pushing towards the federal funds rate in particular. This table asks a simple question using a model known as a vector autoregression or VAR model to ask it. The question is how well each of the monetary aggregate and interest rate variables listed at the top of the table predict macroeconomic variables of interest listed on the left-hand side.
The table shows that the federal funds rate predicts the variables listed in the table better than the other variables such as M1, M2, the three month T-Bill rate, and the 10 year government bond rate, and it is more robust to the sample period than other variables on the list such as the T-Bill rate which does better prior to 1980 than after. There is one interesting line on the table. Housing starts is the only variable examined that does not appear to respond to changes in the federal funds rate.
Because of this table, and many more additional tables in the paper (which also examine interest rate spreads), and because of other papers like this one, the weight of the evidence began to shift towards the use of interest rates and away from monetary aggregates. I should add that the evidence in the paper is not just empirical, there is also a theoretical argument made for the use of interest rates rather than monetary aggregates to measure monetary policy shocks.
Another aspect of the paper is an argument that a credit channel for the transmission of monetary shocks exists. Let's start with this graph from the paper:
This graph shows how the unemployment rate and the bank balance sheet variables deposits, securities, and loans move over time in response to change in the federal funds rate. Under the standard transmission mechanism, the tightening of money reduces bank reserves and lowers bank deposits through the familiar multiple deposit contraction process. In addition, as expected, bank assets also fall which is initially reflected by the fall in securities. However, over time, securities begin to recover and bank loans, a different bank asset, begin to fall instead and after 24 months the change is reflected almost entirely in loans rather than securities.
The fall in loans corresponds fairly well to the rise in the unemployment rate. This then, to Bernanke and Blinder, gives credence to the credit view over the money view in explaining how money impacts the economy. Why? Under the money view, it is the change in deposits and the corresponding changes in interest rates from the fall in liquidity that drive the fall in output after a contraction. Under the credit view, it is the reduction in reserves causing loans to dry up that generates the negative impact on the aggregate economy. This paper argues strongly for the existence of a credit channel as an alternative means by which changes in bank reserves brought about by monetary policy can affect variables such as output and employment.
Will the Bernanke Fed Retain Its Inflation Fighting Credentials?
However, a crucial proviso is that, in conducting stabilization policy, the central bank must also maintain a strong commitment to keeping inflation--and, hence, public expectations of inflation--firmly under control.
Although constrained discretion acknowledges the crucial role that monetary policy plays in stabilizing the real economy, this policy framework does place heavy weight on the proposition that maintenance of low and stable inflation is a key element--perhaps I should say the key element--of successful monetary policy.
I gave the Great Inflation of the 1970s in the United States as an example of what can happen when inflation expectations are not well anchored. ... Even today conventional wisdom ascribes this unexpected outcome to the oil price shocks of the 1970s. Though increases in oil prices were certainly adverse factors, poor monetary policies in the second half of the 1960s and in the 1970s both facilitated the rise in oil prices themselves and substantially exacerbated their effects on the economy. Monetary policy contributed to the oil price increases in the first place by creating an inflationary environment in which excess nominal demand existed for a wide range of goods and services. ... Without these general inflationary pressures, it is unlikely that the oil producers would have been able to make the large increases in oil prices "stick" for any length of time.
...The upshot is that the deep 1973-75 recession was caused only in part by increases in oil prices per se. An equally important source of the recession was several years of overexpansionary monetary policy that squandered the Fed's credibility regarding inflation, with the ultimate result that the economic impact of the oil producers' actions was significantly larger than it had to be. Instability in both prices and the real economy continued for the rest of the decade, until the Fed under Chairman Paul Volcker re-established the Fed's credibility with the painful disinflationary episode of 1980-82. This latter episode and its enormous costs should also be chalked up to the failure to keep inflation and inflation expectations low and stable.
Of course, as has often been pointed out, actions speak louder than words; and declarations by the central bank will have modest and diminishing value if they are not clear, coherent, and--most important--credible, in the sense of being consistently backed up by action...
And here are his misconceptions about inflation targeting from the same speech (the Bernanke and Mishkin 1997 paper he mentions is here):
Misconception #1: Inflation targeting involves mechanical, rule-like policymaking. As Rick Mishkin and I emphasized in ...Bernanke and Mishkin, 1997..., inflation targeting is a policy framework, not a rule. ... Inflation targeting provides one particular coherent framework for thinking about monetary policy choices which, importantly, lets the public in on the conversation. ... monetary policy under inflation targeting requires as much insight and judgment as under any policy framework; indeed, inflation targeting can be particularly demanding in that it requires policymakers to give careful, fact-based, and analytical explanations of their actions to the public.
Misconception #2: Inflation targeting focuses exclusively on control of inflation and ignores output and employment objectives. Several authors have made the distinction between ... "strict" inflation targeting, in which the only objective of the central bank is price stability, and "flexible" inflation targeting, which allows attention to output and employment as well. ... For quite a few years now, however, strict inflation targeting has been without significant practical relevance. In particular, I am not aware of any real-world central bank (the language of its mandate notwithstanding) that does not treat the stabilization of employment and output as an important policy objective. To use the wonderful phrase coined by Mervyn King, the Governor-designate of the inflation-targeting Bank of England, there are no "inflation nutters" heading major central banks. Moreover, virtually all (I am tempted to say "all") recent research on inflation targeting takes for granted that stabilization of output and employment is an important policy objective of the central bank...
A second, more serious, issue is the relative weight, or ranking, of inflation and ... the output gap... among the central bank's objectives. ... As an extensive academic literature shows, ... the general approach of inflation targeting is fully consistent with any set of relative social weights on inflation and unemployment; the approach can be applied equally well by "inflation hawks," "growth hawks," and anyone in between. What I find particularly appealing..., which is the heart of the inflation-targeting approach, is the possibility of using it to get better results in terms of both inflation and employment. Personally, ... I would not be interested in the inflation-targeting approach if I didn't think it was the best available technology for achieving both sets of policy objectives.
Misconception #3: Inflation targeting is inconsistent with the central bank's obligation to maintain financial stability. ...The most important single reason for the founding of the Federal Reserve was the desire of the Congress to increase the stability of American financial markets, and the Fed continues to regard ensuring financial stability as a critical responsibility... I have always taken it to be a bedrock principle that when the stability or very functioning of financial markets is threatened, ... the Federal Reserve would take a leadership role in protecting the integrity of the system...
And this may be of interest:
Given the Fed's strong performance in recent years, would there be any gains in moving further down the road toward inflation targeting? ... I believe that U.S. monetary policy would be better in the long run if the Fed chose to make its policy framework somewhat more explicit. ... To move substantially further in the direction of inflation targeting, ... the Fed would have to take two principal steps: first, to quantify (numerically, and in terms of a specific price index) what the Federal Open Market Committee means by "price stability", and second, to publish regular medium-term projections or forecasts of the economic outlook...
October 24, 2005
Nomination for Next Fed Chair: Ben Bernanke
Personally, I am pleased with this nomination. Here is one reason I'm encouraged:
Fed Official Moves Up and Into Politics, by Edmund L. Andrews, New York Times: ...Mr. Bernanke built a sterling reputation while at Princeton, and has won widespread praise for his cogent analyses while at the Fed. But he has studiously avoided partisan political issues, at least in public. He has said little about issues at the top of Mr. Bush's agenda, like Social Security and tax cuts, and his economic writing betrays few hints of political ideology. "If you read anything he's written, you can't figure out which political party he's associated with," said Mark L. Gertler, a professor of economics at New York University who has written more than a dozen papers with Mr. Bernanke. Mr. Gertler, who said he did not know his close friend's political affiliation until relatively recently, added: "He's not ideological. I could imagine Ben working with economists in the Clinton administration." Alan S. Blinder, a longtime colleague at Princeton who has advised numerous Democratic presidential candidates, also said he had worked alongside Mr. Bernanke for years without having any sense of his political views. "We wrote articles together and sat at the same lunch table thousands of times before I knew he was a Republican," Mr. Blinder recalled. "We never talked politics." Mr. Bernanke enjoys enormous credibility among economists in academia as well as on Wall Street - an advantage for him that may also pay off for Mr. Bush.
I do not believe Bernanke will politicize the job as much as Greenspan did. My worry is the opposite, that he will not speak forcefully enough on issues such as the budget deficit that impact monetary policy. The credibility he has on Wall Street mentioned in the article is important and I don't imagine this upsetting markets. His credibility in the academic world is at least as strong, another factor working in his favor from my perspective.
How will Bernanke differ from Greenspan? First, Bernanke is a much stronger advocate of inflation targeting than Greenspan (see his Journal of Economic Perspectives paper with Frederic Mishkin on this topic, free link from author web page). Second Bernanke is more likely to push for a publicly announced inflation target. Third, Bernanke is an advocate of Fed transparency and though large movements in this direction have already occurred, with this nomination I expect there to be even more transparency in the future. Thus, under the familiar rules versus discretion debate (here too), Bernanke is closer to the rules side than Greenspan.
Who will oppose Bernanke? The strongest statement against him is this tirade by John Tamny from the NRO. As noted in the write-up on Tamny's statement and by Brad Delong, Tamny's arguments have little validity. The piece seems to have been motivated by Bernanke's refusal to drop solvency as part of Social Security reform.
The speculation isn't over as this brings up more questions. Who will be the next chair of the CEA? Who will fill the other open seat on the Federal Reserve Board of Governors?
[Update: Link to WSJ econolog. A large number of blogs talk about Bernanke. Econbrowser, William Polley, New Economist, Calculated Risk, Glittering Eye, and the trackbacks here link to most of them. Prestopundit has links as well, and casts a dissenting vote. I just know I missed someone I should have included...]
Is Greenspan Responsible for China's Asset Bubble?
Greenspan Visits Scene of Fed's China Crime, William Pesek Jr., Bloomberg: To show he means business on China opening its economy, U.S. Treasury Secretary John Snow recently had a powerful prop on hand: Alan Greenspan. While the Federal Reserve chairman retains an almost godlike aura in Asia... Greenspan's presence in China last week didn't help the White House... In fact, Snow seemed to retreat from his campaign to force China to let the yuan rise. ... The trip did offer the Fed chairman a chance to visit the scene of what history may show to be one of his biggest blunders: China's asset bubble. ... It may seem a reach to blame Greenspan and the Fed for irrational exuberance in markets like Shanghai real estate. Yet globalization has globalized the Fed. While it has 12 districts in the U.S., its influence has never been greater. Think of Latin America as the 13th district, Southeast Asia the 14th, Russia the 15th, China the 16th, and so on. The Fed's policy of keeping interest rates low in the first half of this decade fueled ... a cheap capital-fueled investment boom in China. ... The trend has manifested itself in a variety of ways, including fueling a surge in the use of derivatives. ... The upshot may be untold amounts of leverage and risk in a global financial system... And for that, Greenspan's easy-money policies bear some blame. ... Greenspan probably isn't preoccupied with China's liquidity excesses. It's doubtful he'd even acknowledge a relationship between Fed polices and China's challenges, given how artfully he's sidestepped responsibility for excesses in U.S. stocks, housing and Treasury yields in recent years...
I agree this trip was no success from the administration's perspective. However, global excess liquidity caused by Fed policy is not the reason for China's asset bubble and since the premise is unacceptable, it's difficult to pin the result on Greenspan. As has been discussed thoroughly here and elsewhere, the global excess liquidity hypothesis finds very little support as a primary foundation for explaining low world interest rates. Let me first turn to Brad DeLong, then David Altig. Both Brad and David have links to further discussion on this issue. Here's Brad:
Brad Delong: Global Excess Liquidity?: I don't understand the argument that even though inflation is not accelerating, the world nevertheless suffers from "global excess liquidity" ... What happened was not a rise in savings, but a fall in investment as first the collapse of the dot-com bubble and then 9/11 increased uncertainty and diminished businesses' willingness to undertake risky investments. ... In response, the Federal Reserve (and other central banks) shifted to easy money... Are interest rates now "too low"? The usual answer is that interest rates are too low when inflation is accelerating. As long as inflation is stable, that means that the supply of goods and services is roughly equal to the demand for goods and services ... Inflation is roughly stable...
And here's David Altig:
David Altig: Global Dollar Demand And The U.S. Housing Market: ...This is ... a variation on a theme I have emphasized in the past: The "interest rate conundrum", ...[is] fundamentally driven by the desire of foreigners to send their financial capital to the United States. .... Several of my fellow bloggers -- Brad DeLong, pgl, William Polley, and Mark Thoma -- commented on an article appearing a few weeks back in The Economist, suggesting that an explanation that hinging on excess creation of liquidity. Several of these commentators were skeptical about The Economist's position. Count me in on that. Although this will seem hopelessly old-fashioned, here is the recent record on money creation in the United States ... Broad money growth in the 4-6 percent range with nominal GDP growing at a 5-6 percent annual rate just doesn't spell excess liquidity to me. ...
The article is remarkably silent, just a few words, on China's policy of fixing exchange rates. It also does not cite the usual reason for given for excessive risk taking, misperceptions of risk due to an unusually high degree of stability in financial markets in recent years. Even if the Fed had created China's asset bubble, it would only be concerned to the extent that it might feedback onto the domestic economy. There are twelve Fed districts. Period. There may be reasons to criticize Greenspan, but creating China's asset bubble is not among them.
Always Low Priced Healthcare. Always.
Wal-Mart to Expand Health Plan for Workers, by Michael Barbaro, NY Times: Wal-Mart ... is introducing a cheaper health insurance plan, with monthly premiums as low as $11, that the company hopes will greatly increase the number of its employees who can afford coverage. ... The new benefits, which Wal-Mart calls the Value Plan, follow years of complaints that at ... the nation's largest employer, health insurance is out of reach for many of its 1.2 million workers... forcing thousands of them to turn to state-sponsored programs or forgo health coverage altogether. "We are lowering the costs to make health insurance more affordable," said a Wal-Mart spokesman, Dan Fogleman, ... Asked if the new insurance plan was in response to growing criticism, he said, "It's fair to say we are listening, but more so to our associates than anyone else." Health insurance specialists generally praised the new plan, saying its lower premiums were likely to attract more employees and thereby reduce the ranks of the uninsured. ... Currently, fewer than half of Wal-Mart's workers are covered by company health insurance, compared with more than 80 percent at Costco, its leading competitor. ...
Several health insurance specialists questioned whether the company, which is working to burnish its public image, was trying to quickly increase the number of workers who use its health insurance at the expense of the coverage's quality. "Is it the greatest health care plan in the world? Probably not," said Howard Berliner, a professor of health policy at the New School for Social Research. "But my concern is getting people health insurance so they can get health care when they need it. In that sense, anything that speeds that goal is for the better." Uwe E. Reinhardt, a health economist at Princeton University, said that by allowing workers several visits to the doctor before requiring them to pay out of pocket, Wal-Mart had "removed a big financial barrier between doctors and patients," adding that critics "would have trouble attacking this plan."
But analysts cautioned that the new insurance plan would prove a better fit for workers who are young and healthy ... A 60-year-old Wal-Mart employee ... might visit a doctor three times in a one month and then need to pay $1,000 before the company would share the cost of care. Given that many ... employees are paid less than $19,000 a year, the deductible "is pretty significant," ... Tracy Sefl, a spokeswoman for Wal-Mart Watch, ... said that "a plan that is characterized as a healthy person's plan doesn't fully address the needs of a majority of their work force." ... Even as they commended Wal-Mart for offering a more affordable health insurance plan, some industry watchers expressed surprise that the company waited as long as it did to offer a more affordable option...
My hope is that this will attract high quality workers to Wal-Mart, so much so that the increase in productivity more than compensates for the cost of the plan giving Wal-Mart a further competitive advantage and forcing other companies to offer their own slightly more attractive healthcare programs. As the article notes, Costco covers 80% of its employees, but Wal-Mart covers less than half, so Wal-Mart is playing catch up with this move. But it's likely just that, a hope, and I'm not ready to wait for the private sector to solve this one. It hasn't so far. As Keynes notes in another setting, "In the long-run, we are all dead." Yes, but hopefully not from preventable causes.
The Location of Auto Supplier Plants
Click to see larger image
In addition, see econbrowser for more on the auto industry.
October 23, 2005
Classic Liberalism in the Twenty-First Century
Environmental Economics: The Ideal Political Platform Part #2: ...[C]lassic liberalism/conservatism as espoused in the 1970s by many prominent economists, notably Milton Friedman... posits that government should be limited to what government does best, that social welfare should be provided in ways that are minimally distorting to the economy (e.g. lump-sum payments), that the tax system should be simple and transparent, and that individuals should be allowed to do pretty much whatever they want to as long as their actions do not directly harm others... But classic liberalism as espoused decades ago ... under-estimated the environmental problems that would confront us and the need for government intervention in these matters. Below I highlight how the essential tenets of classic liberalism need to be augmented given the environmental realities of the 21st century:
- Classic liberalism assumed that as information improved, private markets would lead to the increased preservation of environmental resources and that externalities ... would be internalized ... given a system of strong property rights. While much improvement in the environmental arena has occurred, ... most economists vastly under-estimated the level of coordination that is required to tackle some of the world’s most serious environmental problems. Issues such as global warming and the loss of biodiversity require much more government intervention then had previously been assumed. This is not to say that this government intervention won’t rely heavily on the workings of the market system, but only that top-down regulation is absolutely necessary...
- ...[T]he government should move us towards a more rational method of risk management in areas that are prone to natural disasters. It is highly inefficient, as well as an abrogation of government responsibility, to create incentives for people to live in areas that are both dangerous and prone to catastrophe by providing them with reconstruction aid every time disaster strikes. The government has two options; either require that all people living in [risky areas] purchase private insurance, or make it absolutely clear that people will not be compensated ... by the government if disaster strikes. Such a policy would ... lead to dramatic shifts in the population densities in many disaster-prone areas..., and perhaps some one-time assistance in relocation would be required. The net effect would be to dramatically reduce future losses of life and property and save the government hundreds of billions in future costs. It would also force private actors (notably insurance companies) to take into account the effects of environmental externalities that until now have largely been ignored.
- Regarding personal health and risk, the government also must play a much more active role... Milton Friedman famously noted that there is no use for the Food and Drug Administration since companies whose products lead to illness will be forced out of the market... What he failed to realize is that if someone gets sick it is extremely difficult to trace the source of the illness, and without government regulation many companies that poison consumers could in fact operate profitably for long periods of time... it is clear that in this highly complex and inter-connected system, where we all are exposed to thousands of chemicals a year, many of which interact in ways that aren’t yet fully understood, where it is hard to trace the origin of products, and where the effects of these products often don’t manifest for years, the ... Food and Drug Administration, the Environmental Protection Agency, and the U.S. Department of Agriculture should all be well-funded, be decoupled from conflicts of interest with industry, and their mandate to protect the public welfare through rational risk assessment should be strengthened.
Increasing Market Flexibility Does Not Require Decreasing Economic Security
Wolfgang Munchau: Why social models are irrelevant, by Wolfgang Munchau, Financial Times: The least helpful contribution one can conceivably make in any economic debate is to recommend that one country adopt the social model of another. ... These days, it is difficult to find a European think-tank that does not advocate adoption of the Scandinavian social model. But the notion that the social model in small, consensual, wealthy and ethnically homogenous northern European countries such as Sweden and Denmark should serve as a model for large economies with huge wealth and income differences and mass immigration such as Germany or Italy is surely bordering on insanity. Yet this is precisely the debate that European Union leaders will be having... Instead of focusing on reforms of the social model, they should look at reforms of the EU’s economic system. The latter refers to the regulation of markets and macroeconomic governance. The former relates to risk insurance and social transfer systems. In the European debate, we have been committing a big classification error by confusing these two systems. ... Globalisation requires ... more flexible markets and a more flexible economic policy. But more flexibility increases demand for more risk insurance and also for more social protection. The right answer is therefore to liberalise markets, while retaining welfare and insurance systems. Instead, Europeans have been doing the opposite. We have scaled down our welfare systems without opening up our markets.
There exists, of course, a relationship between social and economic policies. Social systems can, and sometimes do, adversely affect economic growth. But there is no evidence that Europe’s social model is the main cause for Europe’s astonishingly poor economic performance over the last five years. If that were the case, it would be impossible to explain why Germany, France and Italy had higher growth rates than the US and the UK until the early 1990s. Nor would it be possible to explain Austria’s magnificent economic performance despite its German-style social model. Instead, a far more likely cause of Europe’s bad performance is the combination of inflexible markets and an inflexible economic policy. This is where any intelligent economic reform programme should start. I could think of no better area for reform than full-scale liberalisation of Europe’s protectionist financial markets. ... The lack of an efficient financial market has economic consequences that go beyond the financial sector itself. First, it means that there is insufficient venture capital for new companies... Second, it means that there is not enough pressure for corporate restructuring; ... Third, it means that many European countries have not developed a well-functioning housing market... There is enough economic reform to keep us busy for several years. But instead, European leaders are wasting time debating the Scandinavian social model...
Paul Krugman: The Bush Tax Cuts and the Deficit
The Bush Tax Cuts and the Deficit, Paul Krugman, Money Talks, NY Times: ...Here are two pictures that may help show why claims that the tax cuts were good for the deficit are wrong. Chart 1 shows federal receipts as a percentage of ... G.D.P.... These receipts plunged starting in 2001, then made a partial – but only partial – recovery over the past year. It’s useful to bear in mind that estimates of the size of the Bush tax cuts put them at about 2 percent of G.D.P. The actual fall in revenue as a share of G.D.P. was much larger ... Even now, revenue is about 3 percent of G.D.P. below its peak...
So revenue as a share of GDP fell after the tax cuts? Why did that happen?
The most likely answer is that by the end of the 1990’s revenues were inflated by the stock market bubble ... When the bubble burst, revenue fell off. ... Back in 2001 ... I argued that predictions of big future surpluses, which were used to justify those [tax] cuts, were wrong – and one reason I gave was that federal revenues were inflated by the stock bubble, and would soon fall.
That explains the past, but the news stories on the deficit are about the present. What's been going on with revenues recently? Why have they been increasing?
Data from the Congressional Budget Office show that ... the revenue surge came from two places, profits taxes and “nonwithheld” income taxes. Profit taxes surged partly because profits themselves surged – this has been an economic recovery in which real wages for most workers have actually gone down, so that profits have gathered the lion’s share of the gains – but also because a temporary tax break instituted in 2002 expired. We don’t know for sure why nonwithheld income taxes surged, but the best guess is that it reflects a bounce in stock prices during 2003-4 and, probably, a bubble in housing. Both are one-time events...
I'm not convinced yet. Here's why. Suppose taxes are cut and GDP growth goes up by, say, 3%, and because of the robust growth in GDP suppose that taxes increase by 2%. Then wouldn't taxes as a percentage of GDP fall? Doesn't that undercut your argument above which relies upon the taxes as a percentage of GDP falling as a sign of falling revenues?
Well, no. ... [E]ven now real G.D.P. is considerably lower than most people thought it would be ... Chart 2 shows, for each quarter since the beginning of 2000, the average growth rate of real G.D.P. over the previous five years. At the end of the 1990’s, people thought that the economy would grow at ... more than 3 percent a year. In fact, economic growth since 2000 has averaged only about 2.5 percent... The bottom line is that there is nothing in the data to suggest that the Bush tax cuts have had a favorable effect on the budget deficit.
Then why are the claims that tax cuts reduced the deficit by increasing revenue so widespread?
The answer, of course, is that wiggle at the end of the line in Chart 1. Revenue is still low by historical standards, but it’s not as low as it was last year. And as a result, the budget deficit actually came down in fiscal 2005, albeit to a level that would have seemed shockingly high a few years ago...
But isn't that better? Shouldn't we be cheering the recent upswing in revenue?
Well, put it this way: if a student gets a D after a string of F’s, his performance has improved – but that doesn’t put him at the top of the class.
Given this and other evidence suggesting the same thing, I'm convinced.
Changes in the Cost of College across Income Classes
The Road to College Is Becoming Clogged With Limousines, by Hubert B. Herring NY Times: This year, ... college tuition ... rose more slowly than it did in recent years, the College Board said last week. Yet ... tuition increases again outpaced inflation. ... Deep in the report, though, is another stark reminder that a private college education is increasingly a luxury... In 1992, the cost of attending a private college amounted to 60 percent of the annual income of the poorest quarter of the nation's families, and 33 percent for the second-poorest quartile. By the 2003-04 school year, the cost had spiked to 83 percent of a family's budget in the poorest quarter, and for the lower middle it had risen to 41 percent. And for the richest quarter of families - those with an average income of $143,000? The increase was merely to 19 percent from 17 percent...
October 22, 2005
Edward Prescott: Privatization of Social Security Should Happen and Will Happen
Cutting taxes, Social Security benefits may boost economy, Nobel Laureate says, by Dave Flessner, Chattanooga Times/Free Press: President Bush may still be struggling to sell ... the virtues of privatizing part of Social Security, but a Nobel-prize economist endorsed the idea... Dr. Edward C. Prescott, an Arizona State University professor who won the Nobel prize in economics last year, told a UTC audience that cutting taxes and Social Security benefits could boost U.S. economic growth by up to $1 trillion. "As the tax rate rises, GDP ... per capita falls," he said. "The evidence clearly indicates that labor supply is highly responsive to tax rates." To pay for the lower tax rates that would stimulate more economic growth, Dr. Prescott said Social Security and Medicare benefits should be cut. In their place, workers should be required to invest in their own savings accounts. Lowering taxes on income and reducing social security would boost economic growth and leave nearly all workers better off, Dr. Prescott said. ... Dr. Prescott conceded that "change is difficult" and "nothing is easy in politics." But Dr. Prescott predicted the eventual collapse of the Pension Benefit Guarantee Corp., the federal agency that insures defined benefit retirement plans. That will force many people to recognize the perils of relying upon plans that appear to guarantee certain benefits without adequate funding or incentives, he said. "It's just a matter of time before we recognize that,"... Dr. Prescott said his studies indicate that Europe's effective average tax rate of 60 percent cuts economic growth by an average 27 percent compared to the growth of the United States with an average 40 percent effective tax rate. Europeans retire earlier, work fewer hours and earn far less money, on average, than their U.S. counterparts, he said. "If the U.S. increases its taxes like Europe, then we'll be as poor as Europe," Dr. Prescott said. ... Despite the record high federal budget deficit this year, Dr. Prescott said debt as a share of the nation's output hasn't increased and shouldn't be a problem for the American economy.
I've made my position pretty clear on this. I am not in favor of privatization nor among the free lunch crowd. I believe substantial market failures exist in the provision of both retirement insurance and health insurance and that government intervention is required to overcome these market failures. I don't believe that further cuts in taxes and social programs are the solution to the deficit problem, I don't think the politics will change, and I don't believe all Europeans would agree with his welfare assessment of the U.S. and European economic systems. But since it's a bad idea to argue with a Nobel prize winner, I think I will just say I disagree and leave it at that.
Is Core Inflation a Systematically Biased Measure of Actual Inflation?
[Update: These are twelve month (year-over-year) inflation rates but the graphs don't change much with other measures, e.g. averaging monthly rates.]
[Update: I added graphs showing the differences between the all item and core rates of inflation for both the CPI and the PPI as well as a two-scale graph showing the accumulated differences for the two series. If there is systematic bias, the accumulated differences should trend upward or downward. Such trending is not evident. The deviations from zero are, however, highly persistent. The graphs are in the continuation frame.]
[Update: This Economic Scene from The New York Times discusses the use of core versus headline inflation, something that has been discussed extensively on blogs, e.g. macroblog has done a lot on this (Google ''core inflation'' at macroblog).
October 21, 2005
New Economist: Productivity, the Fed, and the Use of Real-Time Data
New Economist: Productivity and the Fed: Why you shouldn't always trust real-time data: For those interested in the debate over monetary policy "smoothing" and problems with real-time data, the Federal Reserve's quandary over productivity during the 1990s is salutary. A key challenge facing the Fed at the time was the inconsistent messages it was getting about productivity. Incoming aggregate data initially suggested low productivity growth, but anecdotal firm-level evidence hinted at an acceleration. Which was right?
A new St Louis Fed Working Paper by Richard G. Anderson, and Kevin L. Kliesen examines this period in detail, including long and fascinating quotes from FOMC transcripts. The paper, Productivity Measurement and Monetary Policymaking During the 1990s, shows clearly how Greenspan refused to take the real-time data at face value:
Chairman Greenspan’s view of the nascent acceleration in productivity growth was formed largely by both his numerous contacts in the business sector and his abiding belief that the published aggregate data were not correctly measuring the effects of information technological innovations that businesses were claiming to have garnered.
With few exceptions, Greenspan views were discounted by both the Board’s staff and his colleagues on the Federal Open Market Committee (FOMC). But the Chairman was not dissuaded. He noted, for example, that available data suggested that the service sector had achieved no productivity gain in twenty years, an unlikely event. If this measurement was wrong, how many more were incorrect? As the discrepancies widened, in 1996 he requested that the Board’s economic research staff conduct a project to assess the accuracy of the Bureau of Labor Statistics’ published productivity figures.
Although that study confirmed the picture painted by the then-current data, subsequent data revisions changed the picture. Later published aggregate data converged to the more rapid growth suggested by the Chairman’s anecdotal, firm-level data.
The authors conclude:
Our analysis highlights the difficulties in formulating monetary policy using preliminary, incoming data. Policymakers should be - and are - wary about placing too much faith in initial estimates because data revisions often have significantly challenged the perceptions that policymakers previous held in “real time.”
Recommended reading for all Fed watchers.
Salmon versus Agricultural and Commercial Interests
Latest champions for Northwest's salmon, by Brad Knickerbocker, The Christian Science Monitor: ASHLAND, ORE. - Uncle Sam is getting hammered in federal courts for failing to protect endangered salmon... The US Ninth Circuit Court of Appeals Tuesday rejected the Bush administration's water diversion plan for the Klamath River in California and Oregon because it does not protect the river's coho salmon, listed as threatened under the Endangered Species Act. Just a few days earlier, a federal judge in Portland, Ore., said he has had it with failed attempts to recover wild salmon (not to be confused with the hatchery fish) headed toward extinction in the vast Columbia River Basin, an area the size of central Europe. ...US District Judge James Redden gave federal agencies one year - not the two years they had asked for - to come up with a plan that actually works. And he raised the specter of tearing out mammoth hydroelectric dams in the Columbia-Snake River system ... if they don't succeed. ... If the hydropower dams were to be breached, much less electricity would be produced, which may raise the price of power and make it more expensive for wide segments of the economy in the West. ... Salmon need the right amount of water and the proper temperature to spawn far upstream, and then they head out to the Pacific Ocean for several years before returning to the place of their birth to repeat the cycle. Dams, diversions for irrigation, logging, mining, and urban development all have made the river trips to and from the ocean increasingly difficult. Before eight major dams were built on the Columbia River and the Snake River (the Columbia's main tributary), some 16 million salmon a year filled annual fish runs. Today, that number is down to about 1 million fish, and 12 species of salmon now are listed under the Endangered Species Act. The same is true for the Klamath River. It once saw one of the largest salmon runs. But the number of fish there has declined to the point where extinction is a possibility, largely because of dams and water diversions for agriculture.
In both places, government agencies, Indian tribes, environmental groups, university scientists, and economic interests have been battling it out for more than a decade. Meanwhile, other important variables may be at work over the long term that could have significant impact on salmon runs. ... The essence of the federal appeals court ruling this week - the latest in a series of legal decisions on Pacific salmon that go back more than 30 years - is that the US Bureau of Reclamation's 10-year plan for restoring the Klamath salmon run is "arbitrary and capricious," failing to provide enough water for the fish until the last two years. By that time, the court declared, it well may be that "all the water in the world ... will not protect the coho [salmon], for there will be none to protect." ... "We think the court really got it wrong," says Robin Rivett, a lawyer with the Pacific Legal Foundation who represents irrigators along the Oregon-California border. The Bush administration has pledged some $6 billion over the next decade on salmon recovery in the Columbia Basin. But it also wants to include hatchery fish with wild salmon for purposes of counting fish under the Endangered Species Act, which biologists argue against because it would lead to further salmon declines. It has reduced the amount of officially designated "critical habitat" ... The president has said he'd never approve breaching or removing any of the eight main hydropower dams on the Columbia and Snake Rivers.
I would be very surprised if any damns are breached. I hope we are able to save the wild salmon runs, but I am not optimistic that extinctions will be avoided.
Hal Varian on Housing Prices
Is Affordable Housing Becoming an Oxymoron?, by Hal R. Varian, Economic Scene, NY Times: ...In the short run, the supply of housing in most areas is more or less fixed. Hence the price of housing is determined primarily by the demand side of the market - by how much people are willing to pay for housing. In the last few years, we have seen historically low mortgage rates, which feed directly into housing demand. In several locations, particularly on the East and West Coasts, where land-use restrictions make it difficult to increase the supply of housing, prices have been pushed up to unprecedented levels. Whether these low mortgage rates have created a housing price bubble has been a matter of debate. ... It is quite possible that there is some "froth" in the market ... particularly on the coasts. But even when the froth subsides, housing will remain quite expensive in those areas. Can anything be done?
Some municipalities have started subsidized housing programs... Unfortunately, such programs just increase demand even more, pushing prices up. ... If you really wanted to push housing prices down, you would increase taxes on housing. ... Of course, the total cost of the housing (purchase price plus the present value of the taxes) would be unchanged, so this really does not solve the housing cost problem either. In California, tax policy has played a significant role in housing price dynamics. Proposition 13, passed in 1978, limited property tax increases to 2 percent a year for owner-occupied homes. But when the house is sold, the property tax assessment is based on the sale price. This means the new owner typically faces a significantly higher property tax bill than the old owner. Proposition 13 has been called a "tax on moving." Indeed it is... It is a lot cheaper to add a bedroom to a three-bedroom house than to buy a similar four-bedroom house... For the same reason, empty-nesters have strong tax incentives to keep their houses... The result is that fewer houses come on the market than would otherwise be the case, pushing prices up even more for the limited stock of housing that is available.
Of course, if you intend to move out of state, these considerations are not so relevant. In California, the best thing for empty-nesters to do is to sell their nests and migrate to Oregon. This seems to have become a pretty common practice... So what is the answer to high home prices? Basic economics tells us that for housing prices to fall we have to see a reduction in demand or an increase in the supply of housing. There is some hope on the demand side. As interest rates rise, we should see some moderation in demand; indeed, it appears that housing prices are flattening out in some areas. Ultimately, the only reliable way to make housing more affordable is to increase the supply. But a new house requires land zoned for housing. We cannot make more land, so we either have to use the land we have more intensively or we have to build houses farther from jobs. ... In urban California, traffic has become increasingly congested, putting a limit on how far away from their jobs people can live. Land use restrictions are tight in many desirable residential areas, and political forces are aligned against relaxing these restrictions. Imagine someone who scrimps and saves to buy his dream house in an area zoned for one-acre lots. The last thing he wants to see is his neighbor's lot being subdivided to build two or three new houses. ... Zoning laws and land use restrictions are unpopular among those seeking less-costly housing since they push up the price. But by the same token, once a searcher becomes an owner, he often becomes a fervent supporter of such restrictions. As Pogo put it, "We have met the enemy and he is us."
Richmond Fed President Lacker: Interest Rate Policy After Greenspan
''My concern about inflation is distinctly higher now,'' Lacker told reporters ... ''We're facing the prospect now of the possibility of the energy price surge passing into core prices.''
''Core inflation's drifted to the upper end, on a year- over- year basis, of a range that I find comfortable,''
''Inflation expectations have been downgraded from well-contained to contained and I wouldn't like to see a further downgrade,''
What's new here is an extended discussion of interest policy after Greenspan, the title of the talk. A main point of the speech is that it is wrong to view the Greenspan Fed, often noted for its "flexibility," as following discretionary policy:
To identify discretionary policy setting in the Kydland and Prescott sense as the hallmark of the Federal Reserve under Chairman Greenspan is to seriously misconstrue the historical record, in my opinion.
This is important because it establishes credibility for the institution rather than the individual and makes a smooth transition to a new chair more likely. Another point of the speech is that even in a stable inflation environment, monetary policy still needs to be active in responding to factors that change the real interest rate:
Interest Rate Policy After Greenspan, by Jeffrey M. Lacker, President, Federal Reserve Bank of Richmond: Early next year, we will experience an event that happens rarely in the Federal Reserve — the retirement of the Chairman of the Board of Governors. ... At the end of a policymaker’s term in office, it is natural to look back to appraise the conduct of policy during their tenure, and this task is considerably more pleasant when the results have been favorable.
One distinguishing characteristic of Fed policy under Chairman Greenspan that has been identified by some observers is “flexibility,” ... These observers see the flexibility ... as contrasting with adherence to a monetary policy “rule,” or with adoption of a numerical inflation target... This observation calls to mind the economics literature on “rules vs. discretion” in policy-making, ... Kydland and Prescott showed that ... a central bank can achieve better outcomes today by convincing markets that they will avoid inflationary temptations in the future. This is why central banks have come to focus so heavily on inflation expectations... To achieve superior outcomes, however, the central bank’s promise has to be believable, that is to say “credible.” One way to do so is ... to explicitly commit to a formula that determines the target level of the federal funds rate as a simple arithmetic function of a few macroeconomic variables, such as inflation and unemployment. ... But the benefits of policy credibility can be achieved without a mechanical formula, as long as the central bank adheres to a consistent, predictable pattern of behavior that the public understands. The term “rules,” in the sense used by Kydland and Prescott, is best understood in this broader sense... To identify discretionary policy setting in the Kydland and Prescott sense as the hallmark of the Federal Reserve under Chairman Greenspan is to seriously misconstrue the historical record, in my opinion. ... To my mind, building monetary policy credibility has been the true hallmark of the Federal Reserve under Chairman Greenspan’s leadership. ... Communication ... and ... greater transparency serve to enhance the public’s understanding of how the Fed is likely to respond to economic conditions ... in other words, to help the public form expectations consistent with our future behavior.
Now ... let me turn now to talk about the future. .... To facilitate that discussion ... I ... ask you to suppose that the Fed continues its recent success in maintaining stable inflation expectations... how should we conduct interest rate policy in such a world? First, let me remind you that any interest rate ... has three parts. One is simply compensation for ... expected inflation... A second part is a premium to compensate lenders for inflation risk. The remainder is the “real interest rate,”... If the public is convinced that the central bank will not allow inflation to move persistently outside of some low target range, then expected inflation will not move around a lot ... either. ... Does this mean that the Fed would never have to change interest rates if inflation was fully stabilized? The answer is an emphatic, “No.” The reason stems from the fact that ... real interest rates need to fluctuate in a healthy, well-functioning economy. ... A real rate ... represents a relative price — the price of current resources relative to future resources. In a market economy, relative prices will generally fluctuate in response to shifts in demand and supply. For example, ... Two successive hurricanes have caused devastation ... in the last two months. ... Setting aside the energy price increases, ... A disaster like this ... makes current resources scarcer relative to future resources. In addition, the heightened demand for reconstruction resources places further strain on current capacity. For both reasons, one would expect real interest rates ... to be ... higher than otherwise in the short run... The only caveat to this prediction is the possibility of an offsetting reduction in demand. But what would cause such a demand effect? A catastrophic event can certainly affect ... consumer confidence... But consumers and producers also can ... understand, from the history of such events, that the disturbance to economic activity is likely to be relatively short-lived. ...
To take another example from today’s headlines ... oil price increases can be expected to have implications for real interest rates. ... If the increase is expected to be temporary, its effects are analogous to a disaster-induced reduction in productive capacity, making current production more costly relative to future production. An increase in real interest rates is needed ... to reflect the relative scarcity of current and future resources. Energy prices figured prominently in the economic events of the 1970s... The proper lesson from the 1970s is not that energy price shocks induce major recessions; it is that monetary policy that reacts to energy price shocks by accommodating the rise in inflation and then subsequently has to fight inflation can induce major recessions. Thus, sharp energy price increases are not, by themselves, reasons to ease policy... Productivity trends seldom make the headlines, but ... When a sustained increase in productivity comes to be widely recognized by households and firms, the effect is to increase the demand for current resources relative to supply. ... If real interest rates do not change, a step-up in productivity growth would raise current demand by more than current supply. Thus, real interest rates have to rise... All three of my examples thus far have required real interest rates to rise. ...[A]n example in which real interest rates must fall ... is an independent fall in investment spending. This is different from my other examples because a change in investment spending reduces the demand for current resources rather than the supply... I hope I have convinced you that there is more to monetary policy than responding to inflation scares or “emerging inflation pressures.” Real shocks that alter the relative balance of current and future resource utilization will require appropriate adjustments to real interest rates over time...
So, what will interest rate policy look like in an after-Greenspan world ... The Fed will have to constantly monitor the state of the economy, understand the shocks that are affecting the economy’s growth, and form an assessment of the appropriate implications for real interest rates. In other words, not that different from recent Fed policy. It’s important to remember that... models will never be perfect. ... This may be one reason why rule-like policymaking may never take the form of the simple arithmetic formulas that are so handy for research purposes... Is the Federal Reserve in danger of losing its hard-won reputation with the upcoming change in leadership? ... I don’t think so. I anticipate a stable transition ... My confidence in the institutional continuity in the conduct of monetary policy rests in large part on what we have learned from ... the Greenspan era ... [about] expectations and the importance of consistent behavior ...[This is] now widely understood in the central banking and academic worlds...
[Update: There's yet another by Atlanta Fed president Jack Guynn who says policy remains accommodative. Quoting:
That ... suggests ... that we should continue to move toward a neutral setting for monetary policy. The Fed already has moved interest rates a long way toward a more normal level... By most conventional measures, however, policy is still accommodative. ... In evaluating the costs of a potential drop in the rate of output growth or an unwelcome rise in inflation, I believe that a significant acceleration of inflation would be the larger and more troubling outcome in the period ahead.]
Proposed Changes in National Park Policy
The National Parks Under Siege, Editorial, New York Times: Year after year, Americans express greater satisfaction with the National Park Service than with almost any other aspect of the federal government. ... there is no incentive to revise the basic management policy that guides park superintendents... Longtime park service employees feel much the same way. Yet in the past two months we have seen two proposed revisions. The first, written by Paul Hoffman, a deputy assistant secretary in the Interior Department, was a genuinely scandalous rewriting that would have destroyed the national park system. On Tuesday, the Interior Department released a new draft. ... But the new draft would still undermine the national parks. This entire exercise is unnecessary, driven by politics and ideology. The only reason for revisiting and revising the 2001 management policy was Mr. Hoffman's belief ... that the 2001 policy is "anti-enjoyment." This will surely come as news to the 96 percent of park visitors who year after year express approval of their experiences. ... The ongoing effort to revise the 2001 policy betrays a powerful sense, shared by many top interior officials, that the national parks are resources not to be protected but to be exploited. This new policy document ... would remove from the very heart of the park system's mission statement: "Congress, recognizing that the enjoyment by future generations of the national parks can be ensured only if the superb quality of park resources and values is left unimpaired, has provided that when there is a conflict between conserving resources and values and providing for enjoyment of them, conservation is to be predominant." These unambiguous words contain the legal and legislative history that has protected the parks over the years from exactly the kind of change Mr. Hoffman has in mind... One of the most troubling aspects of this revised policy is how it was produced. Instead of being shaped by park service professionals ..., this is a defensive document that was rushed forward to head off the more sweeping damage that Mr. Hoffman's first draft threatened to do. It is a tribute to the National Park Service veterans who worked on it that they were able to mitigate so much of the harm, even though they ... risked their jobs to protect the parks from political appointees in the Interior Department. ... At least two deeply worrying new directives have been handed down. One allows the National Park Service ... another way to further the privatization of the national parks and edge toward their commercialization. ... More alarming still is a directive released last week that would require park personnel who hope to advance above the middle-manager level to go through what is essentially a political screening. What we are witnessing, in essence, is an effort to politicize the National Park Service - to steer it away from its long-term mission of preserving much-loved national treasures and make it echo the same political mind-set that turned Mr. Hoffman, a former Congressional aide to Dick Cheney and a former head of the Cody, Wyo., chamber of commerce, into an architect of national park policy.
The parks aren't, in general, allocated according to the price mechanism. The fees are often far below the market clearing level. We use things like lotteries and first come first serve to allocate park enjoyment all in the name of, gasp!, equity. Sometimes poor people get in ahead of the wealthy. Imagine that. Before further privatization of the National Park Service occurs, we should ask whether allocating these resources with the price mechanism, which runs the risk of excluding people from the parks according to income, is what we want as a society.
October 20, 2005
Higher Education Enrollment Trends by Race/Ethnicity
Table 2.2 Trends in Percentage Enrollment of 18-24 Year-Old High School Graduates by Race/Ethnicity, Showing Opportunity Gaps, 1970-1999
Sources: NCES 2000a, 216, table 187. The numbers in the table are percentages.
The gap is the difference in attendance rates relative to whites. If you are willing to let race/ethnicity proxy for income, understanding it is an imperfect measure (see page 25 in the text for a discussion of this), this table indicates that poorer students do not attend at the same rate as higher income students, on average, a problem that has not improved with time. There does appear to be a difference in access by income. Though the numbers hint in this direction, it appears harder to make the case, with this table anyway, that access has become more difficult over time. I plan to do more posts based on the data in the book and elsewhere that will give more information, at least indirectly, on this issue. One final comment. Only 43.7% of 18-24 year-olds enrolled in college in 1999. That means
more than half [a substantial portion] of our population does not have more than a high school education [Update: The original statement needed to be amended since the 43.7% figure only refers to a seven year window of data, see the clarifying comment by John H. Bishop who notes the percentage of adults with some college, not necessarily a degree, is generally in the 50-60% range]. When I talk about education as a solution to competition from globalization, this is the group I'm most worried about.
Ben Bernanke: The Economic Outlook
The Economic Outlook, by Ben Bernanke, Chairman, President’s Council of Economic Advisers: ...The economy’s resilience was put to severe test during the past five years, even prior to Katrina. A remarkable range of shocks hit the U.S. economy .... Yet, in the face of all these shocks, ... the American economy has rebounded strongly.
Policy actions taken by the President and the Congress were important in helping to get the economy back on track. Notably, beginning with the President’s 2001 tax cuts, multiple rounds of tax relief increased disposable income for all taxpayers, supporting consumer confidence and spending while increasing incentives for work and entrepreneurship. Additional tax legislation passed in 2002 and 2003 provided incentives for businesses to expand their capital investments and reduced the cost of capital by lowering tax rates on dividends and capital gains. Together with appropriate monetary policies, these policy actions helped spur economic growth... Today the U.S. economy is in the midst of a strong and sustainable economic expansion... An important reason for the recovery has been improved business confidence. To an extent unusual in the postwar period, the slowdown at the beginning of this decade was business-led rather than consumer-led. ... Supported by appropriate fiscal and monetary policies and by the economy’s innate strengths, business confidence has risen markedly in the past few years. The effects are evident in the investment and employment data. ... Although growth in GDP and jobs capture the headlines, one of the biggest macroeconomic stories of the past few years is what has been happening to productivity. ... Thus, on each of three key indicators of the real economy—GDP growth, job creation, and productivity growth—the United States in recent years has the best record of any major industrial economy, and by a fairly wide margin. Finally, while there has been a notable rise in overall inflation this year, prices on non-energy products have continued to increase at moderate rates. ...
Let me turn now to the outlook. In the shorter term, the devastation wrought by the hurricanes has already had palpable effects on the national rates of job creation and output growth. ... The economic impact of the hurricanes included significant damage to the country’s energy infrastructure. ... Even as the energy sector continues to recover, it remains true that the prices of oil and natural gas have risen sharply in the past two years, ... and continued increases would at some point restrain economic growth. Thus far at least, the growth effects of energy price increases appear relatively modest. ... House prices have risen by nearly 25 percent over the past two years. Although speculative activity has increased in some areas, at a national level these price increases largely reflect strong economic fundamentals, including robust growth in jobs and incomes, low mortgage rates, steady rates of household formation, and factors that limit the expansion of housing supply in some areas. House prices are unlikely to continue rising at current rates. However, ... a moderate cooling in the housing market, should one occur, would not be inconsistent with the economy continuing to grow at or near its potential next year. The current account deficit presents some economic challenges. ... While the current-account imbalance partly reflects the strong growth of the U.S. economy and its attractiveness to foreign investors, low U.S. national saving also contributes to the deficit. The United States should work to increase its national saving rate over time, by encouraging private saving and by controlling federal spending to reduce the budget deficit. Our trading partners must also play a role in reducing imbalances, by becoming less reliant on export-led growth and increasing domestic spending, and by allowing their exchange rates to move flexibly as determined by the market.
The economic challenges posed by hurricanes Katrina and Rita reinforce once again the importance of economic policies that promote growth and increase the resilience of the economy. ... The energy bill ... should help address the Nation’s energy needs in the longer term. As an additional step, the Administration will continue to work with Congress to take measures that will permit needed increases in refinery capacity. The Administration has made a number of other proposals to increase economic growth, including proposals to reduce the economic costs of litigation, to increase quality and reduce costs in the health-care sector, and to address national needs in education and job training. The Administration is currently engaged in several international negotiations, including the Doha round of the World Trade Organization as well as talks with China on a number of matters involving trade, exchange rates, and needed financial reforms. Liberalized trade and capital flows promote economic growth, and we should strive to achieve those objectives... It is important that we persist in these efforts and not retreat to economic isolationism, which would negatively affect the long-run growth potential of the economy. Fiscal discipline, always important, has become increasingly so ... The President remains committed to controlling spending and cutting the budget deficit in half by 2009. ... The President also remains committed to reforms to address fiscal challenges in the longer-term, such as Social Security...
I hope that, at some level, the plan is a bit more detailed than a simple we should cut programs, and that they will realize that program cuts are not enough, not politically feasible, and not the best way to solve the deficit problem.
Posted by Mark Thoma on Thursday, October 20, 2005 at 09:47 AM in Economics
New York Fed President Geithner on Global Imbalances
- sees substantial risks due to global imbalances, risks that are not fully understood.
- is insistent that fiscal authorities need to regain control of the budget and says "Improving our fiscal position is the most effective means we have available to reduce our vulnerability during this prolonged period of adjustment."
- in equally insistent that fixed exchange rate regimes must allow more flexibility.
- worries that increases in demand growth in the foreign sector needed to offset a decline in U.S. consumption and increase in U.S. saving will have to overcome difficult political hurdles.
- says smooth adjustment requires, in addition to improved fiscal management, a strong and flexible financial system and open and free trade.
- says that avoiding protectionism calls for "improving educational opportunity and achievement in this country, and perhaps also in improving the design of the temporary assistance we provide individuals who bear the brunt of the adjustment costs than come with greater global economic integration."
Here's the speech:
U.S. and the Global Economy, by Timothy F. Geithner, President, New York Fed: I want to focus my remarks today on the imbalances in the world economy and their implications .... These imbalances... present challenges—and risks ... The sources of these imbalances are varied and complex. ... not anticipated and not fully understood. ... The magnitude and persistence of these imbalances seems to be the result of the interaction of two forces. The first involves a decline in U.S. savings relative to domestic investment, matched by an increase in savings relative to investment in parts of the rest of the world, principally in emerging Asia and the major oil exporters. ... The second feature ... has been an increase in the willingness of the rest of the world to invest its savings in the United States. ... This phenomenon is due in part to the perceived attractiveness of relative returns in the United States arising from the acceleration of productivity growth here, and in part due to the dynamics associated with exchange rate regimes linked in one way or another to the dollar. Together these forces have produced larger imbalances ... that have been sustained longer and financed more easily than conventional wisdom would have thought possible a decade or even five years ago. ...
This ... should concern us because it is not simply the result of the savings and investment decisions of the private sector. The fact that we are using a substantial part of the savings we are borrowing from the rest of the world to finance an unsustainable level of public borrowing leaves us more vulnerable than if those savings were being used for productive private investment. ... It should concern us because of how the imbalance has been financed. A substantial portion of the capital inflows ... has come from foreign central banks—which have been accumulating dollar reserves to preserve exchange rate arrangements that are unlikely to be sustainable and are already in the process of change... And ... these imbalances matter because at some point they will have to reverse. Market forces will at some point induce an adjustment. And that inevitable process of adjustment will bring with it the risk of ... slower growth in the United States and in the rest of the world. The magnitude of this risk is difficult to measure with any confidence. Past episodes of external adjustment offer some reassurance, but the present circumstances seem sufficiently different from historical precedent that history may not be a particularly useful guide. ... The risks associated with this adjustment process may be magnified ...[because the] average household in the United States today has a higher level of debt to income and is somewhat more exposed to interest rate risk than in the past. ... The adjustment process is also complicated by the fact that the rest of the world does not appear likely ... to be in a position to provide a sufficiently strong offsetting source of demand growth to compensate for the necessary slowing in U.S. domestic demand. ...
What can we do to mitigate these risks? For the United States, these challenges put a premium on putting in place a more credible fiscal policy framework, maintaining as strong and resilient a financial sector as possible, and preserving an open and flexible economy. ... Improving our fiscal position is the most effective means we have available to reduce our vulnerability during this prolonged period of adjustment. ... And even though substantial fiscal consolidation would not by itself bring the external imbalance down to a more sustainable level, it would improve the prospect for a smoother adjustment... The increase in the flexibility and resilience of the U.S. economy over the past two decades has a lot to do with the increased openness of the U.S. economy. ... We jeopardize future income gains if we are unable to sustain support ... a relatively open trade policy. How effective we are in meeting this political challenge is likely to depend significantly on how effective we are in improving educational opportunity and achievement in this country, and perhaps also in improving the design of the temporary assistance we provide individuals who bear the brunt of the adjustment costs than come with greater global economic integration. ... For global growth to be sustained at a reasonably strong pace during this period of adjustment, the desirable increase in U.S. savings ... would have to be complemented by stronger domestic demand growth outside the United States, absorbing a larger share of national savings. Exchange rate regimes, where they are currently closely tied to the dollar, will have to become more flexible, allowing exchange rates to adjust in response to changing fundamentals. ...
I've stated my views already, they are close to those of Geithner, so I won't repeat them again. Besides, from previous comments, I have the sense that many of you are tired of being told about the virtues of free trade and the efficiency gains of structural adjustment and would prefer that economists listen a little more and lecture a little less.
Dallas Fed President Fisher: Cost-Pull Disinflation from Globalization
Globalization and Texas, by Richard W. Fisher, President, Dallas Fed: ...Speeches delivered by Federal Reserve Governors and Bank presidents are subject to interpretation in a manner akin to the ancient art of prophecy, which often divined the future by slicing open an animal and studying its entrails. It is interesting to be the “slice-ee” ... Philip Coggan ... [w]riting in the Financial Times last week, ... noted that when the great French statesman Talleyrand died, his archrival, Prince Metternich of Austria, was heard to muse, “I wonder what he meant by that?”...
[F]or the magic of free enterprise to work, fiscal authorities and central bankers must provide a healthy economic environment for the private-sector managers... in a challenging new global environment. [G]lobalization ... may well be the key development of our era; yet, we do not understand it very well. ... Globalization has intensified worldwide competition for investment capital. The consequences have included pushing governments to simplify or lower tax burdens to attract these funds... for legislatures and parliaments to maintain the rule of law, minimize obstacles to flexibility and maximize the ability to compete... The forces of international competition may be heralding a period when decisionmakers responsible for fiscal policy are forced to focus on investment rather than public-sector consumption. In ... today’s newly competitive world, governments’ purpose ... is to build an economic infrastructure that fosters private-sector production and growth, rather than transferring spending from one part of society to another. In an increasingly global economy, ... a dollar’s worth of government spending on consumption or entitlements has a higher opportunity cost today than it did yesterday. This will likely lead to a reconfiguring of government decisionmaking that in the past has short-changed infrastructure, research, education and other more productive public investments. ...
On the inflation-fighting front, globalization has been a positive factor. ... By lowering trade barriers ... we have benefited on the inflation front ... [as] competition from abroad acts as a check on price increases by our own producers. ... To be sure, the growth of Russia, India, China and other new economic entrants has created upside price pressures, too. ... [P]roducers have felt some upward pressure on non-energy commodity prices driven by new sources of global demand. Steel is a case in point—as are copper and so many other commodities. Even so, I feel that the net effect of new entrants like China into our markets ... has been a plus in exerting downward pressure on core inflation. I refer to this phenomenon internally at the Dallas Fed as “cost–pull disinflation.” As long as we keep our markets open and hold protectionists at bay, I expect this will continue...
October 19, 2005
Demand for Bartlett's Book Shifts Outward
D'day Rushes Book of Canned Bushie, by Rachel Deahl, PW Daily: Sometimes getting your pink slip can be a good thing. That's the case with Bruce Bartlett, a now-former senior fellow at the conservative Dallas-based think tank National Center for Policy Analysis. Bartlett, an ardent Bush supporter in 2000 who was also a member of the George H.W. Bush Treasury department, was given his walking papers on Monday after his boss ... John C. Goodman read the manuscript of his upcoming book, The Impostor: How George W. Bush Bankrupted America and Betrayed the Reagan Legacy. After The New York Times reported the news of Bartlett's firing, Doubleday ... quickly bumped the book's release date from April 4 to February 28... [and] upped the book's print run from 30,000 copies to 50,000. Nicole Dewey, associate director of publicity at Doubleday, says her "phone rang off the hook" ... with calls from all the major papers and talk shows. ... that is clearly enough, in Doubleday's eyes, to bring in quite a few more book sales.
Is an attempt to undermine his credibility the next step?
Speeches by Fed Governor Kohn and Cleveland Fed President Pianalto (Update 2: Fisher and GeithnerToo)
The Economic Outlook, by Fed Governor Donald L. Kohn ...In sum, I see risks on both sides of my expectations that the growth of economic activity will slow modestly on balance over the next year or so, leaving the economy producing at about its sustainable potential. But unless activity slows unexpectedly, and after the rise in retail energy prices, the risks may be skewed a little toward the upside on inflation. ... Obviously, we are considerably closer to where policy needs to be than we were sixteen months ago, but we are not yet at a point where we can stop and watch the economy evolve for a while. ... How far we go will depend on the evolution of economic activity and prices...
Economic Conditions and Monetary Policy, by Sandra Pianalto, President, Cleveland Fed ...Katrina and Rita did not change the broad contours of my forecast for continued economic growth and lower inflation into 2006. So, to me, the plan of continuing to remove the remaining amount of policy accommodation still looks like a sound one. We have already removed a substantial amount of that accommodation, and it is fair to ask how much further we might have to go. ... The answer ... depends on how economic conditions unfold.... Monetary policymaking requires managing risks. That means having a plan that is flexible enough to take into account sudden surprises and changing conditions. While I may be uncertain about which path the economy will take, ... Removing the remaining monetary policy accommodation puts us in the strongest possible position to react as evolving economic conditions require...
The message from the speeches is transparent - unless incoming data alter the picture substantially, rates will continue to rise.
Globalization and Texas, by Richard Fisher, President, Dallas Fed: My recent soundings ... have caused my brow to furrow, reflecting concerns about the drag on growth by Hurricanes Katrina and Rita and the increases in energy prices. Several questions arise. How permanent are these influences? ... Will energy and associated costs work their way into core inflation? ... I must give an honest answer. ... I really don’t know... we must listen carefully to the anecdotal evidence... Price stability is a necessary condition for achieving maximum sustainable economic growth. Central bankers have always... recoiled from inflation. ... Here the Fed watchers who read entrails might take note: I am fully confident that the Fed will continue to do its part by containing inflationary expectations and pressures. ... You will note that the operative phrase ... was “inflation expectations.” A key to containing them is the conduct of the FOMC. For my part, as a member of the FOMC, I will not waver from advocating policy that discourages expectations of higher core inflation...
Update: There was yet another speech today, this one by Timothy Geithner, President of the New York Fed. However, this talk did not address the future course of monetary policy. Instead, the focus is on global imbalances and how they will be resolved. This would also be good to present more fully later:
U.S. and the Global Economy, by Timothy F. Geithner, President, New York Fed: For global growth to be sustained at a reasonably strong pace during this period of adjustment, the desirable increase in U.S. savings and the necessary slowing in U.S. domestic demand growth relative to growth of U.S. output would have to be complemented by stronger domestic demand growth outside the United States, absorbing a larger share of national savings. Exchange rate regimes, where they are currently closely tied to the dollar, will have to become more flexible, allowing exchange rates to adjust in response to changing fundamentals. The global nature of these requirements does not imply that the United States can put the principal burden for adjustment on others... the U.S. economy is in many ways in a relatively favorable position to manage through the risks in the adjustment process ahead. ... But we face a number of difficult long-term challenges as a nation—in our fiscal position, in how well we equip our citizens to prosper in a more competitive world and in our ability to sustain political support for the policies, including our relatively open trade policy, that have been an important source of the improvement in U.S. prosperity...
The Future of American Manufacturing
Do American Manufacturers Have a Future?, by Robert J. Samuelson, The Washington Post (WSJ version, WaPo version here) The question posed by the bankruptcy filing of Delphi Corp. -- the largest U.S. auto parts company -- is whether manufacturing in America has a future. Manufacturing employment now accounts for only one in nine U.S. jobs, down from one in three in 1950. ... the decline reflects higher efficiency -- making more things with fewer people. ... [L]lately, the news about manufacturing has seemed particularly dismal. Since mid-2000, three million jobs have vanished. .... Delphi's bankruptcy suggests that the U.S. auto-industrial complex faces another wrenching shakeout. ... The entire industry is caught in a cost-price squeeze. It needs price "incentives" to sell vehicles. ... High labor costs are ... a huge problem...
Since 1948, the UAW and GM, Ford and Chrysler have crafted contracts ... providing above-average hourly wages..., rich benefits and strong job security. For example, laid-off UAW workers essentially get full salary and benefits indefinitely. But the limited competition of the protected market has given way -- now automakers vie with imports and firms with non-unionized U.S. plants. Now comes the reckoning. ... According to the UAW, Delphi is seeking deep cuts in both wages ... and total labor costs including fringes ... "If we do this right, Delphi will remain one of the world's leading global automotive suppliers," said chief executive Steve Miller. "Yes, with a smaller U.S. manufacturing footprint. … If we do it badly, Delphi may be broken up into small pieces, and America will have lost some of its precious industrial treasures." GM, Ford and Chrysler are also headed toward bankruptcy unless they curb labor and "legacy" costs, he predicted. ... The fate of American manufacturing lies largely in American hands. Of course, some labor-intensive production will go abroad. But in many industries, job losses and cost cutting -- though devastating to individuals -- can sustain production and restore profitability. The American steel industry now produces more than in the 1980s, though it has lost two-thirds of its jobs. ... But one giant unknown clouds everything: China. Until now, its booming U.S. exports have mostly displaced exports from other countries. As China modernizes ... this could change dramatically. The combination of low wages, a huge market and an artificially low currency confers staggering competitive advantages. ... Unless the currency rises substantially, the United States could lose many industries that, by all other economic logic, it shouldn't. Therein lies the real threat of extinction or something close to it.
With respect to China, it is not at all certain that revaluation will help U.S. manufacturers for reasons expressed by Joseph Stiglitz:
Much of China’s recent gains in textile sales … came at the expense of other developing countries. America will once again be buying from them, and so total imports will be little changed...
So stripping labor down to its barest bones may impose lots of costs on the labor side of the equation with little in the way of higher manufacturing employment to show for it. And in any case, do we want to specialize in low wage manufacturing jobs with wages dictated by world competitive pressures, or perhaps higher wage manufacturing jobs sustained through protectionism? Or might we transition to something better? I don't think we have a clear sense of where our economic ship is headed or even, perhaps, how to steer the ship through policy choices. What will be our
competitive absolute/comparative advantages in the emerging global economy?
The Effect of Communism on Preferences
Good bye Lenin (or not?): The Effect of Communism on People's Preferences, by Alberto Alesina, Nichola Fuchs Schuendeln, NBER WP 11700, October 2005: Abstract Preferences for redistribution, as well as the generosities of welfare states, differ significantly across countries. In this paper, we test whether there exists a feedback process of the economic regime on individual preferences. We exploit the "experiment" of German separation and reunification to establish exogeneity of the economic system. From 1945 to 1990, East Germans lived under a Communist regime with heavy state intervention and extensive redistribution. We find that, after German reunification, East Germans are more in favor of redistribution and state intervention than West Germans, even after controlling for economic incentives. This effect is especially strong for older cohorts, who lived under Communism for a longer time period. We further find that East Germans' preferences converge towards those of West Germans. We calculate that it will take one to two generations for preferences to converge completely. [Free version on author web site, here too.]
Posted by Mark Thoma on Wednesday, October 19, 2005 at 12:33 AM in Economics
Federal Reserve Vice Chairman Roger W. Ferguson on the Economic Outlook for the U.S.
Economic Outlook for the United States, Federal Reserve Vice Chairman Roger W. Ferguson: I appreciate the opportunity to speak to you today about the outlook for the U. S. economy. ... To jump right to the bottom line, I believe that the outlook for the economy remains solid despite the devastating blows delivered to the Gulf Coast by Hurricanes Katrina and Rita. ... Before the hurricanes, ... the outlook was relatively benign: continued moderate economic growth accompanied by little change in the underlying pace of core inflation. There were, of course, risks in this forecast. The cumulative impact of the rise in energy prices on inflation and activity ... was clearly one concern. So too was the ongoing rise in home prices and the possibility that this phenomenon is unsustainable. ... I do not think that a significant and widespread drop in home prices is the most likely outcome, but the situation will require careful monitoring in the months ahead. A further risk is the apparent deceleration in business spending on new equipment and software (E&S). ... Are businesses becoming more reluctant to invest?...
I'd now like to turn to the economic effects of Hurricanes Katrina and Rita. ... At this point, it seems likely that the hurricanes had, at most, a small effect on the supply side of the economy. ... The hurricanes have, however, adversely affected the outlook for inflation. ... Consumer energy prices are projected to rise substantially in the second half of this year, and some spillover into the prices of non-energy goods and services looks likely as well. ... In general, economists believe persistent changes in relative prices have a larger effect on economic activity than do temporary changes. ... A large, long-lasting increase in the relative price of energy will affect inflation for a time. ... The behavior of inflation expectations is the key ... If expectations for long-run inflation become unanchored ... the possibility of a wage-price spiral increases...
The reaction of the business sector to permanently higher energy prices is more complicated. ... ... firms tend, where possible, to substitute capital and labor for energy consumption. In the 1970s and 1980s, such substitution greatly reduced the amount of energy consumed ... I'd expect to see a similar response to the latest price run-up in the years ahead. ... Studies have shown that adjustments by households and businesses in response to higher energy prices reduce the long-run level of potential output in the economy. This reduction mainly reflects the tendency of production to become more labor intensive ... In essence, labor productivity grows more slowly after an energy price shock and that effect lowers the trajectory for potential output... What does all of this mean for the conduct of monetary policy? In my view, it reinforces the need for policy to continue to be dependent on the incoming data on output and prices and on our forecasts for how those variables will evolve over time. ... it is also important to recognize that the measurement of economic activity in the immediate aftermath of the hurricanes may give an incomplete picture. Since it began withdrawing monetary accommodation in June 2004, the FOMC has repeatedly stated that its future policy actions will be governed by the expected performance of the economy. ... For now, I believe that our policy of removing monetary accommodation at a "measured" pace is most likely to promote our broader objectives of price stability and maximum sustainable economic growth.
October 18, 2005
San Francisco Fed President Yellen with an Update on the U.S. Economy
Update on the U.S. Economy, Janet Yellen: ...I'll start by addressing some major developments in the U.S. economy relating to employment and output growth. I'll review the recent past and indicate my sense of the economy's likely path going forward, focusing particularly on risks I see relating to energy and the housing sector. Next I'll turn to the inflation picture. Finally, I'll conclude with some thoughts on the course of monetary policy in the U.S.
The part of the speech that follows this introduction repeats remarks she has made before on using fiscal policy rather than monetary policy to address the consequences of the hurricane, so I will not repeat them. The problem is that the lags in monetary policy are too long to be of much help and monetary policy cannot be directed at a particular region. I will also add that while monetary policy can increase or decrease aggregate demand, it cannot produce oil or refineries, it cannot replace lost supply. Returning to the speech, Yellen next discusses her view of the strength of the economy and two risks to output growth in the future, higher energy costs and a fall in housing prices:
When Hurricane Katrina hit at the end of August, the economy was doing quite well. Over the preceding two and a half years, real GDP had grown steadily at, or above, its potential ... With this stretch of near or above-trend growth in economic activity, slack ... has gradually ... diminished—that is, jobs have increased by more than enough to absorb a growing workforce. ... Indeed, the latest reading on unemployment before the storm was for August, and it came in at 4.9 percent, a number that's near conventional estimates consistent with so-called "full employment." ... Evidence amassed since the storms suggests that the economy has been remarkably resilient and apt to remain on a solid track...Now to the two risks to output growth and employment that I mentioned—energy prices and housing. As I said, these were present even before Katrina struck. ...
On the risks to output growth from higher energy costs:
The outlook for trend-like growth in output that I discussed earlier incorporates noticeable effects of the energy shock on household and business spending. However, there are inevitable uncertainties about the intensity of these effects. For example, the intensity depends importantly on whether the higher prices are viewed as transitory ... or as a more permanent feature of the economic landscape. If they are seen as largely transitory, then consumers and firms typically try to maintain something close to their usual level of spending while the higher prices last ... If higher energy prices are expected to persist, however, a deeper and longer-lasting cutback in spending is more likely. To gauge perceptions concerning the permanence of higher energy prices, the natural place to look is at futures prices. Even before Katrina, ... these futures prices reflected the sense that global demand for oil would remain strong in an environment where there is little excess supply available and where geopolitical uncertainty creates risks to existing supplies... Early signs suggest that spending is holding up reasonably well in the wake of higher energy prices, although consumer confidence dropped substantially after the storms...
At this point, she repeats remarks she has made previously on risks from a housing collapse, so I won't repeat them (see Yellen: There is a Bubble But Don’t Pop It With Monetary Policy and Calculated Risk). The main message from this section is that there are risks of two types, one from the existence of a housing bubble which explains part of the increase in prices, and another from a change in the fundamentals. She notes that the long-rate conundrum is not fully understood so we cannot rule out the possibility that historical relationships will be restored, i.e. that long-term rates could rise, and that it could happen fairly quickly (but she is not predicting this will necessarily happen). Summarizing, she is wary of two big risks on the output side, problems due to high energy costs and problems due to a housing market crash, both of which relate to the Fed's goal of keeping output near full employment.
What about the Fed's other concern, inflation? Yellen says that so far, inflation and inflationary expectations are well-contained. But what about the future? A key here, something Greenspan discussed yesterday, is how much of the increase in energy costs will pass through to output prices. Yellen notes, like Greenspan, that the economy has changed considerably since the 1970s and the degree of pass through has fallen, but it isn't known with much certainty is by how much so the Fed needs to remain wary that higher input prices will eventually, after some lag, pass through to output prices. The key, she notes, is inflationary expectations since the expectation of inflation is a self-fulfilling prophecy. Here there is good news since long-term expectations have fallen by half a percent since the Fed began tightening, though medium term expectations appear to have risen. But she makes clear that the Fed must remain vigilant and not allow expectations to lose their anchor:
My focus thus far has been on ... keeping the economy ... in the vicinity of full employment. However, ... the Federal Reserve is also keenly focused on maintaining price stability. In my judgment, inflation has been relatively well-contained and essentially compatible with the Fed's price stability objective... The question for policy, of course, concerns the future, not the past. Increases in energy prices, ... are likely to continue boosting headline inflation. And a key question is whether higher energy prices also will elevate core inflation. In part, this depends on whether businesses are able to pass through higher energy and material prices or instead are forced to absorb them into the bottom line. ... Naturally, much research has gone into analyzing what happened during the 1970s, ... One of the key findings concerns the role that inflation expectations play in generating the wage-price spiral. ... the idea is that inflation expectations are like self-fulfilling prophecies. If people expect higher inflation, they will behave in ... ways that will actually generate higher inflation ... What's the evidence on people's inflation expectations? ... A recent survey taken by the University of Michigan recorded a large jump in inflation expectations over the next twelve months, and a smaller increase in longer-term expectations. But I would not read too much into this, since the short-term survey results reflect recent energy price developments ... An alternative source of information on inflation expectations comes from analyses using a ... Treasury Inflation-Protected Security ... to separate out the inflation compensation component embedded in nominal interest rates... Using this kind of analysis, ... it is notable that longer-term inflation expectations—those covering the period from five years ahead to ten years ahead—appear to have declined by half a percentage point since the Fed began tightening policy. ... However, the Federal Reserve cannot take it for granted that inflation expectations will remain well-contained. Rather, it is the job of a central bank to earn, through its actions, the public's confidence in its commitment to price stability. ...
Finally she asks if eleven rate increases is enough. She defines neutral as 3.5% - 5.5% and notes that currently rates are at the low end of that range. Because rates are at the low end of neutral, she says this causes the presumption of more rate increases. But there's no way to know for sure where neutral is (she mentions 4.5% but again cautions there is no way to know for sure), so all of it is uncertain. Yellen then says this means that incoming data will be of paramount importance. However, she does make one thing clear, a rise in inflation is unacceptable:
Over the past sixteen months, ... the Federal Open Market Committee has ... been gradually removing the policy accommodation ... After eleven 25-basis point upward moves..., the question of exactly what constitutes a neutral stance has become more compelling. Conceptually, policy can be deemed "neutral" when the federal funds rate reaches a level that is consistent with full employment ... The neutral rate is easy to define conceptually, but it's difficult to know in practice when we're there, because estimates ... are highly uncertain and the factors influencing that rate can change over time. That said, ... I consider it reasonable to put the current neutral rate in the range of 3-1/2 to 5-1/2 percent. At 3-3/4 percent, the current federal funds rate is toward the lower end of this band. This suggests a presumption that the rate will need to be raised further. Indeed, financial markets now appear to expect the funds rate to peak at about 4½ percent... Again though, I want to emphasize that there is no way to know precisely what the neutral stance is. To my mind this means that, as the federal funds rate target nears a reasonable estimate of the neutral rate, monetary policy must become more and more dependent on incoming data relating to the strength of aggregate spending. It is equally important, of course, to monitor developments relating to inflation... One option that is clearly not on the table is allowing an unacceptable rise in inflation. It has taken many years of consistent performance for the Federal Reserve to earn the public's confidence in its commitment to price stability, and this consistency of purpose remains essential.
Google's Search Gives Publishers Seizures
Books of Revelation, by Eric Schmidt, Wall Street Journal: Imagine sitting at your computer and, in less than a second, searching the full text of every book ever written. Imagine an historian being able to instantly find every book that mentions the Battle of Algiers. Imagine a high school student in Bangladesh discovering an out-of-print author held only in a library in Ann Arbor. Imagine one giant electronic card catalog that makes all the world's books discoverable with just a few keystrokes by anyone, anywhere, anytime. That's the vision behind Google Print, a program we introduced last fall ... Recently, some members of the publishing industry who believe this program violates copyright law have been fighting to stop it. We respectfully disagree with their conclusions, on both the meaning of the law and the spirit of a program which, in fact, will enhance the value of each copyright. Here's why. Google's job is to help people find information. Google Print's job is to make it easier for people to find books. ... For many books, these results will, like an ordinary card catalog, contain basic bibliographic information and, at most, a few lines of text where your search terms appear. We show more than this basic information only if a book is in the public domain, or if the copyright owner has explicitly allowed it by adding this title to the Publisher Program... Any copyright holder can easily exclude their titles from Google Print -- no lawsuit is required.
This policy is entirely in keeping with our main Web search engine. ... we copy and index all the Web sites we find. If we didn't, a useful search engine would be impossible... Only by physically scanning and indexing every word of the extraordinary collections of our partner libraries at Michigan, Stanford, Oxford, the New York Public Library and Harvard can we make all ... titles discoverable with the level of comprehensiveness that will make Google Print a world-changing resource. But just as any Web site owner who doesn't want to be included in our main search index is welcome to exclude pages from his site, copyright-holders are free to send us a list of titles that they don't want included in the Google Print index. For some, this isn't enough. ... [W]e believe ... that the use we make of books we scan ... is consistent with the Copyright Act, whose "fair use" ... allows a wide range of activity ... all without copyright-holder permission. Even those critics who understand that copyright law is not absolute argue that making a full copy of a given work, even just to index it, can never constitute fair use. ... The aim of the Copyright Act is to protect and enhance the value of creative works in order to encourage more of them ... We find it difficult to believe that authors will stop writing books because Google Print makes them easier to find, or that publishers will stop selling books because Google Print might increase their sales. Indeed, some of Google Print's primary beneficiaries will be publishers and authors themselves. ... Imagine the cultural impact of putting tens of millions of previously inaccessible volumes into one vast index ... searchable by anyone, rich and poor, urban and rural, First World and Third, en toute langue ... entirely for free. How many users will find, and then buy, books they never could have discovered any other way? How many out-of-print and backlist titles will find new and renewed sales life? How many future authors will make a living ... solely because the Internet has made it so much easier for a scattered audience to find them? This egalitarianism of information dispersal is precisely what the Web is best at; precisely what leads to powerful new business models for the creative community; precisely what copyright law is ultimately intended to support; and, together with our partners, precisely what we hope, and expect, to accomplish with Google Print.
Resistance to Google is futile. The books will be assimilated.
Snow Falls Silent in China
Snow Shifts His Demands on China By Edmund L. Andrews, NY Times: For two years, Treasury Secretary John W. Snow has pushed and prodded China to let its currency float more freely. On Monday, he declared his satisfaction and changed the subject. After a week of meetings from Shanghai to Beijing, Mr. Snow buried his specific demands for the yuan beneath a broader call for China to overhaul its system of banking and investment. ... "We are here to encourage the progress, to support the progress," he said on Monday. "Moving toward a truly flexible exchange rate regime requires quite a large number of steps," he added. "We recognize that will take some time." That was a far cry from what American manufacturers had wanted ... Mr. Snow all but ruled out the possibility that he would accuse China of currency manipulation when he reports to Congress in early November. ... If Mr. Snow's week showed anything, it was that American officials have learned the limitations of pressuring Chinese leaders from outside.
Update: Interestingly, this editorial from the Wall Street Journal endorses the creation of social insurance programs in China (see Brad Setser for more on this) and China's efforts to intervene in currency markets and maintain a stable yuan:
Kibitzers in Beijing, Editorial, Wall Street Journal: It requires some audacity to tell another country how to run economic policy, but at least a high-level American delegation in Beijing is giving China some good advice, along with the bad, for a change. Although still fronting for protectionists in the U.S. Congress, Treasury Secretary John Snow and his entourage have become more constructive. To be sure, the administration still shows little sign of embracing the benefits that a stable yuan continue to bring, for both China and the global economy. ... Treasury Undersecretary for International Affairs Tim Adams told us that the currency issue was just one issue in a "three-pronged approach." The administration is now pushing China to ... focus more on domestic consumption and allow foreign companies help develop a more sophisticated financial-services industry. As Mr. Adams notes, the two goals are closely linked. A key factor behind China's high savings rate is the need to set aside funds to finance health care and retirement in the absence of an effective social security or private pension system. Developing financial instruments that allow Chinese to insure against these risks ... would obviate the need for such a high level of precautionary savings. ... China is remarkable among developing countries for its openness, in terms of both exports and imports and, however its economy develops in future, a stable yuan will continue to offer immense benefits not just to China but to its global trading partners. Mr. Snow's recognition that there are other issues besides China's currency is a step in the right direction. Perhaps in time it will allow Washington's yuan fixation to quietly fade into the background.
Alan Greenspan on Energy
Energy, by Alan Greenspan: Even before the devastating hurricanes of August and September 2005, world oil markets had been subject to a degree of strain not experienced for a generation. Increased demand and lagging additions to productive capacity had eliminated a significant amount of the slack in world oil markets ... Although the global economic expansion appears to have been on a reasonably firm path through the summer months, the recent surge in energy prices will undoubtedly be a drag from now on. In the United States, Japan, and elsewhere, the effect on growth would have been greater had oil not declined in importance as an input to world economic activity since the 1970s. How did we arrive at a state ... so fragile that weather, not to mention individual acts of sabotage or local insurrection, could have a significant impact on economic growth? ... The history of the world petroleum industry is one of a rapidly growing industry seeking the stable prices that have been seen by producers as essential to the expansion of the market. In the early twentieth century, pricing power was firmly in the hands of Americans, predominately John D. Rockefeller and Standard Oil. ... Rockefeller had endeavored with some success to stabilize those prices by gaining control ... of nine-tenths of U.S. refining capacity. But even after the breakup of the Standard Oil monopoly in 1911, pricing power remained with the United States ... Indeed, as late as 1952, crude oil production in the United States ... still accounted for more than half of the world total. ... Of course, concentrated control in the hands of a few producers over any resource can pose potential problems. ...[T]hat historical role ended in 1971, when excess crude oil capacity in the United States was finally absorbed by rising world demand. At that point, the marginal pricing of oil ... abruptly shifted to a few large Middle East producers ... To capitalize on their newly acquired pricing power, many ... in the Middle East, nationalized their oil companies. But the full magnitude of the pricing power of the nationalized oil companies became evident only in the aftermath of the oil embargo of 1973. ...[and the] ... further surge in oil prices that accompanied the Iranian Revolution in 1979... The higher prices of the 1970s abruptly ended the extraordinary growth of U.S. and world consumption of oil and the increased intensity of its use ... In the United States, between 1945 and 1973, consumption of petroleum products rose at a startling average annual rate of 4-1/2 percent, well in excess of growth of our real GDP. However, between 1973 and 2004, oil consumption grew ... at only 1/2 percent per year... Much of the decline in the ratio of oil use to real GDP in the United States has resulted from growth in the proportion of GDP composed of services, high-tech goods, and other presumably less oil-intensive industries. Additionally, part of the decline in this ratio is due to improved energy conservation ... These trends have been ongoing but have likely intensified of late with the sharp, recent increases in oil prices... [T]he story since 1973 has been as much about the power of markets as it has been about power over markets. ... The failure of oil prices to rise as projected in the late 1970s is a testament to the power of markets and the technologies they foster. Today, the average price of crude oil ... is still in real terms below the price peak of February 1981. Moreover, since oil use ... is only two-thirds as important an input into world GDP as it was three decades ago, the effect of the current surge in oil prices, though noticeable, is likely to prove significantly less consequential to economic growth and inflation than the surge in the 1970s...
[T]he opportunities for profitable exploration and development in the industrial economies are dwindling, and the international oil companies are currently largely prohibited, restricted, or face considerable political risk in investing in OPEC and other developing countries. In such a highly profitable market..., one would have expected a far greater surge of oil investments. ... But because of the geographic concentration of proved reserves, much of the investment in crude oil productive capacity required to meet demand, without prices rising unduly, will need to be undertaken by national oil companies in OPEC and other developing economies. Although investment is rising, ... many governments perceive that the benefits of investing in additional capacity to meet rising world oil demand are limited. ... Unless those policies, political institutions, and attitudes change, it is difficult to envision adequate reinvestment into the oil facilities of these economies. Besides feared shortfalls in crude oil capacity, the status of world refining capacity has become worrisome as well. ... A continuation of this trend would soon make lack of refining capacity the binding constraint on growth in oil use. This may already be happening in certain grades... [T]he expansion and the modernization of world refineries are lagging. For example, no new refinery has been built in the United States since 1976. ... Much will depend on the response of demand to price over the longer run. If history is any guide, should higher prices persist, energy use over time will continue to decline relative to GDP. ... With real energy prices again on the rise, more-rapid decreases in the intensity of energy use in the years ahead seem virtually inevitable. Long-term demand elasticities over the past three decades have proved noticeably higher than those evident in the short term...
Altering the magnitude and manner of energy consumption will significantly affect the path of the global economy over the long term. ... We cannot judge with certainty how technological possibilities will play out in the future, but we can say with some assurance that developments in energy markets will remain central in determining the longer-run health of our nations' economies. The experience of the past fifty years ... affirms that market forces play a key role in conserving scarce energy resources, directing those resources to their most highly valued uses. However, the availability of adequate productive capacity will also be driven by nonmarket influences and by other policy considerations. To be sure, energy issues present policymakers with difficult tradeoffs to consider. The concentration of oil reserves in politically volatile areas of the world is an ongoing concern. But ...one hopes ... that ... does not distort or stifle the meaningful functioning of our markets. Barring political impediments to the operation of markets, the same price signals that are so critical for balancing energy supply and demand in the short run also signal profit opportunities for long-term supply expansion. Moreover, they stimulate the research and development that will unlock new approaches to energy production and use that we can now only barely envision. Improving technology and ongoing shifts in the structure of economic activity are reducing the energy intensity of industrial countries ... If history is any guide, oil will eventually be overtaken by less-costly alternatives well before conventional oil reserves run out. Indeed, oil displaced coal despite still vast untapped reserves of coal, and coal displaced wood ... New technologies to more fully exploit existing conventional oil reserves will emerge in the years ahead. ... We will begin the transition to the next major sources of energy, perhaps before midcentury, as production from conventional oil reservoirs ... is projected to peak. In fact, the development and application of new sources of energy, especially nonconventional sources of oil, is already in train. Nonetheless, the transition will take time. We, and the rest of the world, doubtless will have to live with the geopolitical and other uncertainties of the oil markets for some time to come.
October 17, 2005
Philadelphia Fed President Santomero with an Insider's Look at Monetary Policy
I am confident that the passing of the torch from Chairman Greenspan to his successor will be smooth and seamless. For one thing, while processes may change, the Fed’s mission will not. Our dual mandate of fostering full employment and a stable price environment remains firmly in place. For another, ... In addition to the Chairman, the policy process also includes the other six members of the Board of Governors and the 12 Reserve Bank Presidents. All ... participate in the discussions, and contribute... The result is a dynamic mix of keen insight and intellect, of economic analysis and interpretation, and of stewardship and policymaking from some of the best economic minds in our nation. ... Media reports ... cite widespread concern over large fiscal budget and international trade deficits, ... growing inflationary pressures, and ever-present political uncertainties. They lament the passing of the baton from Alan Greenspan... A leading Wall Street economist recently called him “the world’s most revered central banker” and credited him with “...saving the world from financial collapse.” When I read this quote, I had a strong sense of déjà vu. I remember when Paul Volcker left the Fed. A New York Times article expressed a similar concern, saying: “The markets had incredible confidence in Paul. Investors saw him as the one guy with the knowledge, guts and skill to stop inflation and hold the system together… Indeed, some economists are saying that one reason there is growing fear of an economic catastrophe is that the Reagan administration let Volcker go, replacing him with the less-experienced and less-well-known Alan Greenspan.” In short, despite the challenges posed by any transition, I have no doubt that the Federal Reserve will continue to grow and evolve under its new leadership...
I agree. Now, on to the description of the FOMC policy setting procedure.
The Evolving Role of the FOMC: An Insider’s Perspective on Monetary Policy, Presented by Anthony M. Santomero, President, Federal Reserve Bank of Philadelphia: ...I would like to relate to you what I have learned on my journey from academia to the trenches of policymaking. And, I would like to share with you an insider’s perspective on the inner-workings of the Fed’s monetary policymaking activities as a current voting member of the ... Federal Open Market Committee. I will discuss the actual making of monetary policy, providing a glimpse into what goes on behind closed doors in Washington. Then, I will describe some of the challenges faced by monetary policymakers... In the end, I believe you will share my view that the Federal Reserve and its Federal Open Market Committee have proven to be very effective mechanisms for making sound monetary policy decisions.
The Federal Reserve Let me begin with the observation that the Federal Reserve is an enigma to many. ... Ask who in the Fed makes these decisions, or how they decide, and most people will say, “Alan Greenspan decides where interest rates should be. ” But in reality, it is actually a committee decision. Now that I am on the inside, I can ... provide insight on the Fed body that Congress has entrusted to direct monetary policy — the Federal Open Market Committee, or the FOMC...
The Mechanics of the FOMC Currently, the FOMC has eight scheduled meetings per year. ... During scheduled FOMC meetings, we follow a standard agenda. ... Perhaps most important to the meetings and adding immense value to the process is the diverse professional experience of the participants. With backgrounds ranging from banking, to finance, to economic forecasting, to academia, each participant brings his or her own perspective to the issues...
Let me be more specific. Most meetings are one-day events, running from 9:00 a.m. to about 1:00 p.m. Although roughly twice a year, we meet for two days ... The policy portion of every meeting begins with a review of recent events in both financial and foreign exchange markets, and a review of the details of open market operations since the last meeting. ... Next, the director of research and statistics at the Board of Governors presents the state of the national economy and the Board staff’s forecast of where the economy is headed. He includes considerable detail ... using our large-scale econometric model of the U.S. This is then supplemented by an overview of the international situation by the head of the international division at the Board of Governors. A thorough exchange of views, with questions and answers, debate and discussion, is all part of the process of sharing views and increasing understanding.
As you can imagine, there is a lot of material here. The forecast is assembled into a book ... often referred to as the Green Book... After the presentation of the staff forecast, the fun really starts. With the exception of the Chairman, each member — that is, six Governors and 12 Presidents — presents his or her views on their local regional economy and the national economy. The Bank Presidents generally provide in-depth and real-time information regarding developments in their own Districts... This discussion provides valuable “tone and feel” information about economic activity throughout the country. As a regional Bank President, I spend a good deal of my time collecting up-to-date intelligence on current and likely future economic conditions ... around the Third District, as well as my everyday contacts...
Next we move to the most crucial stage of the meeting: the discussion of policy options and a policy action. To focus the discussion, the director of the Division of Monetary Affairs, who is secretary to the Committee, outlines the options before us. ... He is not supposed to second guess the committee or to make a recommendation for a particular policy action, but rather to present a clear and objective case for the range of actions the Committee may wish to consider, offering both the pros and cons surrounding the policy under consideration. Typically, three options are considered, most often centering on should interest rates be moved up, down, or kept the same. This analysis too is sent to the FOMC participants in advance in a second book known as the Blue Book for its traditional blue cover.
At this point the Chairman weighs in. After hearing all the arguments and data and weighing people’s views, he offers his perspective on where the economy is, what the risks are, and what appears to be the appropriate policy going forward. This is followed by a second go-round in which all of the participants react to both the policy options presented and the Chairman’s proposal. At times this can be lively, as the Committee tries to converge on a consensus. It is common for some differences of opinion to remain; yet the decision is most often one that all can support. This is then followed by the formal vote. ... Up until this point we may have decided what to do, but now we must direct the operating parts of the Fed to take action consistent with the policy decision, and we must inform the public of our actions. The first is reasonably straightforward. The System Open Market Desk is instructed to ... cause the fed funds rate to move to the ... target ... Next, the FOMC considers its public announcement. When the Committee votes on the policy action, the press release is discussed at some length. Our goal here is to inform the market of not only what we decided but why...
Before adjourning, the FOMC breaks so that the members of the Board of Governors may convene to vote on requests they have received from Reserve Bank’s boards of directors to bring the discount rate in line with the new fed funds target...
A Period of Transition ...But you may be asking yourself – will this soon change? As many of you know, Alan Greenspan’s term at the Fed is coming to a close. ... as the Greenspan era draws to a close, we look ahead at the challenges we face under a new Chairman in an increasingly complex economic environment. The new leader of the Fed may have his or her own way of doing things. So, some aspects of the process of policymaking may change as a new Chairman directs both the Board of Governors and the FOMC. Under new leadership, processes and policies are often reviewed and restructured. This can mean simple things: for example, perhaps a move toward electronic dissemination of documents, or more substantive things, like a move to inflation targeting, which some FOMC members, myself included, support. Nonetheless, I am confident that the passing of the torch from Chairman Greenspan to his successor will be smooth and seamless. For one thing, while processes may change, the Fed’s mission will not. Our dual mandate of fostering full employment and a stable price environment remains firmly in place. For another, our nation’s central bank is more than one person. In addition to the Chairman, the policy process also includes the other six members of the Board of Governors and the 12 Reserve Bank Presidents. All attend FOMC meetings, participate in the discussions, and contribute to the Committee's assessment of the economy and policy options. The result is a dynamic mix of keen insight and intellect, of economic analysis and interpretation, and of stewardship and policymaking from some of the best economic minds in our nation.
...Media reports endlessly dissect the upcoming transition of leadership at the Fed. They cite widespread concern over large fiscal budget and international trade deficits, as well as concerns over potentially growing inflationary pressures, and ever-present political uncertainties. They lament the passing of the baton from Alan Greenspan, who, during his chairmanship, became one of the most venerated figures in economic history. A leading Wall Street economist recently called him “the world’s most revered central banker” and credited him with “achieving record-low inflation, spawning the largest economic boom in U.S. history, and saving the world from financial collapse. ”
When I read this quote, I had a strong sense of déjà vu. I remember when Paul Volcker left the Fed. A New York Times article expressed a similar concern, saying: “The markets had incredible confidence in Paul. Investors saw him as the one guy with the knowledge, guts and skill to stop inflation and hold the system together… Indeed, some economists are saying that one reason there is growing fear of an economic catastrophe is that the Reagan administration let Volcker go, replacing him with the less-experienced and less-well-known Alan Greenspan. ” In short, despite the challenges posed by any transition, I have no doubt that the Federal Reserve will continue to grow and evolve under its new leadership.
Of course, Chairman Greenspan and the Greenspan era have been special. ... How did he accomplish so much?It should be remembered that Alan Greenspan is first and foremost an extraordinary economist. ... But if Alan Greenspan is an extraordinary economist, he is also an extraordinary leader. He will also be remembered as a consensus builder and a developer of talent. It shows in the strength of the organization and the strong consensus that has been achieved at our monetary policy meetings. Unanimity is the rule, not the exception, in spite of strong voices and difficult circumstances. This is a testament to his leadership and the prognosis for a strong Fed for years to come.
Transparency Yet, I think that historians will probably remember the Greenspan era most for the changes we have made to the transparency of Fed policymaking over the past decade. This openness has been the defining aspect of recent monetary policy under the current Chairman. The FOMC has been moving in the direction of greater transparency for some time, and its communication with the markets has improved greatly over the past decade. Information about the Fed's policy goals, its assessment of the current economic situation, and its strategic direction are increasingly part of the public record.
The goal of all these steps is to inform markets about where the FOMC sees the economy today and where it thinks the economy is headed in the future. This has proved to be useful information that has improved the markets’ understanding of our view of the economy and offers them insights into the direction of possible future policy actions. All of these actions are steps in the right direction. It is important for the FOMC to be as open as possible. ... And the record shows it. I believe it is fair to say that monetary policy over the past 15 years has dampened economic volatility even while it has maintained the Fed’s commitment to a stable price environment. Notwithstanding the recent recession, the U.S. economy has performed quite well over the past decade or so; I think the Fed deserves at least some of the credit.
Challenges to Monetary Policy However, although we can take comfort from past FOMC actions, the Committee’s task going forward is not without its share of challenges. I would like to close my formal remarks by taking a few minutes to reflect on the limits and limitations that we continue to face when conducting real-time monetary policy.
However, before I list these on going challenges, let me put them in context. I believe that Fed policy since the Great Inflation has demonstrated both the value of, and the Fed’s commitment to, a stable price environment. Another thing we have learned — and it has been an expensive lesson — is that the best the Fed can do is cushion the economy. It cannot in and of itself force stronger growth than the economy is capable of delivering. Trying to push an economy beyond its potential may temporarily accelerate growth, but it also creates imbalances and increases inflationary pressures that must be addressed, and so boom leads to bust. So looking ahead, I am confident the Fed will take policy actions consistent with economic fundamentals and keep its focus on long-run objectives. ... The appropriate conduct of real-time monetary policy requires policymakers to gauge how strong or weak the economy is at any moment in time, what its most likely trajectory appears to be, and how that trajectory aligns with its long-run potential. This requires a detailed appraisal of data and, importantly, of real-time data on the current state of the economy. Unfortunately, these data often give very noisy signals of what is really going on, and our ability to affect the economy is limited by a few very real technical factors. So, I will close by listing just a few challenges we face in this regard.
Uncertain Measurement The first challenge is our limited capacity to precisely measure and forecast economic conditions in an economy as large and complex as ours. Lags in data reports, on-going data revisions, and the imprecision of the large-scale economic models - all of these things significantly limit our ability to use the tools of economic analysis. In other words, we work with data that are released with a lag and subject to revisions. ... Indeed, the data on which we rely in real time can be imprecise enough to distort the tenor of our policy deliberations and the apparent wisdom of alternative policy actions.
Uncertain Policy Lags The second challenge in contemplating future policy actions is the long and variable lags associated with the impact of our monetary policy actions. It has been estimated that it takes six to 18 months for monetary actions to fully impact the economy. Unfortunately, we never know for certain exactly how long the policy lag will be in any given situation, and waiting to find out is not an option. This is why I argued that the FOMC must focus its efforts on sustaining the expansion and gearing its monetary policy toward long-term growth objectives...
Expectations A final challenge facing monetary policy relates to the role that expectations play in the U.S. economy. ... the recent past has demonstrated that expectations matter a great deal. As consumers and businesses alter their expectations of the future, their behavior changes. If their views change dramatically, this can cause a significant change in real demand. ... The Fed cannot and should not try to manage public expectations. However, it can help stabilize them by being as transparent as possible in its own decision-making. It also must recognize that variations in expectations can have real economic effects that may warrant response...
Conclusion With this I will close. I hope ... you will share my view that the FOMC has proved to be an effective mechanism for making sound monetary policy decisions. Not necessarily perfect, but effective.
Banking Reform in China
Will China's Banking Reform Succeed? By Weijian Shan, Wall Street Journal: ...more than two years ago, China's newly appointed governor of the central bank, Zhou Xiaochuan, told a business audience that China would take a "gradualist" approach to reforming its banking system. Many thought the governor meant China was in no hurry to fix its banks. Since then, however, China has injected more than $60 billion to recapitalize four of its five largest banks and has transferred some $200 billion worth of nonperforming loans out of these banks ... almost twice as much as Korea spent to restructure its banks during the 1997-98 financial crisis. ... A healthy banking system ... is necessary for China to sustain its economic growth. ... In spite of its rapid growth ... the Chinese economy remains inefficient and wasteful. ... These inefficiencies have not yet slowed down the economic expansion because the growth fueled by the country's extraordinarily high savings rate ... As the savings are channeled into investments by banks, the inefficiencies and wastefulness simply turn into bad loans. ... To continue to grow, China needs to clean up its banking system and force its banks to kick the habit of underwriting bad loans. A strong banking system will ensure more efficient allocation and use of scarce resources, allowing the economy to grow on the basis of improved productivity, as opposed to increased input. Chinese leaders' resolve to reform the nation's banking system shows that they understand what it takes to sustain economic growth. They are wise and far-sighted enough to take painful measures without waiting until the going gets tough. Whereas many other countries regard foreign capital as the last resort or a necessary devil in solving a banking crisis, China is in the enviable position of having sufficient [foreign-exchange reserves] to clean up its banks without foreign help. ...
China wants foreign investors not so much for their capital, but for the expertise they bring in. As such, China is prepared to be generous. ... Foreign investors may be only minority shareholders. But it is whether they are treated as necessary devils or welcome angels that will make the difference between the success and failure of China's banking reform. Chinese banking officials do not wish foreign investors to simply take a ride. They want them to contribute to changing how banking business is conducted in China. Chinese banking reform does not just redress the balance sheet, it involves systemic change. ... the most significant step is China's effort to push its banks to adopt good corporate governance. Almost all the national banks have been, or are in the process of being, transformed into joint stock companies with boards whose independent directors must represent a third of the total. ... This subjects them to greater transparency, tighter supervision and close scrutiny by overseas regulators and public shareholders. While what China has accomplished thus far in its banking reform is impressive, Chinese banking still has a long way to go to meet international best practices. ... More broadly, it will take time for Chinese banks to build a real credit culture in which lending decisions are made on the basis of the credit worthiness of the borrower and risk analysis, regardless of relationships and government policies. In hindsight, a "gradualist" approach means one step at a time, although the pace of change is anything but slow. ... The rest of the journey will be very tough. Still, there is good reason to believe that China will get there eventually, given the vision and resolve its leadership has shown in banking reform so far.
Cutting the Budget at the Center of House Agenda
House GOP Leaders Set to Cut Spending Leadership Shake-Up Spurred Policy Shift, by Jonathan Weisman, Washington Post: House Republican leaders have moved from balking at big cuts in Medicaid and other programs to embracing them, driven by pent-up anger from fiscal conservatives concerned about runaway spending and the leadership's own weakening hold on power. Beginning this week, the House GOP lawmakers will take steps to cut as much as $50 billion from the fiscal 2006 budget for health care for the poor, food stamps and farm supports, as well as considering across-the-board cuts in other programs. Only last month, then-House Majority Leader Tom DeLay (Tex.) ... told a packed room of reporters on Sept. 13 that 11 years of Republican rule had already pared down the federal budget "pretty good." ... But faced with a revolt among many conservatives sharply critical of him for resisting spending cuts, DeLay three weeks later told a closed meeting of the House Republican Conference, "I failed you," according to a number of House members and GOP aides. Then, in a nod to the most hard-core conservatives, DeLay volunteered, "You guys filled a void in the leadership." The abrupt shift reflects a changed political dynamic in the House in which a faction of fiscal conservatives -- known as the Republican Study Committee, or RSC -- has gained the upper hand because of DeLay's criminal indictment in Texas, widespread criticism of the Republicans' handling of Hurricane Katrina, and uncertainty over the future of the leadership, according to lawmakers and aides. Now, cutting the budget -- which only months ago seemed far from possible -- is at the center of the agenda in the House. ... But Republicans could be taking a big risk by cutting Medicaid programs while their standing in the polls has plummeted and Democrats gear up for a fight. "We have seen a sea change in the budget policies of House Republicans," said Thomas S. Kahn, the Democratic staff director of the House Budget Committee. "Clearly, the RSC's influence over their budget policies is in the ascendancy."...
The rest of the article contains an interesting account of the politics in the background. With respect to the budget cuts to items like health care for the poor, food stamps, and farm supports, I expect a political firestorm, but a faint voice reminds me to not to be so sure. Outrage is spread pretty thin these days.
[Update: Please read Brad DeLong's post about this story here. Even given Brad's comments about this not being anything new, save for 3 billion, the focus of the discussion in congress and the potential change in power within congress is still of concern because it indicates where future deficit reduction efforts will be focused.]
Paul Krugman: The Big Squeeze
The Big Squeeze, by Paul Krugman, NY Times: ...There are a lot of questions about how Delphi and the auto industry in general reached this point. ... But Delphi's bankruptcy is a much bigger deal than your ordinary case of corporate failure and bad, self-dealing management. If Delphi slashes wages and defaults on its pension obligations, the rest of the auto industry may well be tempted - or forced - to do the same. And that will mark the end of the era in which ordinary working Americans could be part of the middle class. There was a time when the American economy offered lots of good jobs - jobs that didn't make workers rich but did give them middle-class incomes. The best of these good jobs were at America's great manufacturing companies, especially in the auto industry.
As Krugman notes, while America has grown wealthier since 1970, wages have barely kept up with inflation. And as noted recently in the media and elsewhere (e.g. see here), and by Krugman as well, since 2004 the median real income of full-time male workers declined by over 2%. That's of concern:
So what are we going to do about it? During the 1990's optimists argued that better education and worker training could restore the economy's ability to create good jobs. Mr. Miller of Delphi picked up that argument as part of his public relations campaign for wage cuts: "The world pays knowledge workers far more than it pays manual, industrial workers," he said. "And that's what's sweeping over here." But that's a very 1999 sort of answer. During the technology bubble, it was easy to believe that "knowledge workers" were guaranteed good jobs. But when the bubble burst, they turned out to be as vulnerable to downsizing and layoffs as assembly-line workers. And many of the high-paid jobs that vanished when the technology bubble burst have never come back, partly because they have been outsourced to India and other rising economies. Today, some of us like to stress the depressing effect of the dysfunctional American health care system on wages. A large part of the problem facing the auto industry and other employers ... is the cost of providing health insurance.... If we had a Canadian-style system ... the big squeeze might be averted, at least for a while. One more reason to be angry with auto executives is that they never threw their support behind national health care in this country, even though such a system is clearly in their companies' interest. What if neither education nor health care reform is enough to end the wage squeeze? That's the possibility that makes free-trade liberals like me very nervous, because at that point protectionism enters the picture. When corporate executives say that they have to cut wages to meet foreign competition, workers have every right to ask why we don't cut the foreign competition instead. I hope we don't have to go there. But denial is not an option. America's working middle class has been eroding for a generation, and it may be about to wash away completely. Something must be done.
I am not ready to give up on education and infrastructure development as a means of getting the U.S. ready to withstand competition in the future. Are we developing and supporting our educational resources and infrastructure so as to be competitive in the emerging global economy? Or are we squandering the opportunity by running up huge budget deficits for other purposes leaving few resources to use to withstand the competitive onslaught that will inevitably come at us? Looking at this chart, and having seen many like it, I am not convinced we have invested in ways that allow the type of educational access for the middle class available in the 1960s and 1970s. Until we've given this a good faith effort, and its hard to say we have when per student support for higher education, and education more generally, has been falling for decades, I can't yet write education off as a viable strategy. Yes, we need to reign in health care costs, etc. that will help too, but let's not abandon knowledge and infrastructure in the process. As the world develops, we will have an comparative advantage in something and that is what we will produce - we won't outsource our comparative advantage. I would prefer it be jobs with the highest possible marginal product and compensation for all our workers.
October 16, 2005
Inflation Adjusted Tuition and Fees Since 1975
Inflation Adjusted Tuition and Fees
Time periods when the disinvestment in higher education has been the most rapid, around 1981, 1991, and 2001, are evident in the graph.
A Recipe for Product Differentiation
Branding, The Myth of Authenticity, by Alicia Clegg, brandchannel.com (also in BusinessWeek Online): What do brands like Häagen Dazs, Baileys Original Irish Cream, Bombay Sapphire and Kerrygold all have in common? Each stretches the myth behind the brand to promote heritage and authenticity. Somewhere in my handbag there's a bar of chocolate with mysterious links to ancient Mayans. I'm going to eat it with a mug of coffee from the "volcanic slopes and Caribbean mountains of Guatemala." ... Working the link between place of origin and product quality is the oldest trick in the brand book. It milks our thirst for mythology and plays mercilessly on our superstitious hope that special places have the power to revitalise and transform. But just how deep does the connection have to be for the magic to cast its spell? ... delve a little deeper and it quickly becomes apparent that the cut-off that divides spoofs from the genuine article is far from precise. At one end of the spectrum are the tricksters; brands like Häagen Dazs ... which brazenly trades on the ice-cool sophistication implied, but never quite claimed, by its phony Scandinavian-sounding name. At the other extreme are genuine nobility, fine wines..., single estate teas and waters prized for their local mineral properties. Somewhere in the middle are brands that mingle fact and fiction in an imaginative fusion of make-believe and authenticity. Which approach suits the brand-savvy world of the post-modern consumer ... do brands that take poetic liberties with our fancy set themselves up for a fall?
Baileys Original Irish Cream is a classic example of a brand that climbs high on the back of a provenance blending fact with fiction. Launched in 1974, Baileys is the world's top selling liqueur brand. In each and every country, the idea that sells Baileys is its Irishness. "It's hugely important," says Baileys' external affairs director Peter O'Connor. ... But is Baileys Irish? So far as the ingredients go, Baileys is what it says: Irish. ... But the Celtic motifs on the label surely hint at a more ancient past than Baileys can legitimately lay claim to in its thirty-plus years of business. ... Its identity is a sham, a colorful invention cooked up by a multinational drinks group, in a London office overlooking the Bailey hotel. And the signature? "There's no Mr or Mrs Bailey," admits O'Connor. "... The R.A. Bailey was a way of ... getting across that the product comes from Ireland." ... Strong design and good judgment have helped Baileys make the most of its assumed identity. The packaging ... has strong Irish associations, but the allusions are made sparingly ... The bottle's retro look has been carefully managed too...
Beverage specialist Clipper is a master of imaginative suggestion. On its classic teas range, the company displays artworks loosely associated with the product's place of origin. The English breakfast blend shows a carved sandstone relief from sixth century Northern India; the Assam tea is represented by a jeweled turban pin from the Mughal dynasty. ... The links between modern classics and the cultures to which they lay claim are sometimes very loose indeed. Premium gin Bombay Sapphire is a good example of this. Launched in 1987, the brand is allegedly made from a long-lost recipe dating back to 1761. The brand's main pulling point ... is its design-led square blue bottle depicting Queen Victoria, Empress of India. But how many of ... its "heritage cues," have a basis in fact? Not many. ... the brand has no links with the famous jewel, nor with Victoria, beyond the hijacked allusions. ... Yet curiously, none of this takes away from Bombay's appeal. What counts is that the fusion of ideas works stylistically, elevating it into something more interesting than just another gin brand. ... Brands that aspire to be contemporary classics have to work on many levels. First and foremost, the product needs ... some special quality that sets it apart. But having a "story" to tell, something that fixes a brand's identity in people's imagination and gets across what it stands for is crucially important too. Whether the story is made up, or rooted in fact, is beside the point. Like a fable in folklore, what matters is that the brand's mythology has the power to intrigue and to draw people in.
Thanks for the Suggestion
U.S. Offers Details of Plan for Open Markets in China By Edmund L. Andrews, NY Times: The Bush administration is expected to present China's political leaders on Sunday with a sweeping plan to overhaul China's financial markets and open the country to foreign banks, investment firms and insurance companies. ... The plan ... calls for China to speed up the privatization of state-owned companies, including banks; to develop a Chicago-style futures market for currency trading; to establish an independent credit-rating agency; and to crack down on bailouts for banks left holding bad loans. "What we tried to do is take a quantum leap in sophistication and scope," said Timothy D. Adams, undersecretary for international affairs at the Treasury Department. "It gives you a picture of the truly complex nature of what we are trying to do." Though many of the ideas are familiar, and often supported by Chinese leaders in principle, the list reflects an increased effort to lecture China about internal financial issues. That could backfire. Chinese leaders invariably bristle at pressure from American officials, and they could view the new American "priorities" as an unwelcome intrusion. The new tack comes as Treasury Secretary John W. Snow continues to show little progress on the volatile economic dispute with China over exchange rates...
The Privatization of Public Universities
At Public Universities, Warnings of Privatization By Sam Dillon, NY Times: Taxpayer support for public universities, measured per student, has plunged more precipitously since 2001 than at any time in two decades, and several university presidents are calling the decline a de facto privatization of the institutions that played a crucial role in the creation of the American middle class. Graham Spanier, president of Pennsylvania State University, said this year that skyrocketing tuition was a result of what he called "public higher education's slow slide toward privatization." ... The share of all public universities' revenues deriving from state and local taxes declined to 64 percent in 2004 from 74 percent in 1991. At many flagship universities, the percentages are far smaller. About 25 percent of the University of Illinois's budget comes from the state. Michigan finances about 18 percent of Ann Arbor's revenues. The taxpayer share of revenues at the University of Virginia is about 8 percent. "At those levels, we have to ask what it means to be a public institution," said Katharine C. Lyall, an economist and president emeritus of the University of Wisconsin. "America is rapidly privatizing its public colleges and universities, whose mission used to be to serve the public good. But if private donors and corporations are providing much of a university's budget, then they will set the agenda, perhaps in ways the public likes and perhaps not. Public control is slipping away."
Around here, you see examples of this everywhere. We are now building much of the infrastructure on campus using donor money rather than state support. Many faculty now come to us as endowed chairs funded from private sources. At the University of Oregon the percentage of state support is 13%, down from 32% in 1990 and the share of that from tuition, i.e. out of student's pockets, has risen substantially during that time. And if you include all the fees that have been shifted onto students that are billed separately from tuition, their share has risen even more:
...the future of hundreds of universities and colleges has become a subject of anxious debate nationwide. At stake are institutions that carry out much of the country's public-interest research and educate nearly 80 percent of all college students, and whose scientific and technological innovation has been crucial to America's economic dominance. ...The average in-state tuition nationwide for students attending four-year public colleges increased 36 percent from 2000-01 through 2004-05, according to the College Board, while consumer prices over all rose about 11 percent. The Morrill Act of 1862 granted federal land to states to finance the creation of public universities, and one of their core missions ever since has been to provide services that promote the well-being of communities and states. Today, educators using the term "privatization" say universities are being forced to abandon this social compact. In the process, many major public universities are looking more like private ones.
Since the state isn't supporting us to any significant degree, we have been trying to get out from under many of the state's restrictions. That part is a lot harder. That 13 cents on the dollar purchases a lot of restrictions on what we are allowed to do as an institution. One thing we asked the state to do was to allow us to set our own tuition rates, or at least set them different from other schools in the state. We were allowed some, but not full flexibility. We are not alone in these types of requests:
For instance, the University of Virginia and other public universities in the state responded to years of dwindling financing by asking Virginia's General Assembly to extend their autonomy and to reaffirm the university governing boards' authority to raise tuition. ... Two years ago, Miami University of Ohio became the first public institution to adopt the tuition model used by private colleges, eliminating the differential between in-state and out-of-state residents. Across the nation, educators said, public anger is rising not only about tuition but about the increasing numbers of faculty members who focus on research rather than on teaching undergraduates, and about the time that university presidents spend hobnobbing with billionaires. University administrators say all three phenomena are related to the transformation of revenues. As private donations and federal grants make up a larger proportion of universities' revenue, more professors are paid mainly to conduct research. And as state financing drops, more building projects depend on private philanthropy. At the University of Wisconsin at Madison, Grainger Hall, which houses the business school, was financed largely by donations from David W. Grainger, chairman of W. W. Grainger Inc., the business-to-business distributor; from his wife; and from the Grainger Foundation. The school of pharmacy is in the new Rennebohm Hall, named after Oscar Rennebohm, whose drugstore chain amassed a fortune. The Rennebohm Foundation financed the building. "Wisconsin people see all the construction on campus and don't understand why the university is complaining about budget cuts," Dr. Lyall said. "We have this apparent incongruity of building growth at a time when resources for teaching in those buildings are shrinking."
And this point is important too:
But flagship universities are less vulnerable to financing declines than are hundreds of state-run four-year colleges that do not offer doctoral programs or conduct significant research, said David Ward, president of the American Council on Education, the nation's largest association of universities and colleges. The flagships can replace some state revenues with federal grants and private donations, but the four-year colleges cannot ...
As we shift more and more costs onto students, as we go out of our way to attract students who provide more net revenue, as we accept more and more money with small seemingly insignificant strings attached, we should look very carefully at the students that are excluded in the process and at how it potentially diverts us from our core mission.
October 15, 2005
New Law Induces Big Increase in Bankruptcy Filings
A Rush to Beat Bankruptcy Deadline Filings Spike on Last Weekday Before Tougher Law Takes Effect, by Terence O'Hara, Washington Post: ...bankruptcy court clerk offices around the region and the country yesterday overflowed with filers beating the deadline before tougher new bankruptcy rules take effect Monday. ... Charles Miller, division manager of the Alexandria court clerk's office, said ..."We were surprised by how well prepared the filers were in general," ... "They had done their homework. They just waited until the last minute." The line of filers stretched out of the clerk's office waiting room in the late afternoon. "It was wild ... at least wild for us," Miller said. The rush to file under existing bankruptcy rules was caused by passage this year of the Bankruptcy Abuse Prevention and Consumer Protection Act , which takes effect at midnight Sunday night. The law, long pushed by banks and consumer lending companies, is the most extensive change in the U.S. bankruptcy code in decades. It makes it harder for individual filers to erase debts by, among other things, requiring filers to go through credit counseling. Higher-income filers in many cases will be forced into Chapter 13 bankruptcies, which require repayment of a least a portion of debt. ... "The biggest change is that it increases dead-weight transaction cost of doing a bankruptcy," said Robert Weed, one of the most active bankruptcy lawyers in the Alexandria court. The new law has been a boon, at least temporarily, to Weed and other bankruptcy lawyers. ... He started turning away clients three weeks ago and had a goal of getting all his clients filed by Thursday. ... courts in New York City, Denver and other jurisdictions reported lines stretching out into streets. In Denver, 300 people were lined up to file by mid-morning. ... Burlingame, Calif.-based Lundquist Consulting Inc., which compiles bankruptcy statistics, said it expected 200,000 bankruptcy filings this week, far and away a weekly record. Typically, there are about 30,000 filings in a week...
Debtors Throng to Bankruptcy as Clock Ticks, By Eric Dash, NY Times: ...Through Oct. 8, consumers had filed more than 1.47 million bankruptcy petitions, a 19.4 percent increase over the same period in 2004, according to Lundquist Consulting, a company in Burlingame, Calif., that compiles bankruptcy statistics. Almost 103,000 petitions were filed in the first three days of this week alone. ... "We have never seen anything like this," said Barbara J. May, a consumer bankruptcy lawyer in St. Paul. "We knew it would be an upswing, but this is pandemonium."
NOVEMBER 1955 FOUNDERING THEORY—The size and peculiar shape of the Pacific trenches stir our sense of wonder. What implacable forces could have caused such large-scale distortions of the sea floor? And what is the significance of the fact that they lie along the Pacific ‘ring of fire’—the zone of active volcanoes that encircles the vast ocean? Speculating from what we know, we may imagine that forces deep within the earth cause a foundering of the sea floor, forming a V-shaped trench. The depth stabilizes at about 35,000 feet, but crustal material, including sediments, may continue to be dragged downward into the earth. This is suggested by the fact that the deepest trenches contain virtually no sediments, although they are natural sediment traps.
One hundred years ago, this appeared:
NOVEMBER 1905 TORPEDO MISS—...it cannot be denied that the torpedo has, at times, been greatly overrated. Indeed, the experience of the recent war seems to prove that only under exceptional and very favorable conditions can the torpedo get in its blow. In the fleet engagements on the high seas it seems to have exercised very little, if any, influence upon battle formations. Consequently, we think it unlikely that torpedo tubes will be fitted into future warships.
Posted by Mark Thoma on Saturday, October 15, 2005 at 12:35 AM in Science
St. Louis Fed President Poole Describes the Fed's Monetary Policy Rule
Fed Successor Should Keep Predictability, Poole Says, Bloomberg: Federal Reserve Chairman Alan Greenspan's successor should maintain his policy of ''consistent and predictable'' moves in the benchmark U.S. interest rate, St. Louis Fed President William Poole said. ... ''We should be hopeful that consistent and predictable Fed policy is likely to continue into the future.'' ... Poole didn't comment on the near-term outlook for interest rates or the economy. The ''highly predictable'' nature of Fed policy in recent years will ''be seen as one of the hallmarks of the Greenspan era,'' said Poole ... On Sept. 20, the Federal Open Market Committee voted to raise the benchmark U.S. interest rate to 3.75 percent and repeated a statement that suggests the rate will continue to rise at a ''measured'' pace. ... ''In due time, the language is going to change,'' Poole said today ... ''What we want to do is make sure we do not have expectations build'' for inflation, Poole told reporters... ''What we are trying to do is to prevent increases, which we have seen from energy, from passing through'' to core inflation and ''becoming a generalized inflation problem.'' ... ''Policy actions should be unpredictable only in response to events that are themselves unpredictable. The response function itself should be as predictable as possible.'' While the Fed can strive to keep inflation at a certain level when averaged over a period of several years, it would be a ''losing game'' to try to eliminate short-term fluctuations, Poole said ... Going after short-term fluctuations ''may have important side effects on financial markets, and indeed employment and output, that are undesirable,'' he said. ''What you need is a central bank framework that produces a high degree of certainty about the average inflation rate over a span of a couple of years, and then you let the market handle all the short-run stuff.'' Fed actions won't affect the rising prices of natural gas, Poole said. ... ''Monetary policy is not going to be able to help restore natural gas production in the Gulf of Mexico,'' Poole said...
Here's the speech itself. I cut a bit, then added the graphs to the text to avoid having them on a separate page as in the original, so this post is relatively long. But for those interested in the nuts and bolts of monetary policy and how to interpret Fed actions, it's worth it. For example, at a recent meeting several regional banks did not propose increases in the discount rate. Poole discusses how to interpret such events, how to interpret what's written up in press releases and minutes, what the Fed considers in setting the target federal funds rate, and so on. The footnotes and references are in the original linked document:
The Fed's Monetary Policy Rule, by William Poole, president, St. Louis Fed: ...I’ve chosen a title designed to be provocative, for I suspect that few consider current Federal Reserve policy as characterized by a monetary rule. My logic is this: There is now a large body of evidence, which I’ll review shortly, that Fed policy has been highly predictable over the past decade or so. If the market can predict the Fed’s policy actions, then it must be the case that Fed policy follows a rule, or policy regularity, of some sort. My purpose is to explore the nature of that rule... Before digging into specifics, consider what the “rules versus discretion” debate is about. Advocates of discretion, as I interpret them, are primarily arguing against a formal policy rule, and certainly against a legislated rule. They believe that policy will be more effective if characterized by “discretion.” Discretion surely cannot mean that policy is haphazard, capricious, random or unpredictable. ... My view has evolved over time to this general position: Monetary economists have not yet developed a formal rule that is likely to have better operating properties than the Fed’s current practice. It is highly desirable that policy practice be formalized to the maximum possible extent. ... monetary economists should embark on a program of continuous improvement and enhanced precision of the Fed’s monetary rule. It is possible to say a lot about the systematic characteristics of current Fed practice, even though I do not know how to write down the current practice in an equation. It is in this sense that I’ll be describing the Fed’s policy rule. And given that, as far as I know, there is no other effort to state in one place the main characteristics of the Fed’s policy rule, I’m sure that subsequent work will refine and correct the way I characterize the rule...
Policy Predictability—A Summary of Findings I’ve discussed the predictability of Fed policy decisions on a number of occasions, most recently in a speech on October 4, 2005 entitled, “How Predictable Is Fed Policy?” Let me summarize the main findings. Over the past decade, the FOMC has undertaken a number of steps towards greater transparency that have greatly improved the ability of markets to predict future policy actions. ... As I have noted previously, I believe that the evidence supports the conclusion that these steps towards increased transparency have brought the markets into much better “synch” with FOMC thinking about appropriate policy actions...
Policy Goals ...The dual mandate in the Federal Reserve Act ... provides for goals of maximum ... price stability, and maximum employment. There are two aspects to achieving the employment goal. First, achieving low and stable inflation maximizes economy’s growth potential and, probably, maximizes the sustainable level of employment. Second, the Fed can enhance employment stability through timely adjustments in its policy stance. ... The Fed has gravitated to a specification of the inflation goal stated in terms of the core PCE index. In the FOMC meeting of December 21, 1999, Chairman Greenspan provided a clear statement of the case for focusing on the PCE price index rather than on the CPI.
The reason the PCE deflator is a better indicator in my view is that it incorporates a far more accurate estimate of the weight of housing in total consumer prices than the CPI. The latter is based upon a survey of consumer expenditures, which as we all know very dramatically underestimates the consumption of alcohol and tobacco, just to name a couple of its components. It also depends on people’s recollections of what they spent, and we have much harder evidence of that in the retail sales data, which is where the PCE deflator comes from.(6)
There is evidence that the goal is effectively 1-2 percent annual rate of change, averaged over a “reasonable” period whose precise definition depends on context. ... I regard inflation stability as the primary goal not because it is more important in a welfare sense than maximum employment but because achieving low and stable inflation is prerequisite to achieving employment goals. Inflation stability also enhances, but does not guarantee, financial stability. I take note, but will not further discuss here, the ongoing debate as to whether the inflation goal should be formalized as a particular numerical goal, or range.
Characteristics of the Fed Policy Rule The Fed policy rule has a number of elements that can be identified, and in many cases quantified. I’ll now discuss the most important of these.
The Taylor Rule. Statements and testimony of Chairmen ... and other FOMC participants, supplemented by the transcripts and minutes of FOMC discussions ... clearly indicate that the long-run objective of Federal Reserve monetary policy is to maintain price stability... In the short run, policy actions are undertaken with the intention of alleviating or moderating cyclical fluctuations, as Chairman Greenspan has noted:
… monetary policy does have a role to play over time in guiding aggregate demand into line with the economy’s potential to produce. This may involve providing a counterweight to major, sustained cyclical tendencies in private spending, though we can not be overconfident in our ability to identify such tendencies and to determine exactly the appropriate policy response.(8)
Over 10 years ago, John Taylor (1993) noted that these characteristics of FOMC policy actions could be summarized in a simple expression:
i = p + .5 (p - p*) + .5y + r* = 1.5 (p - p*) + .5y + (r * + p*)
where i is the nominal federal funds rate p is the inflation rate p* is the target inflation rate y is the percentage deviation of real GDP from a target, and r* is an estimate of the “equilibrium” real federal funds rate.
Under this characterization of the systematic or “rule-like” character of FOMC policy actions, the funds rate is raised [lowered] when actual inflation exceeds [falls short of] the long-run inflation objective and is raised [lowered] when output exceeds [falls short of] a target level. In Taylor’s example, the target for GDP was constructed from a 2.2 percent per annum trend of real GDP starting with the first quarter of 1984. In subsequent analyses this target has been interpreted as a measure of “potential GDP.” When inflation and real GDP are on-target, then the policy setting of the real funds rate is the estimated equilibrium value of the real rate. ... Taylor showed that his equation closely tracked the actual federal funds rate from 1987 through 1992 except around the stock market crash in October 1987. For such a rule to be operational, data on the inflation rate and GDP must be known to the FOMC. In practice, the equation can be specified with lagged data on inflation and GDP. More generally the equation can be written:
where is the previous quarter’s PCE inflation rate measured on a year-over-year basis, yt–1 is the log of the previous quarter’s level of real gross domestic product (GDP), and yPt–1 is the log of potential real GDP as estimated by the Congressional Budget Office. In order to ensure a “nominal anchor” for the economy, the coefficient a must be greater than 1.0.
Figure 1 shows the equation with the Taylor coefficients (a=1.5, b=.5), an assumed equilibrium real rate of interest of 2.0, and an assumed inflation target of 1.5 percent. The solid line shows the actual federal funds rate and the dashed lines the Taylor rule funds rate. The short-dashed line is the rule constructed with the core PCE inflation rate; the dot-dashed line with the PCE inflation rate.(10) The average differences between the two “Taylor Rules” and the actual funds rate over the entire period are 15 and 7 basis points, respectively. However the volatility of each of the two Taylor Rules is much less than that of the actual funds rate.
Figure 2 shows the comparison of the two Taylor Rules with a larger coefficient on the output gap (b=0.8) and a slightly higher assumed equilibrium real rate (r*=2.3 ). With these assumptions the average differences between the two equations and the funds over the entire period are two and minus three basis points, respectively, and the volatility of the two equations better approximates the volatility of the actual funds rate. My purpose here is not to try to find the equation that reveals the policy rule of the Greenspan Fed–as I stated earlier, I do not know how to write down the current practice in an equation, and the FOMC certainly does not view itself as implementing an equation. Rather, the illustrations should be viewed as evidence in support of the proposition that the general contours of FOMC policy actions are broadly predictable.
Policy Asymmetry. Under most circumstances the direction of FOMC policy actions is “biased” in a sense I’ll explain. Policy bias exists because turning points in economic activity–peaks and troughs of business cycles–are infrequent. Changes in economic activity as measured by output and employment are highly persistent. This persistence can be seen in Figure 3, which shows month-to-month changes in nonfarm payroll employment from January 1947 through August 2005. During expansions, employment changes are consistently positive; during recessions consistently negative. Changes opposite to the cyclical direction are rare and generally the consequence of identifiable transitory shocks such as those from strikes and weather disturbances. This pattern of business cycles generates strong autocorrelations in the month-to-month changes in payroll employment as shown in Figure 4.(11) Given such persistence, once it becomes apparent that a cyclic peak likely has occurred the issue is never whether Fed will raise the target funds rate but whether and how much the Fed will cut the target rate. Similarly, once it is apparent that an expansion is underway, the question is not whether Fed will cut the target rate, but the extent and timing of increases.
Data Anomalies. Fed policy responds to incoming information, as it should. Sometimes data ought to be discounted because of anomalous behavior. For example, the FOMC has indicated that it monitors inflation developments as measured by the core rather than the total PCE inflation rate. This approach is appropriate because the impacts on inflation of food and energy prices are largely transitory; the difference between the inflation rate as measured by the total PCE index and as measured by the core PCE index fluctuates around zero.
Another example ... information about real activity sometimes arrives that indicates transitory shocks to aggregate output and employment. An example of such a transitory shock is the strike against General Motors in June and July 1998.(13) Similarly, the September 2005 employment report reflects the impact of Hurricane Katrina. Transitory and anomalous shocks to the data are ordinarily rather easy to identify. ... The principle of looking through aberrations is easy to state but probably impossible to formalize with any precision. We know these shocks when we see them, but could never construct a completely comprehensive list of such shocks ex ante...
Crisis Management. The above rules are suspended when necessary to respond to a financial crisis. The major examples of the Greenspan era are the stock market crash of 1987, the combination of financial market events in late summer and early fall 1998 culminating in the near failure of Long Term Capital Management, crisis avoidance coming up to the century date change at the end of 1999, and the 9/11 terrorist attacks. In each case, the nature of the response was tailored to specific circumstances unique to each event. ... The history of Fed crisis management since World War II is generally a happy one. ... Perhaps just as important, the Fed has not responded to certain events where it was called to do so. Examples would include the New York City financial crisis in 1975 and failure of Drexel, Burnham Lambert in 1990.(14)
Other Regularities in Policy Stance. Since August 1989, the FOMC has adjusted the intended federal rate in multiples of 25 basis points only. After February 1994, when the FOMC first began to announce its policy decision at the conclusion of its meeting, with few exceptions all adjustments have been made at regularly scheduled meetings. ... In general, the Fed can use intermeeting adjustments to respond to special circumstances, such as the rate cut on September 17, 2001 in response to 9/11, or to provide information to the market about a major change in policy thinking or direction, such as the rate cut on April 18, 2001. My own preference is to confine intermeeting adjustments to circumstances in which delaying action to the next meeting would have significant costs...
Issues to be Resolved The rules-versus-discretion debate historically was framed in terms of policy actions. ... Over the past 15 years, as central bankers, including the FOMC, have striven for greater transparency in monetary policy, communication in the form of policy statements has moved to center stage. It is clear that policy statements are just as important as policy actions, at least in the short run, because significant market effects can flow from these statements. We need to face a new question: Can policy statements become predictable? I think the answer in principle is largely in the affirmative...
Two significant elements in FOMC policy statements are the “balance-of-risks” assessment introduced in January 2000 and the “forward-looking” language introduced in August 2003. The balance-of-risks assessment was introduced to replace the long-standing “bias” statement in the Directive to the Open Market Desk. Historically, the bias statement had referred to the intermeeting period and was not even made public in timely fashion until May 1999. ... a consensus emerged among FOMC participants that the bias formulation did not provide a clear public communication. The balance-of-risks statement attempted to provide insight into the major policy concerns of FOMC members over the “foreseeable future.”... Beginning in August 2003, the FOMC added “forward-looking” language to the press statement. ... In May 2004 the Committee indicated that it “believes that policy accommodation can be removed at a pace that is likely to be measured.” At its following meeting, the FOMC raised the federal funds rate target by 25 basis points. The Committee then raised the target rate by 25 basis points through all its subsequent meetings to this writing... At a minimum, the FOMC can and should aspire to policy statements that are clear and do not themselves create uncertainty and ambiguity. ... In interpreting the FOMC’s policy statements, it is important that each statement be read against previous ones. Changes in the wording are critical to understanding the perspective of the FOMC members about future policy actions.
Rule Enforcement Obviously, there exists no legal enforcement mechanism of the current rule. Nevertheless, there are certainly incentives for the Fed chairman to follow the rule, or work to define improvements. The most powerful incentives arise from market reactions to Fed policy actions. ... It is not in the Fed’s interest to confuse or whipsaw markets, and for this reason market reactions provide an incentive for the Fed to conduct policy in a predictable fashion... Although market responses are the most important disciplining force, FOMC members other than the chairman also provide input, ... Reserve Bank directors weigh in through discount rate decisions. Since 1994, except in unusual circumstances, the FOMC has not changed the intended fed funds rate unless several Reserve Banks have proposed corresponding discount rate changes.(16) ... public opinion can play an important role in enforcing extra-legal rules, as well.
A Summing Up Federal Reserve policy has become highly predictable in recent years, and in the future this predictability will, I am sure, be seen as one of the hallmarks of the Greenspan era. Little has been institutionalized, and for this reason the current Federal Reserve policy rule must be regarded as somewhat fragile. Still, future chairmen will want to extend Alan Greenspan’s successful era and therefore it will be in the interest of future Fed chairmen to commit to pursue policy regularities that work well. I do not claim to have accurately identified all aspects of the Fed’s current policy rule. I am tempted to call it the “Greenspan policy rule,” for Alan Greenspan has surely had far more to do with its construction than anyone else. Nevertheless, I believe that most elements of the rule have become part of a general Fed culture... While it is appropriate to refer to the “Greenspan rule,” I believe that FOMC debates and staff contributions have had a lot to do with development of the rule. For this reason, ... we should be hopeful that consistent and predictable Fed policy is likely to continue into the future.
October 14, 2005
The Houston Chronicle on Dallas Fed President Richard Fisher
No Shrinking Violet, by Jessica Holzer, Houston Chronicle: No one could accuse Richard Fisher of being a dull, old central banker — at least not after his splashy debut as president of the Dallas Federal Reserve Bank. Barely two months on the job he started in April, he managed to spark a rally in the stock market, send bond yields tumbling, and make financial headlines from Frankfurt to Taipei. Fisher, who gets to vote on the Federal Open Market Committee, which sets rates for the Fed, predicted on CNBC that the Fed was in its "eighth inning" of rate hikes — meaning that it would lift rates one more time before declaring its tightening job done — though he added that there could be "extra innings." Back in Washington, Fed officials were stunned. The remarks prompted a Fed spokeswoman to announce tersely that Fisher did not speak for the committee. Fisher admits that he took some heat for his remarks, but he wasn't chastened for long. In a speech last week, Fisher roiled markets again, though less so this time, with yet another metaphor. The Fed, he said, can't "let the inflation virus infect the blood supply and poison the system." The episodes are testament to the power of the FOMC members and the way the media and the financial markets hang on their every word. But they are also telling about Fisher, a former Dallas fund manager and Democratic candidate for the Senate who, according to friends, is smart, ambitious and no shrinking violet. ...
Fisher's button-down résumé is in sharp contrast to his colorful upbringing. His Australian father was abandoned on the streets at the age of six. His mother came from a family of bankrupt Norwegian whalers living in South Africa. The two met, according to Fisher, after his father made his way to South Africa, probably as a stowaway, at age 19. Fisher grew up poor in Tijuana, Mexico, where his parents settled after they were denied entry to the U.S. According to Fisher, his mother crossed the border to California to give birth to him in 1949. "If you grew up like I did, you never had comfort knowing where the next meal was coming from and you never want to live like that again," he said. After the family moved to the U.S., Fisher began a startling rise, helped by scholarships to a prep school in New Jersey and the U.S. Naval Academy.
During his second year at the academy, a visiting professor from Harvard recruited him to that university as a transfer student. To pay the tuition, Fisher held down three jobs — at a bicycle shop and as a short-order cook and a researcher for a professor — and also rented out his room on the weekends to amorous couples. Of his college days, Fisher said, "Obviously, I didn't have a lot of dates and I didn't have a lot of fun, but I am very grateful to Harvard." Lucky for Fisher, the Dallas Fed has a history of outspoken presidents and his comfort in the spotlight was one of his selling points. "We knew that Richard would be a strong voice," said Malcolm Gillis, a member of the Dallas Fed's board and the former president of Rice University. Some say that Fisher will have higher ambitions after his service at the Fed. Given his efforts to keep up his ties with politicians on both sides of the aisle, Fisher does not seem likely to turn up his nose at a prestigious appointment. "Richard will always make a mark because he's an important player," said Al From, the CEO of the Democratic Leadership Council, the centrist Democratic group that Fisher helped to found in the late 1980s. "But I suspect it will always be in non-elective politics."
Which Regions Would Be Hurt Most from a Housing Slump?
Where A Slump Would Hurt Most, BusinessWeek Online: ...If the housing market turns south, where is the economic damage likely to be the greatest? ... the greatest economic impact may not come where prices slide the most. Instead, the regions that see the most pain probably will be those where homebuilding has been a major source of new jobs. A decline in housing could accelerate job losses in the entire local economy ... The most vulnerable spots, according to a new analysis by BusinessWeek, include the Riverside-San Bernardino (Calif.) region -- the so-called Inland Empire east of Los Angeles -- San Diego, Phoenix, and Las Vegas. In each of these areas new jobs in construction accounted for over 20% of total payroll growth in the past year, vs. a national average of 10%. This measure counts more than just housing construction. ... In the East, regions that depend heavily on construction employment for growth include Tampa-St. Petersburg and greater Baltimore. In Newark, N.J., and in the nearby wealthy New Jersey surburbs of New York, rising construction employment is partially masking a decrease in other kinds of jobs. ... Surprisingly, some of the areas that have seen the biggest runup in housing prices aren't overly vulnerable to a homebuilding slide. ... Construction in these coastal cities has been constrained by severe zoning restrictions, along with a shortage of open land. ... Other regions would also come through a housing downturn relatively unscathed. Most Texas cities, for instance, are doubly insulated from a downturn. Housing price hikes been moderate, and construction is a small part of payroll growth ... Contrast that with housing's role as an engine of growth in Southern California's Riverside and San Bernardino counties, which stretch east to the Arizona and Nevada borders. Thanks to inland prices that are far cheaper than those along the coast ... construction is hopping. Subdivisions are being erected by the score in former citrus groves and dairy farms. ... While construction by itself accounts for 33% of new jobs in Riverside and San Bernardino, that share reaches 39% when jobs in lending, real estate commissions, renting, and leasing are included. And it's not just roofers and real estate agents who are finding work plentiful. Also raking it in are small businesses catering to the trend, such as Taylor's Appliance in Riverside. The family-run retailer has added 16 new employees in the past five years, bringing the total to 48... Regions that are heavily dependent on housing for employment growth will suffer more than most when a downturn comes. ... Falling home values are no fun anywhere. But if you want to know which metro areas will really take it on the chin when prices stall out, look for the ones whose jobs depend on it.
The Economic Benefits of Vaccination Programs in Poor Countries
A drop of pure gold, The Economist (free link): What good is vaccination? Obviously it is good for the person receiving the vaccine ... More subtly, it can be good for an entire population since, if enough of its members are vaccinated, even those who are not will receive a measure of protection. ... But in the case of many vaccines, there are non-medical benefits, too, in the form of costs avoided and the generation of income that would otherwise have been lost. ... Quantifying these more general benefits is hard. But a pair of researchers from Harvard University has just tried. David Bloom and David Canning, together with Mark Weston, an independent policy consultant, have looked at two vaccination programmes and attempted to calculate the wider benefits. Their conclusions have just been published in World Economics. Dr Bloom and Dr Canning believed that previous attempts to quantify the non-medical benefits of vaccination had ... failed to take account of recent work on the effects of health on incomes. For their study, they and Mr Weston identified how vaccination ... might increase wealth. The first benefit was that healthy children are more likely to attend school and better able to learn. The second was that healthy workers are more productive. Both of these seem fairly obvious. Two other benefits are less so... One is that good health promotes savings and investment. This is because healthy people both expect to live longer (which gives them an incentive to save) and actually do live longer (which gives them more time to save). The other is that good health—and, particularly, expectations about the good health of one's offspring—promotes the so-called demographic transition from large to small families that usually accompanies economic development. None of these factors, the researchers thought, had been properly taken account of in previous estimates of the cost-effectiveness of vaccination. To demonstrate that ... one of their ideas was correct, they turned to the Philippines. Here, a study called the Cebu Longitudinal Health and Nutrition Survey has been going on since 1983. It follows the lives of Filipina mothers and those of their children born in 1983 and 1984. ... The three researchers ... found a statistically significant difference in the language and IQ scores between otherwise comparable vaccinated and unvaccinated children. In both cases, those of the unvaccinated were lower. Since it is known from other studies that these scores are good predictors of adult income, the researchers concluded that childhood vaccination would have significant economic benefits. In order to predict those benefits, they turned to a vaccination campaign that is just beginning. The Global Alliance for Vaccines and Immunisation (GAVI) is a collaboration of governments, international organisations, vaccine-makers and charities. ... the researchers used data from previous vaccination programmes to estimate both the reduction in mortality and the improvement in the health of the living that might be expected to flow from the new GAVI programme. Then they combined these estimates with existing data about the economic effects of health improvement ... in poor countries... on future income. Using standard accounting methods ... they calculate that the new GAVI programme can be expected to generate an immediate rate of return of 12.4%, rising to 18% by the end of the programme. And that does not include any benefits that might come from the demographic transition. The dispassionate economic case for vaccination, therefore, looks at least as strong as the compassionate medical one. If the figures ... are right, it truly is an investment for the future.
Paul Krugman: Questions of Character
Questions of Character, by Paul Krugman, Commentry, NY Times: ...[M]any ... in the news media ... claim, at least implicitly, to be experts at discerning character - and their judgments play a large ... role in our political life. The 2000 election would have ended in a ... victory for Al Gore if many reporters hadn't taken a dislike to Mr. Gore, while portraying Mr. Bush as an honest, likable guy. ... So it's important to ask why those judgments are often so wrong. ... A large part of the answer is that the news business places great weight on "up close and personal" interviews with important people,... But such interviews are rarely revealing. ... most people ... are pretty bad at using personal impressions to judge character. Psychologists find ... that most people do little better than chance in distinguishing liars from truth-tellers. More broadly, the big problem ... is that there ...[is] ... no way for a reporter to be proved wrong. If a reporter tells you about the steely resolve of a politician who turns out ... unwilling to make hard choices, you've been misled, but not in a way that requires a formal correction. And that makes it all too easy for coverage to be shaped by what reporters feel they can safely say, rather than what they actually ... know. Now that Mr. Bush's approval ratings are in the 30's, we're hearing about his ... bad temper, about how aides are afraid to tell him bad news. Does anyone think that journalists ... just discovered these personal characteristics? ... Those who wrote puff pieces about Mr. Bush ... have been rewarded with career-boosting access. Those who raised questions about his character found themselves under personal attack ... Only now, with Mr. Bush in ... trouble, has the structure of rewards shifted. So what's the answer? ... What we really need is political journalism based less on perceptions of personalities and more on actual facts. ... Think ... how different the world would be today if, during the 2000 campaign, reporting had focused on the candidates' fiscal policies instead of their wardrobes.
Let's come at this from both sides. Bruce Bartlett recently made similar points:
Brad DeLong: Why Oh Why Can't We Have a Better Press Corps? (Cable News Department): Bruce Bartlett is not a happy camper. He's also completely right on this:
Poynter Online - Forums: From Bruce Bartlett, senior fellow, National Center for Policy Analysis: Once again, I just got off the phone with a booker for one of the cable news channels who wanted me to play the role of the knee-jerk Bush supporter and I had to decline. Although I am a conservative who generally supports Republican policies and generally opposes those that come from Democrats, I am uncomfortable being locked into that position. I also don’t think it makes for very good television. I understand that news shows want to show both sides -- or perhaps I should say two sides -- to controversial issues, lest they appear biased towards one position. But why must this always take the form of a debate? Why can’t they interview a person with one position separately and then interview someone else with another position in another segment? Wouldn’t this be a better way of achieving balance than by always having a debate? It’s hard enough to make one’s point in sound-bite form without being distracted by the debating tactics of one’s opponent. And, unfortunately, everyone is now trained to know that when one has the camera and microphone they are pretty much free to say what they like, even if it is totally off topic and even untrue. On one occasion, my opponent called me a liar on air at the end of the segment, so that I could not respond. Afterwards, off camera, he conceded that I was right. But no one watching the exchange ever knew that.... The fact is -- and everyone knows this -- that few issues are black-and-white. There are always nuances that are impossible to discuss in a debate format. But the debate format creates the illusion that there is always a simple answer to every complex problem and encourages average television viewers to assume that those of us in the Washington policymaking community are all idiots totally beholden to our party, without a lick of common sense or integrity...
Lawrence Lindsey: No Need for Inflation Target
No need for US price target - ex-Bush aide Lindsey, by Tim Ahmann, Reuters: An inflation target would do little to improve U.S. monetary policy since the Federal Reserve's anti-inflation credentials are solid, former White House economic adviser Lawrence Lindsey said on Thursday. Lindsey, considered a potential candidate to succeed Fed chief Alan Greenspan ..., also said deciding on an appropriate target would be a nettlesome issue, since the inflation measure most important to Fed policy could change with economic circumstances. "It's not clear, assuming you have a reasonable degree of credibility to begin with, that you gain much by saying at the end of 2006 this index will be such and such. I don't see where the gain is," Lindsey told a forum hosted by the American Enterprise Institute, where he is a visiting scholar. Lindsey ... said a debate was under way at the Fed over what an appropriate inflation gauge might be should the central bank decide that stating a goal for desired inflation was desirable. "Where you see the debate is core (inflation) over not core," he said, referring to inflation measures that strip out food and energy prices, largely because they are often viewed as volatile, ... Lindsey ... said stripping out energy prices made sense in the past when thinking about underlying inflation and interest rates, since their volatility usually reflected problems with supply, rather than strong demand. But he said the current situation was different. "What we have now is not a supply shock that's driving energy but a demand shock, which is arguably, at least in part, related to monetary policy," he said. "If that's true, excluding energy from your measure of inflation would probably be a mistake."...
Sources close to the White House have said Lindsey, who was Bush's top economic adviser during the 2000 presidential campaign and a key architect of Bush's tax cuts, is one the candidates who has a shot at taking the Fed's helm when Greenspan departs. ... Lindsey ... said he thought Bush would wait until after the Fed's Dec. 13 policy-setting meeting to announce a Fed nominee so as not to undercut Greenspan's authority. ... Some analysts think a mid-December announcement would leave little time for Congress to approve a successor before Jan. 31. Lindsey, however, said six weeks would leave ample time for a nominee to be approved. Lindsey also said he thought Bush would move to fill two other vacancies on the Fed's board in concert with his decision on who should replace Greenspan...
My views on this are quoted here by New Economist in his discussion of the The Economist's endorsement of Kohn. With respect to the two most recently discussed candidates, I favor Kohn over Lindsey. [Update: See Brad DeLong on Kohn here.]
October 13, 2005
Financial Times: The Danger of Rewriting Chapter 11
John Gapper: The danger of rewriting Chapter 11, Financial Times: Steve Miller, chief executive of Delphi, was in New York this Monday to explain why he was putting the Michigan automotive parts supplier into Chapter 11 bankruptcy. “We are broke,” he said, holding his hands in the air. “I am sorry to be the one delivering that message.” Mr Miller did not look very sorry. In fact, he seemed like someone whose bargaining position with his employees had just become a lot stronger. Instead of having to wheedle unions into accepting cuts in pay and benefits for Delphi’s 34,000 hourly-paid US workers, he can threaten them with the company defaulting on its defined-benefit pension plan. Nor is Delphi broke. It may have lost $600m (€499m) in the first half of the year, but it has plenty of cash to tide it through the two years that it could be in Chapter 11. ... As Mr Miller also observed, Delphi’s bankruptcy is “well-financed, well-organised and well-planned”. He disdainfully compared Delphi’s approach with the “disgrace and embarrassment” of Collins & Aikman, a parts supplier that went bankrupt in May amid a liquidity crisis and asked customers to pay more to maintain production. How irresponsible of a company that goes into Chapter 11 to be in dire financial straits at the time.
Organised labour, meet organised capital. Chapter 11 of the Bankruptcy Code used to be regarded as a bizarre US arrangement allowing a troubled company’s managers to stay at the helm and restructure instead of being kicked out by the creditors. Eastern Airlines went into Chapter 11 in 1989 and remained there for two years losing money before collapsing. These days, ... Chapter 11 has become a device for reasserting management fiat over workers with the backing of bankers. Financiers have forced steel industry employees who were used to being highly paid to accept lower wages and fewer benefits. Delphi’s Chapter 11 filing suggests Detroit’s workers and retirees are next in line. ... David Skeel, a University of Pennsylvania law professor, says ... managers are given very large financial incentives to act rapidly and to take tough decisions. Delphi, like most Chapter 11 filers, had negotiated so-called “debtor in possession” (Dip) finance from Wall Street before it went to court. ... The covenants on such loans tend to be structured to give managers sufficient time to negotiate a restructuring but to discourage them from hanging around.
Even more pertinently, managers in Chapter 11 cases have their eyes on the prize of cash and equity bonuses if they can work the company into shape speedily without it having to be broken up. Delphi plans to award up to $87m in bonuses and 10 per cent of equity in a new company to its 600 most senior managers. They can get richer by persuading the hourly-paid workers to become poorer. Thus Chapter 11, which used to enable the managers of companies in difficulty to avoid both their creditors and hard decisions, has become fearsomely effective. ... All of this carries a price. They say you should not visit a sausage factory if you like eating sausages and in this case the ingredients being ground up for profits are health and (perhaps) pension rights. It does not take a union activist to be disturbed by the prospect of Delphi workers losing benefits that they dedicated their lives to gaining by working there. The stark contrast between workers’ losses and managers’ gains was one reason for changes to Chapter 11 in the bankruptcy reforms that come into effect next week. The new law bars companies from paying managers Chapter 11 bonuses and limits the time during which they have the sole right to propose a restructuring plan. ... Like many political interventions..., the reason for the changes is understandable but the danger of unintended consequences is considerable. The law reduces both the carrots given to managers and the sticks they can wield without putting much in their place. If managers have less incentive to sort out the financial problems of US rust-belt industries, who will take on the job? There is little sign of Washington doing so. Efforts to reform ... the Pension Benefit Guaranty Corporation – the federal safety net for underfunded schemes – are now stuck in Congress. Politicians tend to be happier handing out subsidies to companies than imposing rules that will upset potential voters. ... The spectacle of Delphi’s “well-financed, well-organised and well-planned” Chapter 11 filing is strange but it at least promises action. The alternative is to let the industry’s problems fester and its companies drift into, well, bankruptcy.
A lot about this article surprises me. For instance, it seems to say that Delphi is not in serious trouble and bankruptcy is a being used as a way to restructure and to force labor to accept lower wages and reduced benefits. I don't see how creating a financial incentive for managers to lower wages and benefits necessarily improves efficiency instead of creating a distortion.
Will Wealth Redistribution in China Make Currency Reform Easier?
China contemplates change, The Economist: ...China’s leaders may finally be readying themselves for a change in the mercantilist, growth-at-any-cost model that has prevailed for decades. The Communist Party leaders’ annual meeting on economic policy ended on Tuesday with word of a strategic shift: from now on, there will be more emphasis on redressing the inequality and social disruption that market reforms have left in their wake. The most immediate worry for China’s leaders is social unrest. Last year, the government documented more than 70,000 demonstrations, attended by some 3m protesters. ... It needs the export sector to continue booming, in order to absorb surplus labour from the countryside and moribund state-owned companies. But it is aware that the rapid growth of recent years has opened fractures that could grow even wider. If China can heal some of those rifts with a greater focus on rescuing those left behind by the new prosperity, this may in turn take some of the pressure off the government to subsidise export workers through currency management. It may also help China to develop domestic demand that can take up the slack when America’s appetite for cheap goods falters...
But though details are sketchy, it seems improbable that China’s move towards more balanced economic growth will be anything like the kind of radical leap that foreign observers would like. There are some brands of wealth redistribution that would make foreign investors very jittery, such as higher taxes. Hu Jintao, China’s president, is still consolidating power; even if he had a radical vision of a China less dependent on the cravings of the American consumer, it would have to wait until his command of the party was firmer. More importantly, it would have to wait until Chinese consumers became sufficiently confident in the social safety-net and the provision of affordable health care and education that they were willing to save less and spend more. ... And though the rising tide of China’s economy undoubtedly has the power to lift all boats, there are worrying rigidities in the system, caused by the under-development of its financial system and the fact that economic reform has not been accompanied by political reform. Officials rightly fret that further economic changes could undermine the stability of the party’s rule. Amid all the talk of addressing the wealth gap, the party’s plenum reiterated a commitment to rapid growth by restating a goal of raising China’s GDP to double its 2000 level by 2010...
The Dallas Fed: Has the Housing Boom Increased Mortgage Risk?
I was hoping to find a copy of the remarks by Richard Fisher from his speech today, but the speech is not posted at the Dallas Fed site. Given his occasional proclivity to speak from the cuff and shake markets, I had high hopes. But I found this article instead and it is a worthy substitute. This post is fairly long, but I wanted to include all of the article's analytics. I did take out the footnotes, but left the footnote references in the text. They are in the original linked document.
The paper asks the question, "Has the Housing Boom Increased Mortgage Risk?" and finds that concern is warranted.
Has the Housing Boom Increased Mortgage Risk?, Southwest Economy, Federal Reserve Bank of Dallas, Issue 5, September/October 2005, by Jeffery W. Gunther and Robert P. Moore: For several years, house price appreciation has outstripped income growth in the United States, with most of the price gains concentrated in the East and West. While moderate increases in house prices often reflect, and contribute to, a region's economic and financial health, the steepness of recent price increases has raised concerns. In particular, it has been suggested that borrowers, emboldened by rising house prices, are turning to riskier types of mortgages in order to qualify for the debt necessary to purchase increasingly expensive homes, thereby potentially setting the stage for repayment difficulties in the future. We examine mortgage characteristics in different regions to assess the extent to which high appreciation in house prices has been associated with the use of riskier types of mortgages. ... our analysis focuses on the distinction between traditional fixed- and adjustable-rate mortgages (ARMs), given the availability of consistent regional data on traditional ARM usage. Because ARMs offer initial monthly payments below those required on fixed-rate mortgages at the expense of more variable payments over time, the proportion of mortgages represented by ARMs provides a suitable gauge for assessing the potential link between rising house prices and mortgage risk. The results are consistent with a direct effect of the housing boom in encouraging the use of traditional ARMs and, by extension, other types of mortgages, such as interest-only loans, that reduce initial payments at the expense of higher payments later in a mortgage's life. While other aspects of our results point to some mitigation of the housing boom's effect in raising mortgage risk, the analysis overall indicates concern is warranted...
House prices recently have tended to rise rapidly in the East and West, as shown in Chart 1. Nevada house prices rose 34 percent in 2004, followed by Hawaii, 25 percent; California, also 25 percent; and the District of Columbia, 23 percent. In contrast, house price appreciation has been relatively modest for many other states. Texas experienced an increase of only 4 percent.
A notable reason for sharp house price appreciation in the East and West is the prevalence in those regions of restrictions on construction and land supply. With housing demand rising in many markets-propelled by general factors such as low interest rates-regions with a tight supply of new homes, resulting from tough zoning requirements or a limited supply of vacant land, have tended to experience the sharpest appreciation. Partly reflecting such building constraints, growth in the stock of housing units has been relatively low in California and especially the Northeast (Chart 2), helping boost house prices in those regions. Conversely, Texas has experienced a substantial volume of home building and high growth in the housing stock, helping explain the state's moderate house price appreciation.
In addition to the supply-side effect of building constraints, other factors may have boosted housing demand in some regions more than others, contributing further to regional disparities in house price appreciation. ... anecdotal information suggests the coastal housing markets may have benefited from strong immigration and international investment, with Florida especially popular among European and Latin American investors and California attracting substantial investment from Asia.
One of the most notable concerns associated with the housing boom is ... homebuyers ... frequently opting for mortgage features that reduce the level of initial payments at the expense of higher or more variable payments over time. ... homebuyers may have been willing to assume the added risk ... if lowering their initial payments was necessary in order to qualify for the ... purchase increasingly expensive homes. Also, homebuyers' expectations of continued increases in house prices may have overshadowed any concern about the potential for higher mortgage payments in the future. ... these nontraditional products ... offer initial monthly payments below those required on fixed-rate mortgages, but at the expense of more variable payments. ... By choosing ... a ... nontraditional mortgage, homebuyers can reduce their initial payments and boost their chances of qualifying for credit, ... However, such variable-payment mortgages also increase a borrower's risk exposure...
In analyzing the potential effect of the housing boom in raising mortgage risk, we focus on the share of ... traditional home mortgages, that is represented by ARMs. The distinction between fixed and adjustable rates provides an especially convenient focal point for the analysis; regional data on traditional ARM usage are available on a consistent basis and over a prolonged period, whereas regional data on the different types of nontraditional mortgages are relatively sparse. Before turning to the regional analysis, we should note that at the national level ARM usage is well below historical highs. As shown in Chart 3, the ARM share in 2004 was near the middle of its 1985-2004 range. Nevertheless, recently the ARM share has actually been substantially higher than its historical relationship with long-term interest rates would predict, as shown by the chart's fitted line. This observation raises the question of why homebuyers have frequently turned to ARMs, despite having the option of a very low fixed-rate loan... Our regional analysis is designed to provide evidence regarding the potential role of the housing boom in helping boost ARM usage above its historical pattern.
To assess the extent to which sharply higher house prices have contributed to greater use of ARMs, we examine ARM share movements in different regions. Recent gains in ARM usage display a pronounced regional pattern (Chart 4).
States in the East and especially the West experienced substantial increases in ARM usage last year, whereas the middle of the country recorded relatively small increases.
Most notable, for our purposes, is that the regional pattern of recent changes in ARM usage shown in Chart 4 is highly similar to the regional pattern in house price gains shown in Chart 1. ... The correlation between the regional patterns in the two charts suggests a link between house price appreciation and ARM usage. To provide further evidence regarding the nature of their relationship, we can also examine various component parts of the overall regional correlation between house prices and ARMs. Toward this end, we now examine in more detail the relationship between house price appreciation and changes in the ARM share, using annual data for each state and the District of Columbia from 1990 through 2004.
As a first step in our historical analysis, we categorize the 765 observations (15 years for 51 regions) into four groups, based on house price appreciation. The first group represents the 25 percent of observations with the lowest appreciation in house prices, while the fourth group contains the 25 percent of observations with the highest appreciation. We then calculate the average annual change in ARM share for each group.
As shown by the first set of bars in Chart 5, observations with the highest appreciation in house prices tended to have the highest change in ARM share, suggesting a direct relationship between the housing boom and ARM usage.
However, some states may have tended to experience high annual changes in ARM share for other reasons besides high house price appreciation. To help purge the data of such unwanted regional effects and obtain a more direct view of the correlation between house price appreciation and changes in ARM share, we now subtract state averages from our annual observations. The difference between a state's house price appreciation in a particular year and its average appreciation over the entire 15-year period represents a deviation from the state's typical house price experience. Similarly, subtracting away a state's average annual change in ARM share from the change in ARM share that occurred in each year provides a measure of abnormal changes in ARM share. By analyzing deviations from state averages, or mean adjusted data, the potential confounding influence of any fixed regional effects can be avoided. The second set of bars in Chart 5 shows the relationship between house price appreciation and changes in ARM usage, calculated using the mean adjusted data. ... As shown in the chart, deviations in the annual change in ARM share from state averages are much higher for observations representing large positive deviations in house price appreciation. This finding further supports the notion of a direct relationship between house prices and ARM usage. The final set of bars in Chart 5 is expressed in terms of deviations from not only state averages but also time-period averages. After purging the data of all fixed state and time-period effects, house price appreciation and changes in ARM share are still positively correlated, providing further evidence of a direct relationship.
Finally, the first set of bars in Chart 6 represents the average change in ARM share in 2004 for the four groups of states shown in Chart 1, categorized according to house price appreciation. Consistent with what the analysis showed for the entire period from 1990 to 2004, the 2004 change in ARM share was substantially higher for the states with the strongest house price appreciation. And the same is true for the average level of ARM usage in 2004, as shown by the second set of bars in Chart 6.
The empirical patterns evaluated so far are cause for concern, because they tend to support the perception that borrowers have been turning to riskier types of mortgages to qualify for the purchase of increasingly expensive homes. However, there are some additional trends that would appear to mitigate, albeit only partially, concerns regarding increased mortgage risk. In particular, along another key financing dimension, home mortgages in high-appreciation states appear more conservative than in low-appreciation states. There is some indication that leverage, or the proportion of the house price financed and not paid upfront, has tended to be relatively low in high-appreciation states. The third set of bars in Chart 6 shows that the average 2004 share of conventional, fully amortized home purchase loans with a loan-to-value ratio above 90 percent was relatively low for the states shown in Chart 1 as experiencing the greatest house price appreciation. This association between high house price appreciation and low loan-to-value ratios is also apparent in Chart 7; high loan-to-value ratios were relatively uncommon in the East and West last year, whereas in Texas, a low-appreciation state, high loan-to-value ratios were much more prevalent.
Because these loan-to-value data reflect only first mortgages, without accounting for piggyback, or second, loans extended concurrent with a first mortgage, loan-to-value in high-appreciation states may be substantially understated. Nevertheless, another possibility is that many trade-up homebuyers in high-appreciation states, having benefited from past home price appreciation, may tend to have sufficient accumulated wealth to make a large down payment. While the lack of data on piggyback loans precludes firm conclusions, the coexistence of ARMs and low loan-to-value ratios in high-appreciation states may make sense. Because trade-up homebuyers in these states have accumulated substantial equity, their loan-to-value ratios may be relatively low. At the same time, though, income levels generally have not kept pace with house prices, perhaps impelling homebuyers to turn to ARMs to qualify for as much credit as possible, based on their current earnings.
Another interesting pattern in the regional housing data involves the rate of home ownership. Contrary to popular concerns, the available data do not reveal an adverse overall effect of the housing boom in pricing potential buyers out of the market and reducing the rate of home ownership. As indicated by the fourth set of bars in Chart 6, the rate of home ownership actually has risen substantially in high-appreciation states. Of course, the rising home-ownership rates in high-appreciation states do not mean no potential homebuyers have been priced out of the market. Nevertheless, it remains true that a greater proportion of households are living in their own home, despite higher home prices. ARMs and nontraditional mortgage products that can help potential homebuyers qualify for a mortgage may have contributed to the rising rate of home ownership.
If one were to judge mortgage risk based on recent delinquency rates, concerns over ARMs and nontraditional mortgages would seem misplaced. As shown by the final set of bars in Chart 6, home mortgage delinquency rates have tended to be relatively low in high-appreciation states, despite the greater prevalence of ARMs....
But, of course, these delinquency data from 2004 do little to allay concerns over increased mortgage risk in high-appreciation states, in the form of increased usage of ARMs and also nontraditional mortgages. Given the recent rapid increases in house prices, one would not expect to find many signs of credit difficulties; financially strapped borrowers could, if nothing else, simply sell their homes for a profit, rather than default on their loans. In this manner, rapidly rising house prices can conceal the added risk they engender. It is the possibility of stagnant or falling home prices in the future, combined with the potential, built into much recent borrowing, for increases in the level of mortgage payments relative to income, that gives rise to concern.
October 12, 2005
Fed Governor Olson on the Fiscal Outlook for the U.S. Economy
Update on the U.S. Economy and Fiscal Outlook, by Fed Governor Mark W. Olson: ...My remarks will focus on the near-term economic outlook of the United States in the immediate post-hurricane aftermath. Then I will address the fiscal challenges that the country confronts... I had expected that I would be going into the September FOMC meeting, and then speaking to you, with the U.S. economy on an upward trajectory. But that expectation changed dramatically when Hurricanes Katrina and Rita came along. Although the combined effect of the hurricanes was contained within a geographic area ..., the potential for spillover effects on the economy more broadly was difficult to assess. The disruptive effect on oil refining, natural gas distribution, and chemical production; the damage to major ports and transportation infrastructure; and the significant devastation of a major city raised the risks of an effect on the economy that exceeded the direct effects on the areas battered by the storms. To be sure, these disruptions also had adverse implications for costs and prices. Further clouding the picture, the fiscal policy implications of funding the rebuilding and restoration had not yet been fully defined.
As our September FOMC meeting followed Hurricane Katrina by approximately three weeks and was held concurrently with the formation of Hurricane Rita, I felt that there was insufficient information as well as great uncertainty about how these forces would play out in the near term. As a result, I voted to pause in the removal of policy accommodation until more was known. ... A frustrating aspect of the situation is that even now, some six weeks after the first of the hurricanes made landfall, the incoming data are only beginning to shed some light on the economic ramifications of the storms. Clearly, however, the destructive power of these hurricanes reduced economic activity ... The Federal Reserve estimates that Hurricane Katrina reduced industrial production by 0.3 percent in August, even though it struck near the end of the month. Oil and gas production and refining were particularly hard hit. ... Petroleum refining, chemical plants, and electricity distribution were also relatively hard hit by the hurricanes. All told, industrial production was held down significantly in September as a result of lower output in these sectors. That said, various daily and weekly data sources indicate that the industrial sector is beginning to recover in October ... Industry sources suggest that much of the repair and recovery effort will likely be undertaken over the course of the next several months, and as that occurs, production rates should gradually return to normal. Beyond the industrial sector, one indicator of economic activity more broadly is the behavior of employment. Last week's employment report for September indicated ... the direct disruption effects of the hurricane. More important, the apparent absence of significant indirect effects in other areas of the United States is an indication that the underlying gains in employment and income were well maintained outside the Gulf region.
An important question for policymakers is how inflation and economic activity will respond in coming months. One concern is that the rise in energy prices, as well as the downshift in consumer confidence seen in recent readings, may hold back aggregate demand at least for a time. However, the rebuilding itself should provide some impetus to demand in coming quarters. At the same time, of course, higher prices for energy items, including gasoline, heating oil, and natural gas, will be adding to top-line inflation in the near term. As well, these price increases will put upward pressure on the costs of the producers of other items, thereby posing the risk of some impetus to core inflation. Whether these pressures are, in fact, passed through to core inflation will depend on a host of considerations, ... Needless to say, developments in this area will be the subject of intense scrutiny on my part in coming months.
A vital contributor to the rebuilding and recovery effort will be the various actions of the federal government. The magnitude of the devastation called for a significant response from the federal government, and the Congress and the President acted quickly to provide emergency spending and tax breaks to aid the areas affected by the hurricanes. Whether these emergency fiscal measures will ultimately be financed by increased federal borrowing, or by finding offsetting spending decreases or revenue increases, is still an unsettled issue in the Congress. To a certain extent, temporary emergency federal borrowing may be viewed as appropriate, as the costs would ultimately be spread out across all U.S. taxpayers over time. Nonetheless, given the current size of the federal deficit, additional federal borrowing raises issues because of the potential negative effects that higher deficits can have on the economy. ... the budget figures for the fiscal year just ended were little affected by the fiscal policy response to the recent hurricanes. Only a small portion of the emergency federal outlays budgeted for hurricane relief were actually spent in September, ... Moreover, the total magnitude of the federal response is still unknown, adding to the uncertainty associated with the fiscal outlook.
Viewed from a longer-term perspective, the financial position of the U.S. federal budget has oscillated dramatically over the past ten years. Ten years ago, the federal budget had a deficit that amounted to about 2-1/2 percent of GDP, ... the best estimates ten years ago had the federal budget still running deficits far into the future. However, as it turned out, a number of positive developments pushed the budget into surplus in 1998 through 2001. Importantly, bipartisan support in the Congress for establishing and maintaining some measure of budget discipline was demonstrated by adherence to the guidelines set by the PAYGO rule and the discretionary spending caps. ... The federal budget also benefited significantly from economic developments that occurred outside of policy actions. In particular, federal tax revenues increased substantially more rapidly than expected and at a rate greater than the robust pace of economic growth seen in the late 1990s. Also, the rate of growth of medical care costs slowed somewhat from its high previous rate, in part because of legislative changes. Remarkable as it now seems, progress on the deficit was sufficiently dramatic that only five years ago serious policy discussions were undertaken concerning the possibility of effectively retiring all outstanding U.S. federal government debt. Obviously, the federal budget did not continue to unfold in the manner projected at that time.
The rapid pace of ascent from deficit to surplus in the late 1990s was exceeded by the pace of descent back to deficits beginning in 2002. This development was the result of a number of factors. In 2001, tax cuts approximately the size of projected on-budget surpluses were passed. Defense and homeland security spending increased in the wake of the attacks on September 11, 2001, and other nondefense domestic spending also increased at a substantially faster rate. The budget rules put in place back in 1990 ... both the caps on discretionary spending and the PAYGO rule--were allowed to expire after 2002 ... Besides these policy actions, spending for federal health programs also increased at faster rates as a result of a reacceleration in medical costs. During this time, the economy experienced a mild recession, and the stock market declined for several years after its peak in 2000...
Worrisome as these short-term fiscal issues are for the United States, they pale in comparison with the fiscal issues that are projected to begin emerging by the end of this decade. ... pressure on the U.S. federal government budget, as spending for federal government retirement and health programs will rise rapidly. A more slowly growing workforce could also tend to damp economic growth and, thus, federal tax revenues. So far, solutions to these long-term challenges have eluded policymakers. It is imperative, however, that solutions be identified and implemented. The sooner such changes are made, the less painful and disruptive they will be. ... The most important factor in ultimately achieving a federal government budget that balances over the business cycle and maintains that fiscal discipline over time is the will of the political system to make the necessary hard choices on government spending and taxes. ... Clearly, there are numerous ways in which budget policy could be adjusted to bring the budget back into balance in the short run and to maintain it over the long run. In any event, these difficult choices must ultimately be made.
If left unchecked, persistent and widening federal government deficits will have an increasingly corrosive effect on the U.S. economy because, all else being equal, federal government borrowing takes up some of the funds that would otherwise go to finance capital accumulation or to purchase capital assets from abroad. A good deal of controversy has swirled around the question of whether increased federal borrowing reduces domestic investment, and presumably increases interest rates, or whether it increases U.S. borrowing from abroad. Viewed from a broader perspective, however, that distinction is probably not very consequential because future national income is lower in either case. For the federal government to run a deficit in the short run as a temporary response to an emergency event, such as the recent devastating hurricanes, or a recession or a war is not the type of fiscal policy imbalance that tends to have a negative long-run effect on an economy. To the contrary, appropriate discretionary fiscal responses to these types of situations can have beneficial economic effects ... However, it is imperative that the nation come to grips with the ... federal government spending programs and taxes to bring the budget toward balance ... The benefits of taking timely and appropriate federal budget actions are important for the long-run health of the U.S. economy.
Fed Governor Bies on Regulatory Responses to Credit Risk and Discrimination in Mortgage Markets
Regulatory Issues, by Fed Governor Susan Schmidt Bies: ...Today, I would like to focus on three regulatory issues that are currently high on the list of both bankers and supervisors: credit risk, particularly in residential and commercial real estate; the proposed revisions to the current minimum regulatory capital requirements; and the new disclosures under the Home Mortgage Disclosure Act (HMDA).
First, I would like to talk about credit risk, which has been the leading cause of bank failures over the years and remains the biggest risk for most financial institutions. While credit performance has been very strong lately, and banks of all sizes survived the 2001 recession with only a slight decline in credit quality, banking supervisors have become concerned recently about apparent increased risk-taking in both commercial and residential real estate lending. .... The federal agencies issued joint guidance on home equity lines of credit, or HELOCs, in May; we are now working on additional guidance on affordability products in the residential mortgage market and on underwriting practices in the commercial real estate market. Residential real estate lending has been a significant focus of supervisory attention this year. Average U.S. housing prices have appreciated more than 80 percent since 1997... Home prices react fundamentally to factors affecting affordability, such as household income growth and mortgage interest rates. But another factor apparently fueling price appreciation has been an increase in speculative buying...As home prices have risen, lenders have turned to a variety of ways to help their customers buy the homes they want. ... Non-traditional, or "affordability," mortgage products are designed to minimize down-payments, initial monthly payments, or both. ... From the point of view of bank supervisors, affordability products do not necessarily pose solvency concerns. Despite the apparent decline in underwriting standards, less than 5 percent of outstanding mortgages have a loan-to-value ratio greater than 90 percent, which means that the vast majority of homeowners have a significant equity cushion; in the event prices fall... Still, affordability products pose special risks ... The bank regulators are conducting a survey of industry practices with respect to affordability products and are considering guidance on the subject in the near future. We hope to find out whether financial institutions are fully assessing and managing the new risks posed by affordability products...
I would now like to discuss a few recent developments pertaining to regulatory capital. As most of you probably know, ... Last week, the four federal bank regulatory agencies--the Federal Reserve Board, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency and the Office of Thrift Supervision--decided to publish an interagency advance notice of proposed rulemaking (ANPR) for revisions to the existing risk-based capital rules. All four agencies are looking forward to comments from the industry and others on the proposal. ... Bankers--particularly at small-to-medium-sized institutions--have expressed concerns about our work on regulatory capital rules because of the potential competitive implications ... As we move forward with revisions ..., we continue to be quite interested in the comments of bankers and others about the potential implications of these proposals...
The topic of fair lending, seen through the prism of the new Home Mortgage Disclosure Act data on mortgage loan pricing, is easily worth a speech in itself. Today, I will only be able to touch on the topic. However, you will be hearing more from the Federal Reserve about these data as we conduct further analysis. The data ... raise as many questions as they answer. ... As you have seen in recent headlines, the data show that African-American and Hispanic borrowers obtain higher-priced mortgage loans much more frequently than do whites or Asian-Americans. For example, African-American borrowers obtained higher-priced conventional home purchase loans in 2004 more than three-and-one-half times as often as white borrowers; Hispanics, more than twice as often as whites. Such great disparities raise legal issues of compliance with fair lending laws as well as basic ethical, social, and economic questions. Attempting to answer those questions would be well beyond the scope of my remarks today. I will simply emphasize that disparities of this kind challenge us to understand them better. ... Th[e] partial explanation for the differences in the incidence of higher-priced borrowing, however, begs for its own explanation: Why is there a racial and ethnic difference in the tendency of borrowers to obtain loans from lenders that concentrate on higher-priced lending? Qualitative and quantitative research on such questions will be critical to understanding racial and ethnic differences in lending outcomes. Staff at the Federal Reserve will continue their research, and we hope and expect others will join them...
Fed Governor Kohn on How Globalization Affects Inflation and Monetary Policy
Globalization, Inflation, and Monetary Policy, by Donald L. Kohn: ...I intend to spend much of the ... time discussing the ... effects of the process of globalization on my job as a central banker. ... I have been struck recently by the contrast between the views reported in the media and views among academic economists on this issue of globalization and inflation. The media tend to concentrate on the increasing availability of cheap goods and competitive pressures on labor compensation as a continuing ... check on inflationary tendencies in industrial economies. In contrast, just two weeks ago, I attended a conference of leading academic and central bank researchers on inflation ... at which globalization was hardly mentioned. One modeler had tacked an import price variable onto the equations explaining U.S. inflation, but the rest simply ignored any developments beyond our borders. ... The academic view implies that for the most part I can proceed with regard to inflation as if the United States is, to a first approximation, a closed economy. To act as if the outside world does not matter flies in the face of the major changes we have witnessed in recent decades. The advance of globalization has ... directly held down the rate of increase of the imported-goods component of the consumer price index (CPI) and, thus, the rate of increase of the overall index; ... Globalization has reinforced disinflation by intensifying the competitive pressures faced by U.S. firms and workers. ... For workers in some sectors, labor compensation has likely been restrained by the threat of jobs being shifted overseas ... and this wage restraint in turn has helped to hold down domestic prices.
How important have these direct and indirect price effects been? A precise answer to this question is beyond our abilities, but ... although not necessarily inconsequential. ... imports have had at most only modest effects on U.S. prices in recent years, although more-significant effects were recorded in a few specific categories... In addition, ... historically, industrializing countries have often raised global demand more than supply. Somewhat surprisingly, however, a number of these countries are currently producing more than they are spending. Their trade accounts tend to be in surplus, in some cases substantially, an indication that they are supplying more goods into the global economy than they are demanding. ... For a variety of reasons, some emerging-market economies have resisted upward pressures on their exchange rates, even if that resistance requires buying large quantities of dollars to keep their currencies from appreciating. ... less than fully flexible exchange rates are probably contributing to the surpluses of these economies and to their disinflationary effect on the rest of the world. Taking all these factors into account, where do I come out on the question of how recent trends in globalization have affected inflation in the United States and other industrial countries? On balance, under current circumstances, the entry of China, India, and others into the global trading system is probably having a modest disinflationary effect here. But it is neither large nor inevitable. ... we cannot rule out the possibility that globalization might some day even create inflationary pressures on balance.
If globalization is having a modest but persistent downward effect on U.S. inflation, what about its effects on employment, the other component of the Federal Reserve's dual mandate? Here, I think the answer is clearer: An expansion of trade does not impinge on an economy's ability to create jobs and operate at its potential, given time for any temporary sectoral disruptions to be worked out. ... That we now have an unemployment rate as low as 5 percent, and have sustained that rate without an appreciable pickup of underlying inflation, is evidence that our economy's ability to provide jobs on a sustained basis has not been impaired. Although globalization should have little effect on aggregate employment..., international trade does expand the economy's productive potential. By ... permanently raising the level of potential output... Globalization in its latest manifestations does not relieve central banks of their responsibility for maintaining price and economic stability. ... How the forces of demand, potential supply, and expectations interact has probably not been changed in any fundamental way by the recent trend of globalization. ... the ... extent and duration of its damping influence on inflation in the future are open questions. ... To the extent that the U.S. can more readily draw upon world capacity, the inflationary effect of an increase in aggregate demand might be damped. But from another perspective, integrated economies and financial markets can also exert powerful feedback, which may be less forgiving of any perceived policy error. ... The need to compete for business in a globalized economy has quite likely raised the efficiency and flexibility of economic systems as well as reinforcing the requirement for noninflationary monetary policies...
Greenspan on the Virtues of Free Markets and Information Technology
Economic flexibility, by Chairman Alan Greenspan, October 12, 2005: ...In my more than eighteen years at the Federal Reserve, much has surprised me, but nothing more than the remarkable ability of our economy to absorb and recover from the shocks of stock market crashes, credit crunches, terrorism, and hurricanes--blows that would have almost certainly precipitated deep recessions in decades past. This resilience, not evident except in retrospect, owes to a remarkable increase in economic flexibility, partly the consequence of deliberate economic policy and partly the consequence of innovations in information technology.
...For this country's first century and a half, government was only peripherally engaged in what we currently term the management of aggregate demand. Any endeavor to alter the path of private economic activity through active intervention would have been deemed inappropriate and, more important, unnecessary. ... The free-market paradigm came under ... vigorous attack after the collapse of the world's major economies in the 1930s. As the global depression deepened, the seeming failure of competitive markets to restore full employment perplexed economists until John Maynard Keynes offered an explanation ... He argued that, contrary to the tenets of Smith and his followers, market systems did not always converge to full employment. ... In the place of Smith's laissez-faire approach arose the view that government action was required to restore full employment and to rectify what were seen as other deficiencies of market-driven outcomes. A tidal wave of regulation soon swept over much of the American business community. Labor relations, securities markets, banking, agricultural pricing, and many other segments of the U.S. economy became subject to the oversight of government. ... At the macro level, the system of wage and price controls imposed in the 1970s to deal with the problem of inflation proved unworkable and ineffective. And at the micro level, heavy regulation of many industries was increasingly seen as impeding efficiency and competitiveness...
Starting in the 1970s, U.S. Presidents ... responded to the growing recognition of the distortions created by regulation, by deregulating large segments of the transportation, communications, energy, and financial services industries. ... As the 1980s progressed, the success of that strategy confirmed the earlier views that a loosening of regulatory restraint on business would improve the flexibility of our economy...
Beyond deregulation, innovative technologies, especially information technologies, have contributed critically to enhanced flexibility. ... Deregulation and the newer information technologies have joined, in the United States and elsewhere, to advance flexibility in the financial sector. Financial stability may turn out to have been the most important contributor to the evident significant gains in economic stability over the past two decades... recent regulatory reform, coupled with innovative technologies, has ... contributed to the development of a far more flexible, efficient, and hence resilient financial system than the one that existed just a quarter-century ago. ...
Governments today, although still far more activist than in the nineteenth and early twentieth centuries, are rediscovering the benefits of competition and the resilience to economic shocks that it fosters. We are also beginning to recognize an international version of Smith's invisible hand in the globalization of economic forces. ... We appear to be revisiting Adam Smith's notion that the more flexible an economy, the greater its ability to self-correct after inevitable, often unanticipated disturbances. That greater tendency toward self-correction has made the cyclical stability of the economy less dependent on the actions of macroeconomic policymakers, whose responses often have come too late or have been misguided. It is important to remember that most adjustment of a market imbalance is well under way before the imbalance becomes widely identified as a problem. ... administrative or policy actions that await clear evidence of imbalance are of necessity late...
Flexibility is most readily achieved by fostering an environment of maximum competition. A key element in creating this environment is flexible labor markets. Many working people, regrettably, equate labor market flexibility with job insecurity. Despite that perception, flexible labor policies appear to promote job creation, not destroy it. ... Protectionism in all its guises, both domestic and international, does not contribute to the welfare of American workers. At best, it is a short-term fix .... We need increased education and training for those displaced by creative destruction, not a stifling of competition. ... Accordingly, education is no longer the sole province of the young. Significant numbers of workers continue their education well beyond their twenties. ... to upgrade their skills or get new ones. It is a measure of the dynamism of the U.S. economy that community colleges are one of the fastest growing segments of our educational system...
Although the business cycle has not disappeared, flexibility has made the economy more resilient to shocks and more stable overall during the past couple of decades. To be sure, that stability, by fostering speculative excesses, has created some new challenges for policymakers. But more fundamentally, an environment of greater economic stability has been key to the impressive growth in the standards of living and economic welfare so evident in the United States.
I was pleased to see this remark, "We need increased education and training for those displaced by creative destruction, not a stifling of competition," as I do not believe we do enough to help those displaced by globalization.
Can China Risk Revaluation?
China can't move further on the yuan, by Qu Hongbin, Commentary, International Herald Tribune: John Snow, the U.S. treasury secretary, visits Beijing this week to talk about what China can do to help cut a U.S. current-account deficit ... For months, the United States pressed China to revalue... the yuan, and China finally responded on July 21 ... This has involved, so far, a revaluation of about 2.4 percent against the U.S. dollar. When he arrived in Shanghai on Tuesday, Snow called for more. But China can't deliver, whether it wants to or not. ... The total value of Chinese exports is huge ... and set to be even higher this year. ... That has many in the United States worried that China is using a cheap currency to undermine U.S. competitiveness, while increasing U.S. indebtedness and its current-account deficit. This view assumes that China's exports come from China. But it's not so simple. ... official figures suggest that the value of imported components is as much as 80 percent of the total value of the processed exports. A Japanese-owned factory in China making notebook computers ... will buy Intel chips from the United States, screens from South Korea and other components from its parent in Japan for final assembly and processing. The finished product has a total value of perhaps $1,000, which is recorded as an export from China to the United States. But the imported parts and components may represent up to 80 percent of the computer's value. This distorts China's export value immensely. Looked at from a value-added point of view, China's level of exports wouldn't be at all exceptional. How China trades with the rest of the world can only be determined by its comparative advantage - its abundant labor supply. With at least 200 million surplus rural workers hitting the urban job market, ... China is well positioned to participate in the labor-intensive stages of production for almost all industries. ... The bottom line is that China is effectively exporting labor services ... The value added in China - about 20 percent once double accounting has been stripped out - represents the cost of labor. Maintaining this channel to expand the export of labor services is crucial to sustaining China's development, which centers on shifting rural surplus labor into industrial and tertiary sectors. Given the sheer size of its surplus labor force, China has no choice but to expand the export of its labor services to create jobs. There's only one conclusion: Continuing to bolster labor-intensive production and exports is the only viable means for China to absorb its surplus labor and improve rural living standards. To do so, China must keep the yuan's effective exchange rate competitive for the foreseeable future.
Snow Throws Cold Water on Katrina Bond Bailout
Katrina Bond Bailout No Sure Thing, Snow Reminds Us, by Joe Mysak, Bloomberg: Everyone who thinks the federal government is going to bail out municipalities that can't make their debt service payments because of Hurricane Katrina have another thing coming. The White House opposes guaranteeing state and local debt, Treasury Secretary John Snow told the Senate Finance Committee last week. ... This means the Bush administration opposes a federal guarantee of new bonds, as well as the billions of dollars in bonds sold by Louisiana and Mississippi localities. And this means that, unless the state governments somehow come to the rescue, bondholders can expect defaults in MuniLand. Even if half of the bonds that default are insured, ... This is a big problem .. Investors haven't had this kind of scare since the Great Depression, which means, for most of them, never. They have come to depend on municipal bonds ... Some of them ... even ... only buy general obligations -- those that ... promise to increase taxes to whatever level is needed to repay debt. That cold comfort may not help the bondholders very much if those tax bases have been destroyed, or if most or all of the taxpayers have moved away. In the days following this disaster, ... Somehow, many of those in the market came to believe that Congress would include bondholders in the federal largess they are throwing at the problem. Now, it seems, the sudden socialization of credit risk in the municipal market is not a foregone conclusion. A lot can still happen ... but the argument being made by the market for a bailout is ... Widespread defaults by Gulf Coast issuers will, 1) make it impossible for issuers in those states to borrow money, and 2) raise borrowing costs for all municipalities. This argument is open to debate...Even if issuers in Louisiana and Mississippi default, there is no evidence that other issuers in those states will have a hard time selling their bonds, let alone issuers in other states. There's another argument to be made against a federal bailout, and it isn't so subtle. Consider the constituency. Almost from the beginning, commentators have said Katrina, or the government's response to it, was all about race and class. You can make the argument that helping municipalities pay debt service bails them out. More people are likely to see it as a bailout of bondholders -- a very small, elite club. ... These weren't the people taking refuge at the Superdome or the Convention Center in New Orleans.
Financial Times: Do Not Fear the Rise of Science in Asia
Do not fear the rise of world-class science in Asia, by Charles Leadbeater and James Wilsdon, Commentary, Financial Times: On the edge of Bangalore, at the home of Biocon, one of India’s most successful biotechnology companies, men and women in white coats wander through manicured gardens. There are 1,400 employees on Biocon’s campus and more than 60 per cent have a higher degree. They cost roughly one- tenth of their equivalents in Munich or Cambridge, they speak flawless English and they are available 24 hours a day at the end of a high-speed data line. Das Goutham, one of Biocon’s heads of research, is bullish about India’s potential as a hub for research and development: “Look, if only 5 per cent of Indians were like us, we could have a scientific labour force the size of the entire UK population.” Even with a discount for hyperbole, he has a point. We used to know where new scientific ideas would come from: the top universities and research laboratories of large manufacturing companies based in Europe or the US... All that is changing fast. As globalisation moves up a gear, ... Countries such as China, India and South Korea are fast becoming world-class centres for research, particularly in emerging fields such as stem cell biology and nanotechnology. ... China’s spending on R&D has trebled in seven years ... India now pumps out 260,000 engineers a year and its number of engineering colleges is due to double to 1,000 by 2010. Quantity does not necessarily equal quality, but the Indian Institutes of Technology are ranked among the world’s best universities... There is a tendency among politicians to see these growing scientific capabilities as a threat ... But retreating into a scientific version of protectionism is not an option. More innovation in Asia does not mean less in Europe. Alongside new sources of competition, there will also be new opportunities for collaboration ... We need to develop better mechanisms for orchestrating R&D across international networks and supporting scientists ... to collaborate with their counterparts in Asia...
Tax Panel Seeks to Limit Mortgage Interest and Healthcare Deductions
Tax panel seeks cap on break for homeowners, by Christopher Swann, Financial Times: The president's panel on tax reform is pushing for a cap on the mortgage interest tax deduction, long considered one of the country's untouchable tax breaks. The loophole, which along with other tax breaks for homeownership costs the US Treasury about $100bn (€83bn, £57bn) a year in lost revenue, disproportionately benefits wealthier Americans. George W. Bush had instructed the panel ... to take account of “the importance of homeownership and charity in American society”, a statement that led some to suggest that tampering with existing generous incentives for property ownership would be taboo. But in the final weeks of its deliberations it is leaning towards curbing the tax privileges of higher-end homeowners. The committee ... has been searching for ways to plug a hole in government finances that would be left by the abolition of the Alternative Minimum Tax... This has led them to look at housing and healthcare, the two most costly deductions. Jim Poterba, an economics professor at MIT and a member of the panel, said there was only shaky evidence that the existing system encouraged homeownership and a strong case that it led to overinvestment in residential property to the detriment of other investments. ... Charles Rossotti, senior adviser to the Carlyle Group ... and a member of the panel, says the system tends to encourage the construction of bigger houses rather than an increase in the number of people who own their home. The panel is now considering where to recommend capping the tax deduction. Given wide regional variations in US home prices, it said, it would consider caps based at a certain level above local median prices. However, it warned that any abrupt move to curb tax benefits for housing could be disruptive and unfair. Prof Poterba suggested that it could even consider leaving intact the existing tax structure for the life of existing mortgages. The panel was almost unanimous in arguing that the existing tax structure for healthcare also needed to be overhauled. Individuals are not currently taxed at all on employer-provided healthcare coverage, which has created the single largest tax loophole in the US code, costing the Treasury $125bn a year. That may have contributed to runaway price rises in the healthcare system, the panel said, with some companies offering employees costly insurance plans in part because of their tax-privileged status.
Here are a couple of things I don't quite understand. If the deduction is eliminated on new mortgages only, not on existing mortgages, and it is capped, how much revenue can it bring in over, say, the next five to ten years? Without a fairly low ceiling, I'm skeptical it will provide much of the needed AMT offset. Also, the main argument seems to be that the taxes are distortionary and provide no benefits to compensate. If so, why cap the deduction? Shouldn't it be eliminated entirely? And a point of clarification, saying there is shaky evidence that the mortgage deduction provides benefits simply says the data aren't clear on this point. It does not say that there aren't any benefits.
Yes, taxes and tax deductions are generally distortionary. They may kick me out of the economist's club for not railing against a market inefficiency, but I hope they'll allow me this one. Somehow having too much healthcare and too many houses that are too roomy (got kids?), or both, doesn't bother me too much, though if the mortgage interest deduction is capped at a high enough level, it will bother me less (just above my house value is perfect). There are other places to look besides healthcare and housing to solve the deficit problem and most any tax you examine can be pegged with the distortionary label. It appears the main reason they are targeting these two deductions is simply because they are the two largest potential pools of money, not because they are the source of the large distortions in the economy.
FOMC Meeting Minutes Released
Minutes of the Federal Open Market Committee, September 20, 2005: The information reviewed at this meeting suggested that, before the landfall of Hurricane Katrina on the Gulf Coast, expansion of economic activity had been solid ... While business investment appeared to be losing some momentum, labor markets continued to improve, and increases in core CPI and PCE prices were modest after notable increases earlier in the year. Only limited data bearing on the likely economic effects of the hurricane were available. Oil and gasoline prices, however, were on the rise, spiking to record levels in the days immediately following the hurricane. ... Core consumer price inflation remained benign in July and August. However, the surge in energy prices considerably boosted overall consumer price inflation over those months. Gasoline prices in particular rose steeply in August, and survey data pointed to a larger increase in early September. Producer price inflation was subdued. One survey of households in early September indicated that near-term inflation expectations jumped and that longer-term inflation expectations edged higher...
At its August meeting, the Federal Open Market Committee decided to increase the target level of the federal funds rate 25 basis points, to 3-1/2 percent. ... The Committee's decision at its August meeting was widely expected in financial markets and evoked little price reaction. Over the intermeeting period, however, investors marked down their expectations for the path of policy, partly in response to the devastation caused by Hurricane Katrina. ... In the forecast prepared for this meeting, the staff lowered its projection for economic growth over the remainder of 2005 in light of the economic dislocation associated with Hurricane Katrina. At the same time, however, the staff increased the growth rate forecast for 2006 to reflect the boost to economic activity from the rebuilding effort. By 2007, the level of output was expected to move back to the path it would have followed in the absence of the storm. The staff revised upward its forecast of overall inflation for 2005 and of core inflation for 2006, reflecting the effects of higher energy prices, but lowered its projection for overall inflation slightly for 2006. It was recognized that there were considerable near-term uncertainties and that many data series in coming months would be influenced by the effects of the storm.
In their discussion of the economic situation and outlook, meeting participants agreed that output and employment appeared to have been growing at a good pace before Hurricane Katrina's landfall. Business fixed investment had been a little softer than expected, but household spending had been especially strong. Participants agreed that the widespread devastation in the Gulf Coast region and the dislocation of many people would hold down indicators of spending for a time. But they also were of the view that aggregate demand and output would likely rebound before long, fueled in part by private spending to rebuild and outlays by the federal government to assist in the recovery. With growth of the economy expected to recover, meeting participants were concerned that price pressures, which had been elevated before the storm, could climb further, primarily as a result of additional increases in energy prices. ... On balance, participants thought that there would likely be a significant shift in the timing of aggregate economic activity over the next several quarters but probably little effect on the economy's intermediate-term growth prospects. Several participants voiced concern that the effects of the hurricane were likely to add to already considerable pressures on prices. For the nation as a whole, participants noted that household spending had been fairly robust before the hurricane, supported by strong advances in income and continuing gains in wealth that reflected in part further large increases in home prices. ...
With regard to fiscal policy, meeting participants noted that federal outlays would increase sharply in order to assist with recovery and reconstruction efforts in the aftermath of the hurricane. The eventual size of the increment to federal outlays was unclear, but it was likely to be quite large. The substantial step-up in government spending would add to federal deficits that were already large and underscored the worrisome loss of fiscal discipline evident in recent years. The expansion of federal spending implied an increase in fiscal stimulus at a time when the margin of unutilized resources in the overall economy was probably thin.
Participants' concerns about inflation prospects generally had increased over the intermeeting period. The surge in energy prices, in particular, was boosting overall inflation, and some of that increase would probably pass through for a time into core prices. ... Indeed, some recent survey evidence on such expectations had been troubling, and widening federal deficits were mentioned as a factor that could further stir inflationary concerns. ... Underlying productivity growth to date apparently had remained robust but, at this stage of the business cycle, gains in productivity could not necessarily be counted on to stay strong. ... Still, core inflation in recent months had been quite damped, and market-based measures of longer-term inflation expectations had risen only modestly of late...
In the Committee's discussion of monetary policy for the intermeeting period, nearly all members favored raising the target federal funds rate 25 basis points to 3-3/4 percent at this meeting. Although uncertainty had increased, in the Committee's judgment the fundamental factors influencing the longer-term path of the economy probably had not been affected by the hurricane, but the upside risks to inflation appeared to have increased. Even after today's action, the federal funds rate would likely be below the level that would be necessary to contain inflationary pressures, and further rate increases probably would be required. Moreover, the uncertainties about near-term economic prospects resulting from Hurricane Katrina would probably not be reduced materially in coming weeks. Indeed, underlying economic trends would be particularly difficult to assess over the next several months as a result of the direct, and presumably temporary, effects of the storm and its aftermath on the incoming data. A pause in policy tightening at this meeting had the potential to mislead the public both about the Committee's perceptions of the fundamental strength and resilience of the economy and about its commitment to fostering price stability.
In discussing the statement to be released after the meeting, members agreed that it would be appropriate to characterize the macroeconomic effects of Hurricane Katrina, while significant, as essentially temporary. Members also believed that the statement should again note that both monetary policy accommodation and robust underlying productivity growth were continuing to support economic activity. Although energy prices had the potential to add to inflation pressures, and inflation expectations had recently exhibited some signs of increasing, members agreed that the risks to inflation, as well as those to growth, remained essentially balanced under an assumption of appropriate policy action. The Committee also agreed to reiterate its previous expectation that ". . . policy accommodation can be removed at a pace that is likely to be measured." However, some sentiment was expressed to consider changes to forward-looking aspects of the statement at upcoming meetings, in part because of the considerable reduction in monetary policy accommodation that had already been accomplished.
Votes for this action: Messrs. Greenspan and Geithner, Ms. Bies, Messrs. Ferguson, Fisher, Kohn, Moskow, Santomero, and Stern. Vote against this action: Mr. Olson. Mr. Olson dissented because he preferred that the Committee defer policy action at this meeting, pending the receipt of additional information on the economic effects resulting from the severe shock of Hurricane Katrina.
Physics and the The Scientific Method
Physics strings us along, By Margaret Wertheim, Commentary, LA Times: There has been much talk of late about the scientific method, which usually takes place in the context of distinguishing science from other "less rational" practices, such as religion and magic. But in recent years science itself has been showing increasingly magical tendencies. In the field of theoretical physics, it is now common practice to talk about other dimensions of reality, entire landscapes of universes for which there is no empirical evidence whatever. ...The extra dimensions of string theory and the other universes they might entail have never been observed and, in principle, they may not be observable, at least not directly. At present they are pure fictions. String theory is so fecund in its descriptive power that one physicist has estimated there may be as many as 10 to the power of 100 different versions of its equations! Each one articulates a different set of possible universes and, at present, there is no way of determining if our universe matches any of them. Once upon a time, the sine qua non of scientific practice was supposed to be empirical verification. Experimental evidence was the core principle of Francis Bacon's much-vaunted "scientific method." In truth, the picture has always been more complex. Science is also an engine of the imagination, leading our minds beyond ... what is to ... what might be. Nowhere is the speculative dimension of science more prominent than theoretical physics, which has given us such magical possibilities as time machines made from spinning black holes, wormholes that become portals to the far ends of the universe and the "parallel worlds" of quantum mechanics, which, in theory, make every possible version of history a realized physical fact. The stories that theoretical physicists tell us are written in the language of mathematics, but for all its formal rigor, the science has become in effect a form of speculative literature. Unchained by the fetters of verification, string theorists are free to dream, articulating through their equations vast imagined domains in which almost anything that is mathematically possible is deemed to be happening "somewhere."
In the link above, Not Even Wrong states:
As I’ve explained in detail on other occasions, the simple fact of the matter is that string theory does not make any predictions, unless one adopts a definition of the word “prediction” different than that conventional among scientists. A scientific prediction is one that tells you specifically what the results of a given experiment will be. If the results of the experiment come out differently, the theory is wrong. String theory can’t do this, since it is not a well-defined theory, but rather a research program that some people hope will one day lead to a well-defined theory capable of making predictions.
Posted by Mark Thoma on Wednesday, October 12, 2005 at 12:10 AM in Science
October 11, 2005
Bloomberg Assesses Feldstein's Assets and Liabilities
Harvard's Feldstein May Have Best Credentials, Biggest Liabilities for Fed, Bloomberg: Harvard University economist Martin Feldstein may have the best credentials to succeed Alan Greenspan as Federal Reserve chairman. He may also have the biggest liabilities. The 65-year-old Feldstein, a free-market Republican who served as President Ronald Reagan's top White House economist from 1982 to 1984, is one of a handful of economists Wall Street considers suitable to replace Greenspan, 79, whose term at the Fed expires Jan. 31. ... At the same time, Feldstein's prospects may be harmed by his association with American International Group Inc., a scandal- plagued insurance company where he has been a director for 17 years, as well as a reputation for not being politically astute. ''Marty has something of a tin ear for politics, and that would be a problem in the Fed chairman's job,'' says William Niskanen, who ... is now chairman of the Cato Institute ... Economists say Feldstein's reputation for independence, probity and analytical thinking make him an ideal choice to head the central bank. For most of the last three decades, he has headed the National Bureau of Economic Research ... and he has earned a worldwide reputation as an expert on public finance. A Feldstein appointment might not be so welcomed within the Republican Party. During the Reagan years, he angered supply-side economists by dismissing their claims that soaring budget deficits didn't matter. He publicly argued with then-Treasury Secretary Donald T. Regan, who said tax cuts would spur enough new economic growth to close the budget gap. At one point, Feldstein even advocated a so-called ''stand-by tax'' -- anathema in an administration bent on tax-cutting --to help reduce the budget deficit if it got out of hand.
The biggest impediment to his nomination may be his connection to New York-based AIG, the world's largest insurance company. AIG faces a securities fraud lawsuit ... and is being investigated by federal authorities in a scandal that forced the ouster of its longtime chief executive, Maurice ``Hank'' Greenberg... ''I can't imagine that Feldstein is directly involved, but if there were any reasonable prospect of his being called to testify, with some presumption of culpability on the part of the board, that would be a problem,'' says Thomas Mann, a senior political analyst at Brookings Institution. Feldstein also serves on the board of HCA Inc., the biggest U.S. hospital chain, which is involved in a Securities and Exchange Commission investigation into whether U.S. Senate Majority Leader Bill Frist received insider information before selling his stock in the company.
Feldstein's views on monetary policy and interest rates are spelled out in a series of papers he wrote for NBER. ...he agrees with Greenspan's ''risk- management'' approach of adjusting policy to counter risks to the economy. He ... opposes numerical inflation and growth targets, warning they could backfire and hurt the Fed's credibility. ... he wrote in 2003. ''An inflation target might actually weaken the credibility of a central bank'' if it ''cannot or does not achieve the target value or range, especially if this failure to deliver persists for several years.'' At the same time, Feldstein criticized Greenspan's stewardship of the central bank during the early 1990s, saying the Fed didn't act aggressively enough to increase the supply of money when it became clear the economy was stagnating. ... Feldstein hasn't said whether, if appointed, he'd continue Greenspan's habit of commenting on the federal budget, a practice that occasionally drew criticism from Greenspan-watchers who said he should have confined his opinions to interest rate policy...
Lawrence Lindsey, a Fed governor from 1991 to 1997 ... describes Feldstein as a quiet, hard-driving man with a well-deserved reputation for integrity. He works long hours, frequently traveling to NBER conferences around the world. ... Feldstein forged early ties with the Bush camp. When then- Texas Governor Bush was running for president, Feldstein was part of the economic team that hammered out his plans for budget- and tax-cutting programs and influenced Bush's proposals for overhauling the Social Security system. ''He's certainly been very supportive of the president's fiscal policy and tax program,'' says Lindsey. Lindsey says Feldstein ... would run a ''collegial'' board of governors. ''He would want to have a high- level discussion,'' Lindsey says. At the same time, Lindsey says, Feldstein ''would be a tough guy to argue against'' because ''he's very capable'' and can defend his positions vigorously.
Feldstein's political skills may have sharpened since his Reagan White House days. ... Moreover, Greenspan himself wasn't always as politically savvy as he is now. During his term as President Gerald Ford's chief economic adviser in the mid-1970s, Greenspan sparked headlines around the world by telling a welfare-rights advocate that stockbrokers, not welfare mothers, had been hurt most by the 1973 recession...
Should Fannie and Freddie Be Forced to Go on a Diet?
Adult Supervision, by Armando Falcon Jr., Commentary, WSJ: Over the past several years, corporate America has been rocked by major scandals... Whether it was Enron, Adelphia or WorldCom, Congress wasted no time examining and strengthening the oversight functions and regulatory authority of various federal agencies, including passage of the wide-ranging Sarbanes-Oxley Act. To date, there remains one glaring exception. In the past two years, accounting failures at Fannie Mae and Freddie Mac, known as Government Sponsored Enterprises (GSEs), have led to the largest financial restatements in history -- totaling more than $20 billion -- dwarfing the combined restatements of both Enron and WorldCom. In recent days, news reports indicate the financial misconduct could be wider and deeper than has emerged thus far. Left undetected and unchecked, the web of misconduct ... might have ... caused serious disruptions to our financial system. The likely collateral damage was presciently spelled out in a report on systemic risk that their regulator, the Office of Federal Housing Enterprise Oversight (Ofheo) issued in 2003. Yet ... two and a half years after Freddie Mac's scandal unfolded, legislation to strengthen regulation remains mired in gridlock. One of the key areas of disagreement is the appropriateness and size of the mortgage portfolios these enterprises retain. ... The fact is that they have grown 12-fold in 14 years for one reason: to generate additional profits for the GSEs. That is nonjudgmental, just a fact. ... Currently, there are no real limits on the size of the portfolios. Ofheo's statutory mandate [does] not to limit their amount. However, Fed Chairman Greenspan and other economic leaders have repeatedly warned policy makers that they should be concerned...
Smaller, mission-focused portfolios would better serve everyone, even shareholders. If well managed, they are capable of a fair return to investors and a strong return to the public interest. ... Legislation should give the regulator discretion to manage the size of the portfolios, but be clear as to the regulator's mandate. The mandates in the Senate and House bills are very different ... The Senate bill would direct regulators to design and implement an orderly reduction in the enterprises portfolios without harm to affordable housing efforts. But the House bill ... permits the enterprises to maintain portfolios of any size as long as safety and soundness considerations are met. The House bill should be amended to put the proper mandate in place.
...Fannie Mae and Freddie Mac have constructed their portfolio risk-management strategies around hedging techniques that remain untested by adverse market conditions. Even assuming the companies employ the very best risk-management practices, prudence demands that we have the strongest regulatory structure in place to deal with the fallout if they just get it wrong. ...The growth of the portfolios held by these two GSEs has coincided with a strong economy, except for a mild recession in 2001 that left the housing sector unaffected largely because interest rates fell to historic lows. However, long-term interest rates are more likely to begin an upward trend that may cool off the housing market. ... Freddie Mac and Fannie Mae play an important role in our housing finance system and I support their public mission. The key is to ensure they are truly focused on this mission in a safe and effective manner. If this public-private arrangement is to work, the enterprises must have a fully empowered regulator and get back to serving the public interest, not the ambitions of management.
When the WSJ is calling for more, not less government regulation, it catches your attention.
Greenspan and Snow Go to China
Results sought in China currency reform, By Martin Crutsinger, AP: ...The Bush administration is fielding its top economic team for the Oct. 16-17 meetings in Beijing; Treasury Secretary John Snow leads the delegation, backed by Federal Reserve Chairman Alan Greenspan. The presence of Greenspan has raised hopes among U.S. manufacturers that what could have been just a routine consultive meeting of the U.S.-China Joint Economic Commission will produce more tangible results in the area of most concern -- currency values. ... The first step occurred on July 21 when China announced that it was breaking a decade-long fixed link between the Chinese yuan and the U.S. dollar. ... Optimists hoped for greater moves in the weeks and months to come. But it has not played out that way with the yuan little changed since its July move. American manufacturers contend that the yuan is undervalued ... That makes Chinese goods cheaper in the United States and American products more expensive in China and is a major reason for the trade gap, manufacturers believe. Congress has reacted to the gap with calls for ... 27.5 percent tariffs on all Chinese imports unless Beijing takes more steps to allow its currency to rise in value against the dollar. ... The administration is hoping that the prospect of across-the-board tariffs will prompt China to allow greater appreciation of the yuan...
Is it appropriate for the Federal Reserve Chair to lobby foreign governments on behalf of the administration? There are competing short-run interests. Krugman says it well:
Here's what I think will happen if and when China changes its currency policy, and those cheap loans are no longer available. U.S. interest rates will rise; the housing bubble will probably burst; construction employment and consumer spending will both fall; falling home prices may lead to a wave of bankruptcies. And we'll suddenly wonder why anyone thought financing the budget deficit was easy... I'm not saying we should try to maintain the status quo. Addictions must be broken, and the sooner the better. After all, one of these days China will stop buying dollars of its own accord. And the housing bubble will eventually burst whatever we do. Besides, in the long run, ending our dependence on foreign dollar purchases will give us a healthier economy. In particular, a rise in the yuan and other Asian currencies will eventually make U.S. manufacturing, which has lost three million jobs since 2000, more competitive. But the negative effects of a change in Chinese currency policy will probably be immediate, while the positive effects may take years to materialize. And as far as I can tell, nobody in a position of power is thinking about how we'll deal with the consequences if China actually gives in to U.S. demands, and lets the yuan rise.
I would have no problem with Greenspan's pressure on China if it were clearly linked to monetary policy concerns, but that has not been done. Instead it appears the Fed Chair is making a trip to serve a political purpose on behalf of the administration and to serve the short-run interests of one group, business, over the interests of other groups (though Stiglitz says benefits to business may be small). I don't think that is a proper role for the Fed Chair or the Fed more generally, but then again, there is the idea that the Fed Chair is intended to be the one conduit of political influence on the Board of Governors. Still, to me, this is too close for comfort to the line that maintains the Fed's independence, a line that should never be crossed - but perhaps I'm being too strict.
Guy de Jonquières: Asia's Missing Investment
Asia’s missing investment, by Guy de Jonquières, Financial Times: International investors ... cannot get enough of the great Asian growth story. ... Yet Asian companies appear curiously reticent about joining the party. Eight years after Asia’s financial crisis and with solid growth forecast ... one would expect businesses to be making big capital outlays ... However, with the exception of China, they have not done so. ... Whatever the reason for the caution, it is not lack of funds. ... private sector saving..., according to the latest available data, is higher than before the crisis. ... Some critics blame Asia for generating excessive current account surpluses by saving too much. However, the International Monetary Fund argues in a recent report that the real culprit is an “investment drought”(Asia Pacific Regional Outlook, September 2005). ...[Why have] they ... held back. ... One reason could be the shift of manufacturing to China ... However, studies have found little evidence that China has diverted foreign direct investment away from its neighbours. Another theory is that official data exaggerate companies’ financial strength by ignoring many smaller ones that are still struggling ... Equally, an overhang of unsold property, built before the crisis, may have delayed a recovery in construction. But not all countries experienced property bubbles during the 1990s. Finally, business confidence may have been dampened since the crisis by setbacks such as the severe acute respiratory syndrome scare, the 2001 US growth slowdown and cyclical downturns in the global electronics industry. But all this is conjecture. The IMF confesses it is puzzled. Private economists are also stumped.
Most, nonetheless, still believe investment will recover. There are some positive signs. ... But more investment is not necessarily better: witness China’s vast glut of manufacturing capacity. If the rest of Asia simply reverts to its old habit of investing for export-led growth, it will further depress product prices and fuel western protectionism. To be sustainable, its growth must be based on stronger domestic demand. But ... except in China and India, households are already saving less and borrowing more, so cannot be expected to boost consumption much further. As for governments, ... their finances allow only limited room prudently to increase spending. There is another option. Much of Asia is crying out for better transport, healthcare, education, power and water. The World Bank and the Asian Development Bank say $1,000bn needs to be spent on infrastructure. Governments cannot provide it all. But more imaginative approaches to privatisation could help fill the gap and create new opportunities for private investment. They might also reduce scope for corruption ... Second, there is huge untapped potential to boost wealth creation by stimulating domestic markets. The prime candidates are services, which in much of Asia are shackled by weak competition and over-regulation. Setting them free would yield big productivity and efficiency gains....[S]uch reforms will be essential ... if Asia is to keep growing. Its past development has relied heavily on harnessing abundant cheap labour and capital to producing for export markets. ... How Asia solves its investment puzzle will be critical to shaping its future development. When the region’s next investment wave arrives, it should be judged not just by its weight but by its quality.
While excessive government regulation and intervention is certainly to be avoided, I think there is more to recovery from the investment drought than "imaginative approaches to privatisation" and "Setting them free." For those interested in more on this issue, see , , , , , and .
How Big is a Galaxy?
Milky Way: Larger, Weirder?, Discover: Galaxies are large, but many of them-including the Milky Way-are much larger than suspected. Astronomers at the Keck observatory in Hawaii have found that the Andromeda galaxy-our closest galactic neighbor, 2.2 million light-years away and a familiar sight in the evening sky-is three times bigger than previously thought. Spectrographic analysis shows that 3,000 stars, once believed to be separate from Andromeda, move in lockstep with that galaxy's rotation, as part of its outer disk. "It was completely unexpected says Caltech astrophysicist Scott Chapman... In a related finding, new images from the Gemini South telescope in Chile exposed another giant disk around NGC 300, a far less massive galaxy that resembles our own but is 6 million light-years away. Using Gemini's high-end optics, Joss Bland-Hawthorn of the Anglo-Australian Observatory and astronomer Ken Freeman of the Australian National University counted the brightest stars on the galaxy's fringes. The census shows that, like Andromeda, NGC 300 boasts a broad disk-in this case one that effectively doubles the galaxy's size. The new measurements mean that astronomers must rethink how galaxies are formed. "The one thing that is clear is that all the models of galaxy formation do not predict such large spinning disks," says Chapman. These models typically assume that galaxies were created by gases clumped together by gravity. Since the gases thin out away from the core, star concentration should ease rapidly, and galaxies should exhibit sharp edges. But the stars appear to be obeying unknown rules, tapering off evenly...
[I can't resist this stuff. Apologies there isn't a link - it was typed from the magazine.]
Posted by Mark Thoma on Tuesday, October 11, 2005 at 12:06 AM in Science
October 10, 2005
Fed Watch: Clearly Hawkish Signals
This is something of an abbreviated piece today – I need to focus my attention on final preparations for the Second Annual Oregon Economic Forum. And, truth be told, Fed policy makers are taking some of the fun out of the game at this point with their clear warnings on inflation. Indeed, even “Mr. Eighth Inning,” Dallas Fed President Richard Fisher, who I had previously dubbed a dove, has delivered a series of market rattling comments. David Altig’s compilation of blogs from Mark Thoma and William Polley, among others, provides a great overview of this increasingly hawkish language that appears to point to only one thing – more rate hikes in the coming months. Indeed, this is the theme picked up in this morning’s Wall Street Journal. And incoming data and anecdotal evidence remain supportive of that path.
Probably the most important piece of data to arrive last week was the September labor report, which came in well above expectations with a 35,000 dip in payroll. As far as the Fed will see this report, I think David Altig hits the nail right on the head – it is somewhat of an uphill battle to paint the report in a bad light, especially considering some early guesstimates pointed to a payroll slide of 500,000. Simply put, the labor report will only be supportive of the Fed’s contention that the impact of Katrina and Rita on the demand side of the economy is minimal and locally contained. Consequently, the Fed will focus on the supply side impacts and their arch nemesis, the inflation beast.
What about the continuing troubles in the automotive and airline industries? Over the weekend, we saw the not-unexpected bankruptcy filing of the auto parts maker Delphi (WSJ subscription). Will this rattle Fed officials? Doubtful. As I have argued before, this is part and parcel of the ongoing saga of the US auto industry – an industry whose profits depend upon a vehicle type fewer people want to purchase. Moreover, the industry’s labor woes are legendary. According to the WSJ, the UAW contract with Delphi provides workers with a wage-benefit package of $65 per hour, not exactly competitive internally, let alone internationally. Similarly, airlines are also caught in a structural straightjacket. High labor costs, high fuel costs, and relentless competition all conspire to force an ongoing shakeout in the industry, which some analysts believe will not be complete until an airline actually disappears and takes some capacity with it.
The short story is that Greenspan & Co. are not likely to take their anecdotal clues from industries suffering from structural problems. They will look instead for corporate leaders with wide-ranging activities that are cyclical in nature, which brings me to an article Mark Thoma flagged from yesterday’s New York Times, “ Have Recessions Absolutely, Positively Become Less Painful.” Mark takes issue with the sense of overconfidence regarding management of business cycles, a point I agree with. But my attention was draw to the following section:
No company embodies this change, for better and worse, quite like FedEx. When Alan Greenspan, the Federal Reserve chairman, sees Frederick W. Smith, FedEx's chief executive, during halftime of Washington Redskins games, Mr. Greenspan uses the company's vast reach to check in on the economy.
"He always asks, 'We still O.K.?' " said Mr. Smith, a part-owner of the team whose stadium suite abuts the one Mr. Greenspan uses.
More formally, Federal Reserve staff members rely on FedEx and the nearly six million packages it delivers every day for real-time data that helps set interest rate policy.
If this is so, then Greenspan can’t be happy with what he is hearing, especially with FedEx announcing a 5.5% increase in shipping rates (WSJ subscription), the highest increase in at least nine years. FedEx is clearly confident enough about the outlook to pass on rising fuel costs to consumers. And it’s not just FedEx that’s raising prices – the Wall Street Journal reported that railroad customers are expecting a 5.6% rate hike in the next six months. It is also widely expected that UPS will join the party as well. These are the kinds of price increases that feed their way into virtually every business in the country. The Fed will worry that other firms in other industries will decide that they too should pass on higher costs to customers. Worry enough that they will want to nip it in the bud.
As a side note, notice that FedEx CEO Smith revealed Greenspan’s conversations to a reporter, just a few weeks after French Finance Minister Breton did the same. And the New York Times writes a story on the importance of FedEx to Fed staffers just a few days after FedEx announces a large price hike? Probably just coincidences, all of them – but I don’t like it when the coincidences start to pile up.
In short, worries about demand will not resonate with Fed officials who see enough goods being shipped around the country that freight companies can push through higher prices. In fact, these are the kinds of stories that leave a central banker sleepless at night, because, as Fisher so clearly stated, “any central banker worth his or her salt is genetically unable to tolerate inflation.” The Fedspeak suggests that other officials agree, loudly and clearly, on this point.
Paul Krugman: Will Bush Deliver?
Will Bush Deliver?, by Paul Krugman, NY Times: ...Bear with me while I make the case for doubting whether Mr. Bush will make good on his promise. First, Mr. Bush already has a record of trying to renege on pledges to a stricken city. After 9/11 he made big promises to New York. But as soon as his bullhorn moment was past, officials began trying to wriggle out of his pledge. ... It's not clear how much federal help the city has actually received. With that precedent in mind, consider this: Congress has just gone on recess. By the time it returns, seven weeks will have passed since the levees broke. And the administration has spent much of that time blocking efforts to aid Katrina's victims.
In the news lately, though not prominently enough for Krugman's taste, is the fight over a bipartisan bill to extend Medicaid coverage to all low-income hurricane victims, some of whom can't afford the medicine they need. Since this is a fight the White House has led, Krugman wonders:
Since the administration is already nickel-and-diming Katrina's victims, it's a good bet that it will do the same with reconstruction - that is, if reconstruction ever gets started. ... what's striking to me is that there are no visible signs that the administration has even begun developing a plan. ... And as far as we can tell, nobody is in charge.
I remember hearing that Karl Rove would lead the reconstruction effort. Is anybody in charge of this drifting ship?:
Last month The New York Times reported that Karl Rove had been placed in charge of post-Katrina reconstruction. But last week ... the White House press secretary denied that Mr. Rove ... was ever running reconstruction. So who is in charge? "The president," said Mr. McClellan.
With the president in charge, Krugman expects nothing but foot-dragging on post-Katrina reconstruction. But isn't that politically risky? How can a strategy of reneging on promises pay political dividends?
I've been reading "Off Center," an important new book by Jacob Hacker and Paul Pierson, political scientists at Yale and Berkeley respectively. ... One of their "new rules for radicals" is "Don't just do something, stand there." Frontal assaults on popular government programs tend to fail, as Mr. Bush learned in his hapless attempt to sell Social Security privatization.
So foot-dragging, acting like you are addressing important problems while actually stalling as much as possible is politically effective? Hmmm. Maybe an example would help:
For example, the public strongly supports a higher minimum wage, but conservatives have nonetheless managed to cut that wage in real terms by not raising it in the face of inflation. Right now, the public strongly supports a major reconstruction effort, so that's what Mr. Bush had to promise. But as the TV cameras focus on other places and other issues, will the administration pay a heavy political price for a reconstruction that starts slowly and gradually peters out? The New York experience suggests that it won't.
I see. But suppose I'm not convinced that the administration is this clever. Are there any other explanations?
Of course, I may be overanalyzing. Maybe the administration isn't deliberately dragging its feet on reconstruction. Maybe its lack of movement, like its immobility in the days after Katrina struck, reflects nothing more than out-of-touch leadership and a lack of competent people.
US Offers to Cut Farm Subsidies
US trade chief offers to cut farm subsidies, by Alan Beattie, Financial Times: The US will on Monday offer to end farm export subsidies in five years and slash its domestic subsidies by more than half, in an attempt to revive the flagging Doha round of trade talks. ... Agriculture, one of the most protected areas of world trade, is a sticking point in the negotiations, with the European Union and US at odds about cuts in tariffs and subsidies. ... Writing in the Financial Times, Rob Portman, US trade representative, offers to eliminate farm export subsidies by 2010, the date demanded by the Group of 20 developing countries and some European leaders, including Tony Blair... Mr Portman also agrees to cut those domestic farm subsidies believed to distort world trade by 60 per cent, higher than the 55 per cent reduction the EU was demanding... Bob Stallman, president of the American Farm Bureau, recently said the US should not go beyond 50 per cent. The US also suggests halving a ceiling agreed last year on those farm subsidies regarded as less distorting of trade. This cut, though it meets a demand from development campaigners such as Oxfam, would still allow the US to retain its controversial “counter-cyclical payments”, which compensate farmers for low prices. “The US offer is conditional on other countries reciprocating with meaningful market access commitments and subsidy cuts of their own,” Mr Portman says. The US proposals are designed to put the ball back into the EU's court by offering cuts in domestic farm support and ending export subsidies a key demand of Peter Mandelson, Mr Portman's European counterpart. But Dominique Bussereau, the French agriculture minister, has gained the signatures of 13 of the EU's 25 member states, including Italy, Ireland and Spain, on a memorandum insisting that Brussels trade negotiators consult with them before offering any farming concessions in the Doha talks. His memorandum, seen by the FT, says: “The task is not to negotiate a date for the elimination of our export subsidies, but a period of implementation for what is a conditional concession.” It is likely to dismay Brussels trade negotiators, who assumed they had a clear mandate last year when the EU offered to phase out farm export credits. ... In return for subsidy cuts, Mr Portman also repeated a proposal for substantial cuts in agricultural tariffs, which will require big cuts from the EU and Japan.
I will be surprised if substantial action is taken on this front, particularly given the statement that reciprocal action by other countries will be required and the resistance by France and others to such proposals. And on the notion of "counter-cyclical prices," see PGL at Angry Bear.
Are Dollars Lying on the Used Book Table?
In the Used-Book Market, Textbooks Rule, by Alex Mindlin, NY Times: Textbooks dominate the offline used-book market, according to a study ... by the Book Industry Study Group... The study found that educational books made up 93 percent of all used-book sales in brick-and-mortar bookstores in 2004... Textbooks are more expensive than other used books, said Jeff Hayes, director of market research for InfoTrends... Besides being more expensive, used textbooks also sell in volume; they are about 70 percent more common on bookstore shelves than other used books. "Many of them try to give the student as good a price as they can," Mr. Hayes said. "They're not trying to maximize their profit."
I have a feeling most students would disagree. Is InfoTrends saying that a low margin, high volume sales strategy is inconsistent with profit maximization?
October 09, 2005
Robert Samuelson Wonders How Long Wealth Based Consumption Can Continue
So Long to the Wealth Effect?, by Robert J. Samuelson, Newsweek: Ours is a wealth-driven era, when huge increases in home values and (before that) stock prices make people feel richer and cause them to buy more. ... You can imagine this "wealth effect" as a powerful afterburner that's boosted the economy for roughly 20 years. ...[T]he ... story may be whether the afterburner is flaming out. Just recently, Federal Reserve chairman Alan Greenspan gave a speech suggesting precisely that. Greenspan disclosed the results of a study he had done with Fed staff economist James Kennedy. The study estimated the amount of cash that homeowners have extracted from rising housing prices (those prices are up 53 percent over five years, according to government figures). Homeowners could convert higher real-estate values into cash in three ways ... By estimating all three sources, Greenspan and Kennedy reached annual grand totals, shown on the table below. ... The housing money is extra, on top of personal income.
Greenspan and Kennedy Estimates YEAR | EQUITY EXTRACTED | % OF DISPOSABLE 2000 | $204 bil. | 2.8% 2001 | $262 bil. | 3.5% 2002 | $398 bil. | 5.1% 2003 | $439 bil. | 5.4% 2004 | $599 bil. | 6.9%
Whoa! Consumers had a lot more to spend than ordinary income, almost $600 billion more in 2004. How much of that was actually spent (as opposed to being put into bank deposits, stocks or mutual funds) is unclear. Consumer surveys cited by Greenspan suggest perhaps two thirds, a big chunk of it on remodeling. The economy has depended heavily on all this extra cash. And, before the housing bonanza, there was the stock boom. ... Economists figure that consumers spend between 2 percent and 3 percent of their extra stock-market wealth. That's also a lot of purchasing power. No one has fully explained what caused these immense wealth gains. My own oft-stated belief is that lower inflation is the main cause, because it gradually reduced interest rates. ... But there are many other possible explanations, including financial speculation. Whatever the root causes, the result has been a marathon shopping orgy. ... Could the wealth effect now subside? For stocks, it already has. ... Greenspan has warned that the rapid run-up in home prices won't go on forever. ... Growth in consumer spending would then presumably slow, he said. This need not be a disaster. On paper, the economy could compensate in many ways: more exports and fewer imports (much U.S. consumer spending went to imports); stronger business investment; extra government spending for hurricane rebuilding. ... The fading of America's wealth effect, should it occur, might be ... dull and benign. But there are grimmer possibilities. One is that many adverse forces are now converging: higher energy prices, higher interest rates and debt payments, higher inflation, falling wealth gains. ... For two decades, free-spending American consumers have anchored the U.S. and world economies. If they no longer play that role, it's an open and worrisome question of who will.
The potential solutions to the global and domestic imbalance problems have been discussed extensively here and elsewhere, so I won't try and recount them all again, but one way to summarize them is that with smart monetary and fiscal policy and gradual adjustment in the U.S. and elsewhere, we have a chance of a soft landing. But if current policies continue, the chance of a more difficult adjustment period will rise.
Time to Pony Up to the Truth
Hopes amid the stumbling, by Peter Ferrara, Commentary Washington Times: President Bush conceded Tuesday what has long been obvious ... His Social Security reform efforts have stalled out. Personal accounts for Social Security, however, are still alive and kicking on the Hill, and can still pass within the next few months. Mr. Bush to me is a brave and endearing figure of high character, who has been poorly served by others on many fronts. That is the case in his Social Security reform failure too. ... Despite the president's better instincts, his staff misled him back into this swamp of failure... the staff sold the president the canard Democrats would support personal accounts in return for his support of price-indexing Social Security benefits... As should have been expected, the Democrats have uniformly opposed such price indexing. ... The staff's price indexing debacle was the equivalent to suggesting the president could get Democrats to support sweeping tax cuts if he would only embrace cutting food stamps and public housing. Earlier this year, the president was even sent out to argue for personal accounts, while ridiculously mouthing the proposition the accounts would not solve Social Security's problems. To address long-term solvency, the president put "on the table" large reductions in future promised benefits, delayed retirement age -- and even tax increases. The staff had sold the president another scandalous canard here ... All is not lost, however. Support for the GROW accounts legislation surges in Congress, to stop the current annual raid on the Social Security surplus for other government spending. ... This proposal is political dynamite because it combines the extremely popular idea of ending the raid on the Social Security trust funds with the still quite popular personal accounts, without any tax increases or benefit cuts...
The Role of Government in the Recovery from Natural Disasters
Blueprints From Cities That Rose From Their Ashes, by Anna Bernasek, NY Times: ...A major disaster, like Hurricane Katrina, acts as an involuntary experiment on the economic system. ... The results can be revealing. In the case of a disaster that levels a city, it's quite clear what the city looked like just beforehand, so we can judge its recovery by how quickly and thoroughly it returns to normal. ... the pace of recovery can vary greatly from city to city, and those differences can shed light on how to accelerate recovery from future disasters. What's more, urban disasters may provide clues to ... how to organize an economy, maximizing prosperity by getting the right mix of government and private involvement. Start with two success stories ... Galveston, Tex., and San Francisco. The hurricane that hit Galveston in 1900 killed perhaps 10,000 people ... and destroyed 8,000 buildings. By 1907, Galveston had largely recovered ... In 1906, most of San Francisco survived the initial earthquake only to be leveled in an inferno that raged unchecked. Some 28,000 buildings were destroyed... and 3,000 people were killed. But in just three years, 25,000 new buildings lined the streets, and by 1911, San Francisco had substantially recovered. So what made those two recoveries possible? In both cases, government money made up only a portion of the total losses. By far the main work of rebuilding was done by private individuals. But government at all levels - national, state and local - played a main role in re-establishing the confidence of the entrepreneurs, investors and ordinary citizens that is a prerequisite for economic growth. It achieved this in three ways.
First, government ensured public safety ... The city of Galveston, for example, decided to build a sea wall to protect residents from future storms. ... And ... the entire grade of the city was raised 1 to 15 feet above its previous level. In San Francisco, the federal and local governments worked together to secure the city against earthquake and fire. ... Second, all levels of government reacted promptly and vigorously in each case, taking decisive and tangible steps that provided an essential public reassurance to traumatized citizens. Immediate government spending provided employment to suddenly homeless and jobless citizens, priming the pump of the local economies as they fought to regain their stroke. Two days after the earthquake in San Francisco, while the fires were still smoldering, Congress took action toward rebuilding all the public buildings that had been destroyed. That provided work for many who had their lost jobs. ... Local government acted swiftly, too. ... plans for rebuilding were rejected ... in favor of even faster progress. Third, government focused on ... providing not only essential public safety but also a level playing field. In Galveston, civic leaders undertook anti-corruption reforms that became a model for cities elsewhere. ... In San Francisco, public officials pursued the goal of fairness in other ways. Leaders ... put great pressure on companies that had been refusing to pay fire insurance claims. The companies contended that the damages were due to earthquake, a risk not covered under typical fire policies. In the end, most claims were paid ... although some insurance companies went under...
Even in the most horrific circumstances, cities can come back. ... after the atomic bomb attack of 1945 ... after about 30 years, the city had in many ways recovered. It took that long because the Japanese government was overwhelmed - 66 cities had been bombed during the war - and essentially bankrupt. "The recovery of Japan's cities was almost all a private initiative," Professor Weinstein said [a specialist on Japan in the economics department at Columbia University]. "There just wasn't money around for the government to rebuild Japan." Divining the right mix of government and private activity lies at the very heart of economic policymaking. What disasters show us is the difference between arrangements that work and those that don't. San Francisco recovered in only five years. Nearly a hundred years later, shouldn't we try to do better in New Orleans?
Posted by Mark Thoma on Sunday, October 9, 2005 at 12:15 AM in Economics
October 08, 2005
Are Recessions in Recession?
Have Recessions Absolutely, Positively Become Less Painful?, by David Leonhardt, NY Times: The ... United States has endured an almost biblical series of calamities in recent years - wars, hurricanes, financial scandals, soaring oil prices and rising interest rates - but the economy keeps chugging along at an annual growth rate of roughly 3 percent. It has been able to do so with the help of technology that allows businesses to react ever more quickly to changes. But with little notice, those reactions have also created a new feature of the business cycle: the micro-recession. When one of them strikes, activity slows for a few weeks, sometimes in just certain sectors or regions, as companies adjust to a dip in demand. It has happened much more often in the last few years than in earlier expansions, but growth has picked up each time, thanks in part to the adjustments that businesses have made. No company embodies this change, for better and worse, quite like FedEx. When Alan Greenspan, the Federal Reserve chairman, sees Frederick W. Smith, FedEx's chief executive, during halftime of Washington Redskins games, Mr. Greenspan uses the company's vast reach to check in on the economy. "He always asks, 'We still O.K.?' " said Mr. Smith, a part-owner of the team whose stadium suite abuts the one Mr. Greenspan uses. More formally, Federal Reserve staff members rely on FedEx and the nearly six million packages it delivers every day for real-time data that helps set interest rate policy. ... The business cycle has certainly not been eliminated, as some dreamers suggested during the 1990's boom, but recessions really do seem to happen less often. ... Across the economy, quick reactions, like asking workers to put in more hours one week and fewer the next, have helped lead to the business cycle's new hiccups... At FedEx, the first responders to the business cycle are a group of managers who gather for a worldwide conference call every morning at 8:30 Memphis time. Sitting at a faux-wooden conference table in a spare room, beneath a screen that shows every FedEx plane in the air, they review the last 24 hours of activity. ... Changes like this ... have helped foster the recent economic stability. The amount of inventory that companies keep in their warehouses, in case demand suddenly surges or some boxes become stuck in Oakland, has steadily fallen...
This doesn't fully explain the change in the frequency and duration of business cycles, and a business cycle cannot be detected by "first responders" based upon the past 24 hours worth of FedEx data. There is a step missing here. The article is a story about very short-run variations in output and how companies such as FedEx smooth such fluctuations on a daily or weekly basis, but that does not necessarily change the duration of business cycles. With apologies for the quality of the artwork, here are two possible paths for output through time, one that wiggles a lot and has lots of "micro-recessions" and one that doesn't have any due to innovations such as inventory management changes described in the article:
Eliminating high frequency variation in output is certainly desirable and does stabilize the economy in the very short-run, but, though it is certainly possible to construct models with this property, it is not necessarily the case that eliminating "micro-recessions" also eliminates "macro-recessions." A step connecting the two needs to be provided. For example, better inventory management may smooth very short-run cycles, but be unconnected to business cycle frequency variation in output brought about by wage and price rigidities.
There does seem to be increased stability in the last twenty years, but I'm not predicting the end of recessions forever and ever just yet. And with all the evidence that came out during the Social Security debate on the increased economic risk that households have faced over the last thirty years, it is not clear that increased stability at the macroeconomic level translates into an increase in welfare for individual households.
Tax-panel Will Consider Changing Mortgage Interest Deduction
Tax Panel to Consider Modifying Mortgage-Interest Deduction, by David Streitfeld, LA Times: ...[D]ebate is starting among policymakers about reining in one of the most sacred cows of American public policy: the mortgage-interest deduction and other generous tax benefits granted to homeowners. A presidential commission on tax reform will take up the subject for the first time Tuesday. "Everything's on the table," said Charles Rossotti, a panel member... The mortgage-interest deduction saved homeowners $61.5 billion last year. No one expects the commission to recommend its elimination. Instead, the panel probably will consider scaling back the deduction for mortgage interest on second homes or home equity loans, and changing the deduction for property taxes, among other things. The stakes in such a discussion are huge. Changing the tax benefits for homeowners, even if done slowly, could cause short-term convulsions in the market as buyers recalculate what they could afford. ... Any proposed shift will encounter strong and possibly overwhelming resistance. But with a rising budget deficit, the prospects for change are much greater than they've ever been, say those involved in the debate. ... Eight years ago, capital gains taxes were eliminated for sellers who had profits of as much as $250,000 (for individuals) or $500,000 (for couples). ... Some policymakers and analysts are beginning to wonder whether such breaks are providing the wrong incentives, giving hefty deductions to millionaires buying Beverly Hills estates as well as to speculators snapping up Las Vegas ranch houses hoping to turn a quick profit... Bush specifically charged the panel to take account of "the importance of homeownership and charity in American society." That led many to conclude that the homeowner deductions were safe. ... But ... the mood changed over the summer. ... One reason for the shift: the expected demise of the alternative minimum tax. ... At a meeting in July, the nine panel members agreed unanimously to recommend eliminating the alternative minimum tax as an unfair and poorly designed parallel tax system. Because their mandate is to be revenue-neutral, that required them to come up with $1.2 trillion in other receipts over the next decade...
House May Swat Fannie and Freddie
What Greenspan Didn't Know, CNN/Money: The chairman ... spent much of his time expressing concerns about the large portfolios of mortgage securities held by Fannie Mae and Freddie Mac. .... Asked ... why Greenspan only raised those concerns relatively recently ... Greenspan conceded it had taken him some time to understand the company's complicated structures, and the risks to the companies and the nation's financial systems posed by the concentration of mortgages in their holdings. "It's taken me quite a good bit of time to disentangle the complex structure," he said. "I didn't fully understand when I first looked at them. "It's only fairly recently that it finally became clear to me," he added. "It was a revelation in certain respects."
The result of that revelation is a likely vote later this month on a House version of a bill intended to address these problems, though the White House favors the stricter Senate version. The likely House vote comes after a compromise over an affordable housing fund:
Fannie Mae Bill May Get House Vote, by Annys Shin, Washington Post: A House bill that would change how housing finance companies Fannie Mae and Freddie Mac are regulated is probably headed to the House floor this month, now that Republican leaders have brokered a compromise over a controversial affordable housing fund provision... The proposed fund would be financed by the profits of Fannie Mae and Freddie Mac and would distribute grants to support the construction of low-income housing. Conservative House members had objected to it out of concern the money would end up in the hands of liberal advocacy groups. ... Thursday the bill's sponsors agreed with a proposal by House conservatives that would prohibit groups that engage in election activity from participating in the fund. ... The agreement ... should clear the way for final House passage. Some of the changes to the bill "don't do any harm. Some I'd rather not have seen," said Rep. Barney Frank (D-Mass.), the ranking minority member of the House Financial Services Committee and a proponent of the low-income-housing fund. But Frank said he was pleased to see the bill go forward, calling the fund "a fundamental breakthrough in federal housing policy." The provision is part of a larger bill that would create an independent regulator for Fannie Mae and Freddie Mac after multibillion-dollar accounting scandals at both companies. ... The White House has criticized the measure for not doing more to rein in the two companies... The Bush administration prefers a Senate bill that would limit the types of assets the companies can hold. The Senate has not yet voted on the measure.
A Comparison of Productivity Growth Across OECD Countries
New Economist: Productivity in the OECD: US up, others down: How does recent US productivity growth compare with the rest of the OECD? Pretty darn well, according to a new BIS working paper by Les Skoczylas and Bruno Tissot, Revisiting recent productivity developments across OECD countries. They conclude that the US performance stands out (though the Nordic countries have also seen a pick-up in labour productivity growth). The level of US labour productivity "appears the highest among the major industrial countries", and has been rising the fastest:
The level of US labour productivity appears to be the highest among the major industrial countries and has been rising the fastest in the recent past. There are, however, substantial uncertainties surrounding these international comparisons. But there is little doubt that the US performance has sharply improved in relative terms, as productivity growth has accelerated in the United States but decelerated in most other industrial economies. Indeed, only a few countries (mainly some Nordic countries) have also experienced a structural improvement in their productivity performance over recent years.
That, coupled with migration, means a higher potential growth rate for the United States:
In terms of growth rates, and according to the OECD, potential output might currently be growing by around 3-3¼% per year in the United States, compared to around 2½% in the United Kingdom, 2% in the euro area and 1% in Japan. In terms of changes in growth rates, the United States has seen a clear improvement in its relative position: potential growth is still running at roughly the same pace as in the 1980s, while it has decelerated sharply in the euro area and even more so in Japan.
But what are the reasons behind this higher US productivity growth? The report makes some interesting speculations:
First, the improvement in US productivity does not appear to be the sole result of the reported greater use of IT equipment in the United States compared to other countries since the mid-1990s. The bulk of the US accumulation in IT equipment occurred in the 1990s, ie well after US TFP started to accelerate... Second, there has been an acceleration in trend TFP in the United States since the 1970s, a period over which substantial structural reforms have been implemented... Third, industrial countries have experienced substantial changes in trend productivity growth over the past few decades. If history is any guide, this suggests that the recent divergences could well not be maintained in the future...
Worth reading. The paper also presents some interesting views about the likely impact of structural reform on productivity growth, which I will return to in a subsequent post.
October 07, 2005
Krugman: A Pig in a Jacket
A Pig in a Jacket, by Paul Krugman, NY Times: ...[T]his week Samuel Bodman, the energy secretary ... declared that "the main thing that U.S. citizens can do is conserve." Is the Bush administration going green? No, not really.
Then why the sudden switch to encourage conservation?
The background to Mr. Bodman's remarks is growing public anger over ... the price of gasoline, but the worst is yet to come: just wait until people see their winter heating bills, especially for natural gas ... the political danger to the administration is obvious: polls suggest that many people blame... administration for failing to control price gouging.
Krugman notes that during the California crisis, hardly anyone would believe prices were manipulated, though later it was confirmed that they were, whereas this time it is widely believed that prices are being manipulated when there is no evidence of that happening:
Now, much of the public believes that corporate evildoers with close ties to the administration are conspiring to drive prices up. But this time they aren't, at least so far.
Paul Krugman defending energy companies? Wow!
Just in case you think I've gone soft on the energy industry, let me say that claims that we're having a crisis because environmentalists wouldn't let oil companies do their job are equally bogus... the current crisis is nobody's fault, except Mother Nature's.
Krugman notes that until recently, energy companies weren't interested in building refineries because there was no expected profit in doing so, not because of environmental regulations. With respect to the current crisis, when the supply of a product like energy falls, we need to find a way to reduce demand from its previous levels. Krugman calls this "demand destruction" and notes it is needed to bring demand in line with the reduced supply. But how is this accomplished?
In the absence of an effective conservation policy, prices will do all the persuading: the cost of fuel will rise until people drive less and turn down their thermostats. The problem, of course, is that high prices will impose serious hardship on many families.
And that hardship could mean political trouble, hence the sudden shift to push conservation. But, says Krugman,
[A]s you might expect, the administration's conservation push lacks conviction.... the administration's attempt to promote "Energy Hog," a cartoon pig in a leather jacket, as a conservation mascot verges on the pathetic. So it's going to be a long, cold winter...
The short-run is looking chilly and expensive. What about the longer run?
The long-term case for energy conservation doesn't have much to do with the current shortages. Instead, it's about national security, broadly defined - reduced dependence on Middle East oil supplies, reduced emission of greenhouse gases.
National security? Those are magic words. Will that get the job done?
No such luck: when it comes to substantive actions, as opposed to public relations, it's still the same old, same old. Mr. Bush has ... said nothing about raising mileage requirements and efficiency standards for appliances. And as for a higher gasoline tax, which would be politically possible only with broad bipartisan backing - don't be silly. Conservation's day will come. But it hasn't happened yet.
Has the Bull Left China's Shop?
From accelerator to brake, The Economist: Nowhere has China's growing economic influence been felt more powerfully than in the world's commodity markets. The country's enormous appetite for base metals, minerals and fuels has pushed their prices to new highs and created record profits ... However, ... As the Chinese authorities have attempted to cool overheated parts of their economy, from construction to cars, consumption of some commodities has slowed sharply or even fallen. ... Chinese demand for oil has been just 2% higher so far this year ... demand for cement has been flat; and that for aluminium has declined by 5%. Analysts had been expecting growth ... Slowing demand has hit prices. It is also turning China into a net exporter of some of the materials for which it has until lately been scouring the globe. ... The extent and duration of China's weakening demand for commodities is hotly debated. ... Demand for some commodities looks as strong as ever. One is coal, ... Copper prices keep hitting record highs: China, which consumes a fifth of the world's supply, ... increased its imports by more than 12% in the first eight months of the year. Uranium, for use in nuclear power stations, is also still in demand.
...[There are] doubts a construction upturn could drive the annual growth of import volumes back to 35-40% ... Import growth ... will be constrained by slowing investment in fixed assets for heavy industries and by the excess capacity built up in the past three years. This excess capacity is the main reason to expect more weakness in the mainland's demand for several commodities and hence in world prices. China's huge investment in production facilities for basic metals and materials increasingly will allow the country not only to satisfy its own demands but also to let any overflow wash into world markets.
Steel is the prime example (see chart). The capacity of China's 260-odd steelmakers could ... by the end of 2005 [be] up by 23% year on year ... At a steel conference ..., Nicholas Lardy, of the Institute for International Economics in Washington, DC, pointed to “massive, massive excess capacity” in China at a time when steelmakers elsewhere are curbing production growth. In aluminium, 20% of new smelter capacity in China is lying idle because of a lack of raw materials. Once that comes on ... supply could outstrip demand growth over the next two years—even though demand will be rising at a double-digit pace...
All of this will cause political headaches for the Chinese as well as economic upset for their trading partners. Until now, China's surging exports of manufactured goods have at least partly been balanced by its strong imports of raw materials. If it now starts to export commodities and basic goods as well, trade tensions can only worsen. ... Whether China's government will manage to consolidate the sector to this extent is questionable, given the strength of vested local interests. But that is not the point. ... Both China and the rest of the world will find an end to the long commodities boom hard to handle.
I understand why I should be concerned if central planning or some other inefficiency in China is causing excess capacity and affecting world markets for steel and other commodities. But that is not the argument. I don't understand why I should be concerned with an outward shift in the world supply of commodities resulting in lower prices for key inputs to production. Why is that a problem?
Financial Times: US Set to Reconsider Agricultural Subsidies
US set to reconsider agricultural subsidies, Financial Times: The US administration on Thursday said the country needed to “think beyond the boundaries of current farm policy” in a sign that it was prepared to reconsider decades of reliance on direct agricultural subsidies for its farmers. The comments, made by US agriculture secretary Mike Johanns, are the first clear sign that the US is preparing to make a case to lawmakers and the country’s powerful farm lobby that the US may need to remove trade-distorting subsidies that make the US vulnerable to legal challenge in the World Trade Organisation. ... he suggested that the administration would push for ... environmental programmes and income support for smaller farmers. Such a move could help shield farm programmes from legal challenge in the World Trade Organisation... Mr Johanns said: ... “We have a choice. We can sit back and watch as our farm policy is disassembled piece by piece or we can begin a discussion about how to craft farm policy that provides low-risk, meaningful safety net for our farmers and ranchers.”...
Saying you need to think about something is a long way from eliminating farm subsidies. I'm not holding my breath.
October 06, 2005
Dallas Fed's Fisher Says Inflation a Poisonous Virus
Contemplating the Nature of Money and the Capillaries of Capitalism, Richard Fisher, president, Dallas Fed: ...I want to speak to you today about money and the role of the Federal Reserve ... Money flows are an economy’s lifeblood, and the Federal Reserve’s great responsibility lies in maintaining the cardiovascular system of American capitalism. ...We cannot let ... the inflation virus infect the blood supply and poison the system. Inflation robs us of all that we might otherwise produce with a sound currency. It forces business to think about accounting rather than production. It distorts decisionmaking by investors. It penalizes the elderly and those who live on fixed incomes. It cheats the consumer, especially those in the lower income brackets. It robs savers of the underlying value of their money...
All you need to know about central bankers is that we abhor inflation. I always carry in my pocket a quote from Benjamin Franklin as a reminder of my obligation as an inflation fighter. In 1748, when we were an agrarian society and the crown was the colonies’ currency, Franklin said, “He that kills a breeding sow destroys all her offspring to the thousandth generation. He that murders a crown”—a dollar—“destroys all that it might have produced.” Inflation has been on a slight upward tilt the past couple of years. Readings on core inflation have been within the acceptable range of 1 to 2 percent, but they are edging closer to the upper end of the Fed’s tolerance zone, with little inclination to go in the other direction. As a result, we are in a tightening phase of monetary policy. ... In contemplating monetary policy from this point forward, the brow begins to furrow. Most forecasters expect growth to slow from its previous pace ... due to additional volatility in prices for natural gas, gasoline, certain chemicals and building supplies. To protect their profits, businesses may become more aggressive in pressing for price increases. Will prices increase more broadly, or will the economy slow as profits get further squeezed? Or will both happen simultaneously? The honest answer is: I do not know.
Another reason for anxiety lies in the federal government’s fiscal predicament. ... If the Federal Reserve were to resist the upward pressure on interest rates, it would in effect monetize those increasing fiscal deficits. The Federal Reserve has staunchly resisted monetizing deficits for more than a quarter century, and I feel strongly that it can ill afford to monetize them today. ... If the United States is to remain an economic colossus, its fiscal authorities, like its central bankers, will have to become paragons of prudence and restraint, implementing policies that will put the nation in a position to bolster, not hamper, its competitive edge...
If inflation is looking for a new friend, the Dallas Fed is the wrong place to look (see here too). I will note, however, that he does acknowledge the possibility of economic weakness in the future if profits are squeezed from higher energy prices.
Bush Beats LBJ on Spending
Bush Beats LBJ on Spending, What's New, Cato: In the latest Cato Tax and Budget Bulletin, Stephen Slivinski uses revised data released... by the Congressional Budget Office (CBO) to make ... comparisons of the spending habits of each president during the last 40 years. While ... all presidents presided over net increases in spending, George W. Bush is shown to be one of the biggest spenders of them all, even outpacing Lyndon B. Johnson in terms of discretionary spending. An excerpt from the report:
The increase in discretionary spending - that is, all nonentitlement programs - in Bush's first term was 48.5 percent in nominal terms. That's more than twice as large as the increase in discretionary spending during Clinton's entire two terms (21.6 percent), and just higher than Lyndon Johnson's entire discretionary spending spree (48.3 percent).
These are from the Cato Tax and Budget Bulletin linked above:
I don't think Cato is happy.
Awake at the Wheel, But What Can the IMF Do?
U.S. Gains Little by Urging IMF to Hound China, by Andy Mukherjee, Bloomberg: Tim Adams, the U.S. Treasury's new under secretary of international affairs, has mounted a scathing attack on the International Monetary Fund. ... ''The perception that the IMF is asleep at the wheel on its most fundamental responsibility -- exchange rate surveillance --is very unhealthy for the institution and the international monetary system,'' Adams said ... Adams must know ... that if the IMF were to ... force China to accept a big revaluation in the yuan, People's Bank of China may reduce its purchases of Treasuries. A sudden jump in interest rates won't be in the interest of the U.S. economy. What the Bush administration would really want to see is a slowly and steadily appreciating yuan...The crucial question is that if a gradual appreciation in the yuan is all that the Treasury wants, then why not leave the job to his boss, Secretary John Snow, and his ''quiet diplomacy?'' The answer probably has something to do with Charles Schumer, the Democratic Senator from New York. Schumer, together with South Carolina Republican Senator Lindsey Graham, is ready to press ahead with a bill seeking punitive tariffs on imports from the world's most-populous nation. That bill, if it goes through, will turn the strained trade relations between the U.S. and China into an ugly spat. So Adams probably attacked the IMF to prove that the Bush administration, contrary to what Schumer says, is not a ''wet noodle'' on China. IMF Managing Director Rodrigo de Rato ... made it plain that he too, like Adams's boss, preferred to engage China in ''quiet diplomacy.'' He has a point. After all, what can the IMF do? Formal special consultations, which Adams referred to, have been used only twice in the history of the IMF ... The IMF has no authority to make China revalue its currency, just as it's powerless to get the Bush administration to run a tighter budget. Besides, why is Adams so keen to rock the boat? As long as the Chinese are buying Treasuries, it will be cheaper to rebuild New Orleans.
I'm trying to remember why I'm upset about low interest rates and low priced goods, particularly since revaluing is unlikely to return manufacturing jobs to the U.S. It's because when the system is in disequilibrium and unbalanced, and the disequilibrium conditions persist causing the imbalance to grow, the risks of sudden and severe adjustment back to equilibrium also grow. It's also because disequilibrium can lead to trade wars that do more harm than good. So far, there isn't much evidence that quiet diplomacy has brought about the necessary onset of the gradual readjustment process.
What Has the Fed Learned Recently?
Lessons from Our Recent Business Cycle: A Policymaker's Perspective, by Anthony M. Santomero, President, Federal Reserve Bank of Philadelphia: ...[T]onight, I will ... reflect on the current business cycle and some of the lessons I have learned ... thus far. I will focus on how ... recent events, as well as ongoing trends, have affected both the economy and the conduct of monetary policy in this cycle. ... [B]efore we start, I must remind you that every business cycle is different. Each is the unique product of: (1) a relentlessly evolving economic structure, (2) some surprising new developments, and (3) a sequence of policy actions attempting to stabilize the situation...
[Evolving structure] To discuss the most recent business cycle experience, one must start at the beginning - with the revolution in information and communications technology and its dramatic effect on the economic structure of the U.S. ... a technological revolution of this magnitude does not produce a smooth economic progression. ... Nonetheless, the application of new information technologies has brought real economic benefits to our economy. ... At the same time ... it spawned unrealistic expectations that were manifested in a stock market bubble ... When the bubble burst and the investment boom deflated, aggregate demand decelerated rapidly ... driving the economy into recession. The technology revolution has also been an important contributor to globalization - a second fundamental factor of structural change driving the economy's evolution in this business cycle. ... Like the introduction of new technologies, ... globalization ... benefits are genuine and worthwhile, but they do not come without some costs. The adjustment costs are significant, and in an environment of rapid change, they are ongoing...
[Shocks] There were several new and surprising developments during the most recent business cycle. In 2000, the U.S. stock market declined precipitously and the tech bubble burst. ... This was followed by ... the terrorist attacks of September 11, 2001. ... All things considered, consumer spending came back relatively quickly. But ... businesses confronted these new uncertainties ... and saw new reasons to defer and delay investment spending. The events that followed ... September 11 - the anthrax attacks and then the wars in Afghanistan and Iraq - only served to heighten these uncertainties. Meanwhile, ... accounting scandals and corporate governance issues created new uncertainties, and ... weakened both households' and businesses' willingness to spend. ... Completing the list of shocks is an unprecedented sequence of natural disasters - hurricanes Katrina and Rita. ... Of ... significance for the national economy in this particular case is the impact of the two hurricanes on energy production. ... a classic supply shock ... Given ... tight market conditions, a significant disruption to production was bound to have a sharp impact on prices. ... the baseline projection for oil prices over the next year or so has risen as a result of recent events. This inevitably will mean somewhat less growth and somewhat higher inflation in 2005 and early 2006 than we otherwise would have had.
[Policy] ...[H]ow has the third factor, ... policymakers' actions, affected economic dynamics over the past few years? Here, ... remarkably aggressive policy action was a defining characteristic ... Indeed, monetary and fiscal policy worked together particularly well ... to provide ample and rapid stimulus during the economic downturn. ... The result has been a clear improvement ... over time. Last year, the U.S. economy turned in its best performance since 1999. ... And so, the Fed began to reduce the degree of monetary policy accommodation ... At its September meeting, the FOMC moved its target for the federal funds rate up ... to 3-3/4 percent. In the press release ..., we said the economy appeared poised to continue growing at a good pace before Hurricane Katrina hit. We... expressed our view that ... economic activity at the national level was ... likely to persist. Moreover, the impact of the disruption on the price level warrants careful monitoring. ... I stand by that view...
[Lessons Learned] ...let me now turn to my original purpose ... five distinct lessons that I garnered from the experiences of the recent past.
- Lesson #1: Technological Innovation Can Drive a Cycle ...new technologies and investment in new technologies can be powerful drivers of business cycle dynamics...
- Lesson #2: Globalization is an Important Factor in Economic Dynamics and Inflation ...global dynamics play an important role in the path our domestic economy will follow...
- Lesson #3: Countercyclical Policy Can Be An Effective Demand Force The shape of this business cycle was substantively affected by countercyclical government policies. ... monetary policy is not a panacea; it is a tool that needs to be handled carefully... it remains to be seen whether expansive fiscal policies can be reversed, and the federal budget can be returned to balance ... I see the value of fiscal integrity, and this requires a cyclically balanced federal budget.
- Lesson #4: Monetary Policy Works Best in a Stable Price Environment ...monetary policy works best in ... an environment in which ... expectations about future inflation are well-anchored...
- Lesson #5: Expectations Matter ...Expectations matter and they play an important role in the conduct of national monetary policy. ... As a central banker, I recognize that long-run price stability is always of utmost importance. ... To keep cyclical price pressures and any transitory spike in energy prices from permanently disrupting the price environment, the Fed will have to continue shifting monetary policy from its current somewhat accommodative stance to a more neutral one. But ... the precise course we take with monetary policy must be contingent upon the precise course the economy takes...
...[N]o matter how much we learn, ... I do not think we will ever reach a point where we will eliminate the business cycle. But we may be able to move closer to conducting optimal monetary policy in a world where change is relentless and surprising new developments continue to unfold.
Robert Hall on Job Loss and Job Finding
Job Loss, Job Finding, and Unemployment in the U.S. Economy Over the Past Fifty Years, by Robert E. Hall. NBER WP 11678, October 2005: Abstract New data compel a new view of events in the labor market during a recession. Unemployment rises almost entirely because jobs become harder to find. Recessions involve little increase in the flow of workers out of jobs. Another important finding from new data is that a large fraction of workers departing jobs move to new jobs without intervening unemployment. I develop estimates of separation rates and job-finding rates for the past 50 years, using historical data informed by detailed recent data. The separation rate is nearly constant while the job-finding rate shows high volatility at business-cycle and lower frequencies. I review modern theories of fluctuations in the job-finding rate. The challenge to these theories is to identify mechanisms in the labor market that amplify small changes in driving forces into fluctuations in the job-finding rate of the high magnitude actually observed. In the standard theory developed over the past two decades, the wage moves to offset driving forces and the predicted magnitude of changes in the job-finding rate is tiny. New models overcome this property by invoking a new form of sticky wages or by introducing information and other frictions into the employment relationship. [Free version from author web site.]
October 05, 2005
How Much Power is Too Much?
Marginal Revolution: A Bush plan for avian flu: President Bush said today that he was working to prepare the United States for a possibly deadly outbreak of avian flu. He said he had weighed whether to quarantine parts of the country and also whether to employ the military for the difficult task of enforcing such a quarantine. ... The president had already raised, in the wake of Hurricanes Katrina and Rita, the delicate question of giving the military a larger role in responding to domestic disasters. His comment today appeared to presage a concerted push to change laws that limit military activities in domestic affairs. ... "...Congress needs to take a look at circumstances that may need to vest the capacity of the president to move beyond that debate," Mr. Bush said. One such circumstance, he suggested, would be an avian flu outbreak. He said a president needed every available tool "to be able to deal with something this significant."
The call is to give the president more power so he can mobilize the military quickly in the event of a disaster such as a hurricane or an outbreak of the flu. The inability to respond quickly in response to a large shock is is a problem that the Fed has also faced, and the inability to respond quickly is a problem faced by deliberative bodies in general. When the Federal Reserve system was created in 1914, it was intended to be a system of cooperating banks. Power was shared in various ways and there was an intent to represent the full spectrum of interests in the monetary policy decision making process.
This changed with the Great Depression. It is widely, though not universally, agreed that the failure of the Fed to pump liquidity into the banking system after the crash was a policy mistake. Two reasons are cited for this failure, the inability of democratic institutions to respond quickly, and not having tools such as open market operations available to use in such situations. Democratic bodies are cumbersome decision making entities and change of any type can be difficult. It doesn't take long watching congress to come to that realization. There are many occasions when this is a good thing, we don't want erratic policy shifts and other change on a continuing basis or with each change in party, but when a quick response is required such as pumping liquidity into the banking system after a stock market crash, the deliberative nature of democratic institutions can be a hindrance to an effective policy response. To combat this in the monetary policy arena, power was concentrated into the Central Bank and new powers, such as the ability to conduct open market operations, were granted (the same ideas lie behind the War Powers Act concentrating power in the hands of the president). Today, the Fed functions largely as a single bank in Washington, D.C. with twelve branches.
There is a constant tension between making decisions in a representative, deliberative manner, which works most of the time, and the ability to respond quickly in emergencies which favors abandoning democratic processes and concentrating power in the hands of an individual or a small group of people. There's a reason the power to set off a nuclear attack is concentrated in such a fashion and we are aware of the potential loss of checks and balances when we grant such powers. Though each new risk or shock brings new calls to concentrate power, we should be very careful in taking this step. With respect to monetary policy, I contend we have gone too far. One person, Alan Greenspan, should not have so much control over the course of monetary policy. However, a new Chair without Greenspan's political prowess may not command as much power so the changing of the guard may partly resolve this issue. And to bring this full circle, I will never favor the further concentration of military powers into the hands of a single individual with the ability to deploy those resources domestically.
Dallas Fed's Fisher: The Fed Should Staunchly Resist Monetizing the Debt
A Perspective on the Economic Outlook, Richard W. Fisher, President of the Federal Reserve Bank of Dallas: ...I want to talk to you today about the economy and about confronting problems ... that loom on the horizon. ... The United States ... data present a less than clear picture. ... [T]he pace of economic growth had begun to slow slightly prior to Katrina and ... the disruptions from Katrina, and later from Rita, would initially slow growth a bit more. The U.S. economy grew at a 3.3 percent annual rate in the second quarter. Now, most forecasters anticipate growth closer to 3 percent in the fourth quarter. Many of them expect the bounce back from rebuilding the Gulf Coast to begin in early 2006, though the impact will be spread over several years. ... Inflation has been on a slight upward tilt the past couple of years. Now, the inflation rate is near the upper end of the Fed's tolerance zone, and it shows little inclination to go in the other direction. We now face higher energy prices and businesses' desire to pass the increased costs on to their customers. Combine the energy spikes with spending increases by governments at every level in the aftermath of the two hurricanes-John Maynard Keynes seems to be the patron saint of both liberals and conservatives these days-and you have new demand pressures added to the old ones. The FOMC has taken note of the fiscal situation, as shown by this pre-Katrina passage from the released minutes of the Aug. 9 meeting: "Few signs were evident that greater fiscal discipline in the budget process would emerge any time soon."
In this environment, the markets, if left to their own devices, would produce higher interest rates to ration money and balance the demand and supply of capital. If the Federal Reserve were to resist the upward pressure on interest rates, it would in effect monetize the burgeoning fiscal deficits. The Federal Reserve has staunchly resisted monetizing deficits for more than a quarter century, and I feel strongly that it can ill afford to monetize them today.
I am glad to see the Fed signaling to fiscal authorities that it will not monetize the debt as it has not, in my opinion (and others) been vocal enough in this area. We have heard from a number of Fed officials this week (here, here, here, and here), and unless there are dramatic changes as new data arrive, interest rates are going up.
[See also: William Polley who discusses Bush's remarks today about not yet having a list of final candidates for Fed Chair and notes his statement that the Chair should be politically independent, as endorsed here.]
St. Louis Fed President Poole: Increased Transparency Has Stabilized the Economy
How Predictable is Fed Policy?, William Poole, President, Federal Reserve Bank of St. Louis Fed: Day in and day out all of us depend on a high degree of predictability of the nation’s monetary arrangements. ... Historically, the least predictable aspect of our monetary system has been monetary policy. ... Unpredictability can have high costs. ... Monetary policy decisions can create surprises that affect outcomes from household decisions as to what jobs to take and where to live. Similarly, business firms find that their decisions as to hiring and investment in physical capital may turn out well or poorly depending on the course of monetary policy and its effects on the economy. ...Since 1989, the FOMC has adopted many practices that improve the transparency of its policy actions. Enhanced transparency is ... essential if markets are to understand Fed policy and therefore be more successful in predicting policy adjustments. ...Here are some milestones of changes in FOMC practices that have enhanced transparency:
- August 1989: Policy changes in the target fed funds rate are limited to multiples of 25 basis points. Prior practice of changing the rate in other steps often created market uncertainty as to exactly what the Federal Reserve’s intention was.
- February 1994: Starting with this FOMC meeting, the Committee released a press statement describing its policy action at the conclusion of any meeting at which the Committee changed the target funds rate. Prior to this practice, the market had to infer from Fed open market operations whether, and how, the Fed’s policy stance had changed. Consequently, the market was often uncertain as to the current setting of Fed policy.
- August 1997: Public acknowledgment that policy is formulated in terms of a target for the federal funds rate. The market had come to believe that the fed funds rate was the policy target but all uncertainty about this issue disappeared after this time.
- August 1997: A quantitative target fed funds rate is included in the Directive to the System Open Market Account Manager at the Trading Desk of the Federal Reserve Bank of New York (the “Desk”). Previously, the Fed often discussed policy in terms of the “degree of pressure on reserve positions” in the money market. A clear focus on a quantitative target ended the ambiguity.
- May 1999: A press statement following the conclusion of every FOMC meeting includes the intended funds rate and the policy “bias.” The bias indicated that the Committee was leaning toward an increase or decrease in the fed funds target but had not yet decided to actually change the target.
- December 1999: In its press statement, the FOMC replaces the policy bias language with “balance of risks” language in an effort to lengthen the horizon of its statement and provide a summary view of its outlook for the economy.
- January 2002: The vote on the Directive and the names of dissenting members, if any, are included in the press statement. Previously, this information was not available to the market until the meeting minutes were released following the subsequent FOMC meeting six to eight weeks later.
- August 2003: The FOMC introduces “forward-looking” language into its post-meeting press statement.1 This language suggested the probable direction of the target federal funds rate over the next one or more meetings.
- January 2005: Release of minutes of FOMC meeting advanced to three weeks after the meeting (and before the next scheduled FOMC meeting.)
The purpose of these changes, which have gone a long way toward lifting the traditional veil of secrecy over monetary policy, is to increase transparency of policy, improve accountability, and provide better information to market participants about the future direction of policy. ... Accumulating evidence showed that ... market participants have been increasingly accurate in predicting FOMC policy actions as the steps towards more transparency listed above were implemented. The basic theme of this work is that the economy will function more efficiently if the markets and the Fed are interpreting incoming data the same way. ...It is quite clear that the markets understand Fed policy to a much greater extent than before. My own view is that the market’s improved understanding ... has much to do with the economy’s improved stability. Recessions have become milder and core inflation more stable. Maintaining these gains is important to economic welfare. I would not claim that we have enough evidence to say that the gains are permanent, but we do have enough to say that the effort has been very productive.
- “In these circumstances, the Committee believes that policy accommodation can be maintained for a considerable period.” Federal Reserve Press Release, August 12, 2003. In the press release of January 28, 2004 the language was modified: “…the Committee believes that it can be patient in removing its policy accommodation.” Subsequently, in the press release of May 4, 2004 a second modification of the language was introduced: “… the Committee believes that policy accommodation can be removed at a pace that is likely to be measured.”
There is quite a bit more in the speech on the empirical evidence for increased accuracy in the prediction of Fed behavior.
Graphs Gathered from Blogs (September 2005)
There is also a directory of links to graphs from other months.
October 04, 2005
Governor Kohn as the Next Fed Chair?
Kohn, Long Shot for Fed Chief, Helped Shape Greenspan's Views, Bloomberg: ...During his 30 years at the Board of Governors, Kohn ... has attended more policy meetings than any current Fed member. He served as Greenspan's top strategist for 15 years before Bush promoted him to governor in 2002. He embraces much of Greenspan's thinking on financial markets, risk and interest-rate policy. ... [S]ays Robert Parry, former San Francisco Fed Bank president ... ''He was very close to the chairman, and they discussed issues frequently. He and this chairman were really a team.'' Kohn shows up as a long-odds candidate to replace Greenspan in surveys and on betting sites, well behind leader Ben S. Bernanke ... One drawback: Kohn has few visible alliances on Capitol Hill, analysts say. Kohn says he has no party affiliation and declined to be interviewed for this story... ''If you talk to the Fed staff in private and ask them who would Greenspan like to replace him, the answer would be Don Kohn,'' says Roger Kubarych, economic adviser to HVB America Inc. and a former deputy director of research at the New York Fed. ... Under Greenspan, Kohn helped scrap policies that kept financial markets guessing about where the Fed wanted interest rates to go. Following a presentation by Kohn in December 1987, Greenspan urged reluctant policy makers to assign a numerical target to the federal funds rate, the interest charged for overnight loans between banks. Eventually, that figure became the most important signal of Fed policy. ... Because of his close alliance with Greenspan and personal involvement with policy across three decades, Kohn may also be the most resistant to major change, former colleagues say. ... Like Greenspan, Kohn remains a skeptic on the merits of tethering Fed policy to a numerical inflation goal. He favors a discreet approach that allows the Fed to maneuver around its double mandate from Congress: keeping inflation low and keeping employment high.
I think the writer means discretionary policy rather than a "discreet approach." I'm a stronger advocate of inflation targeting than Kohn, but I would not oppose him and a Greenspan clone with his experience would not be likely to upset financial markets.
The Bank of Canada's David Dodge on Solving Global Imbalances
The Evolution and Resolution of Global Imbalances, Remarks by David Dodge, Governor of the Bank of Canada: ...Today, I will talk about two types of global economic imbalances. The first relates to ... savings and investment ... being distributed across countries in an increasingly uneven way. The second is the possibility that, over the next couple of decades, the global economy might face a protracted period in which desired savings exceed planned investment, partly because of demographic trends. If economic policy-makers do not take appropriate measures quickly enough, there is even a risk—albeit a small one—that the world economy could end up with ... widespread demand deficiency and a persistent deflationary gap. ...Geographical imbalances are not necessarily a bad thing, nor are the large capital flows that they generate. Indeed, ... world financial markets ... allow savers in one country to lend to borrowers in another. Such a process leads to higher global growth ... If markets ... operate without interference, imbalances can resolve themselves in a reasonably smooth manner. But in the absence of appropriately functioning market mechanisms, there is a greater risk that the correction will be abrupt and disorderly. ... a disorderly correction might also lead governments to adopt wrong-headed protectionist measures... [R]egardless of how these imbalances are resolved, it is clear that the resolution will require greater net national savings in the United States. Investment in the U.S. economy will need more financing from domestic sources ... This implies an increase in net U.S. exports and a decrease in net exports elsewhere in the world, as well as an increase in domestic demand in other countries. Exchange rate movements have an important role to play in this regard, ... efforts by some countries to slow or prevent required adjustments by pegging exchange rates are ... counterproductive. ... such policies raise the risk of a much larger and more disorderly correction in the future, as well as an outbreak of protectionism... Within the United States, higher interest rates can be expected to lead to increased savings. Authorities could also encourage greater national savings with a tighter fiscal policy. And they could implement ... reforms to encourage national savings through taxation ... and other measures. But if the United States alone were to act to resolve its imbalance ... it would leave the global economy with much weaker aggregate demand. And so a number of other countries must focus on stimulating domestic demand. ... So, how can we stimulate domestic demand outside the United States? ... Structural reforms to remove market rigidities are important for most of us. Many need to improve or develop their financial system ... For some, the development of social safety nets would be helpful, so citizens don't feel the need to hold excessive precautionary savings. And for a few, more stimulative fiscal policy would be helpful.
...[T]he second type of imbalance ... will be posed by evolving economic and demographic realities. ... Let me ... expand on this risk by highlighting two trends that will be important over the next decade or two. First, ... Asia's share of the world economy will continue to grow. ... Asian nations have traditionally had a higher rate of savings ... so, all other things being equal, we can expect that global desired savings will rise. But all other things are not equal. The second trend that we can expect is higher desired savings in most OECD economies as the baby-boom generation prepares for retirement. Taken together, these two trends can certainly be expected to lead to a higher level of global desired savings. So it is critical for policy-makers to act now, so there can be an increase in demand and investment to compensate... To deal with this expected slower growth in domestic demand, ... what can policy-makers do to support ... private consumption, government spending, and investment? In terms of investment, ... First, one might look to governments to provide an expansionary fiscal policy. ... Certainly, the economies of emerging Asia have the scope to support demand with fiscal policy. But in North America, Europe, and Japan the scope for fiscal policy ... appears to be very limited ... But if there is one thing that all governments can do to stimulate demand, it is to have appropriate structural policies ... We all need to take steps to improve the flexibility of our labour markets ... We also need to recognize that well-functioning credit markets are extremely important ... The improvement of labour and financial market policies is particularly important in Europe. In emerging Asia, improving income-security policies is essential ...In closing, ... I'm not saying that a disorderly correction to global imbalances is certain to happen. Nor am I saying that the global economy is inevitably headed for a deflationary shortfall in demand. What I am saying is that, as prudent policy-makers, we must not rely on good fortune to help us muddle through...
Rip van IMF?
Has the IMF been asleep at the wheel, and ignored surveillance of exchange rates?, Brad Setser: Tim Adams - the new US Treasury Under Secretary - thinks so:
IMF Article IV requires that the IMF exercise "firm surveillance" over the exchange rate policies of members. ... We understand that tough exchange rate surveillance is politically difficult for the IMF. It is also true that a country has the right to determine its own exchange rate regime. Nevertheless, the perception that the IMF is asleep at the wheel on its most fundamental responsibility—exchange rate surveillance—is very unhealthy for the institution and the international monetary system. (emphasis added)
I am not exactly a fan of the Bush Administration's economic policy, but on this, I agree with Tim Adams and the Treasury. The IMF did not call out countries with overvalued exchange rates in the 1990s ... And it has refused to call out countries that are engaging in massive, sustained intervention to maintain undervalued exchange rates now. The IMF remains far more willing to criticize countries with inappropriate fiscal policies (the US) than to criticize countries that are intervening heavily to maintain inappropriate exchange rates (China, Malaysia, many oil exporters who peg to the dollar). ... The IMF's Articles call on every country to "avoid manipulating exchange rates or the international monetary system to prevent effective balance of payments adjustment or to gain unfair competitive advantage over member countries." It is pretty clear at least to me that China's de facto peg is an impediment to effective balance of payments adjustment. ... But you might ask, doesn't every country have the right, according to the IMF charter, to select its own exchange rate regime. Certainly. But that does not give it the right to hold to whatever exchange rate it likes without being subject to international criticism. I'll turn the microphone over to Morris Goldstein.
IMF members are free to pick fixed rates, floating rates or practically any currency regime in between. ... But what is not permitted under IMF rules is to engage in a particular kind of intervention - namely large scale, protracted, one-way intervention. .... China ... cannot legitimately maintain that it alone gets to decide as a sovereign matter what the exchange rate between the RMB and the dollar should be ... regardless of economic signals about whether that rate is or is not an equilibrium rate...
Much of the recent strain associated with globalization can be linked to China's steadfast defense of its dollar peg, and its current policy of spending $300 billion, a bit over 15% of its GDP, to resist RMB appreciation. That has consequences. Among other things, ... It almost certainly reduces overall employment in the manufacturing sector. ...It helps keep US interest rates low, and that supports employment in the housing sector. China may not impact on overall employment in the US, but it certainly has an impact on the composition of employment. If the Fund does not take multilateral exchange rate surveillance seriously, the US will no doubt eventually opt for what might termed unilateral exchange rate surveillance - and I don't think that is a good thing. De Rato and the Fund claim that US concerns about exchange rate manipulation reflect domestic political pressure. No doubt true. But that does not mean the basic argument made by the US lacks merit. ... Of course the US is taking a risk by pushing on the Fund to push on China too. There is a small chance China might actually listen to the US, and agree to make real changes to its exchange rate regime ... if the US government continues to run large deficits and US households continue not to save, it is not clear that the US really wants global adjustment ... On one hand, the US wants China and others to let their exchange rates appreciate, which means that they will intervene less and thus have fewer dollars to invest in US treasuries. On the other hand, the US government intends to borrow a ton of money ($100 b, $200 b) to rebuild New Orleans and the Gulf Coast, pushing the US deficit up. If China and others followed the US government's advice, the world's central banks [would be] ... buying fewer bonds, just when the US needs to sell more bonds to borrow the funds needed to rebuild...
The Best News Money Can Buy
Faux News Is Bad News, Editorial, NY Times: Federal auditors have blistered the Bush administration for secretly concocting favorable news reports about itself by hiring actors to pose as journalists and slipping $240,000 in taxpayer funds to a sell-out conservative polemicist. ... the administration plainly violated the law against spreading "covert propaganda" at public expense, according to the report of the Government Accountability Office. ... The scheme was so seamy that auditors were unable to document whether Mr. Williams actually delivered all the articles and talk-show hype that his company claimed in quietly billing the government for $186,000 worth of yessiree-Bob "news."...
October 03, 2005
Fed Watch: How Does the Fed See the Economy Evolving?
I was struck by the title of David Altig’s piece The Savings Rate Increases – And That Ain’t Good, as well as similar thoughts by Kash at Angry Bear. What strikes me is that I often see hand-wringing about the possibility of a rise in the savings rate and the economic imbalances manifested in the current account deficit. In my mind, these are two sides of the same coin – it is most likely that the latter will improve in tandem with an increase in household saving, and that means a fall in consumption growth. Fundamentally, the current account represents an excess of broadly defined consumption over productive capacity, and reducing economic imbalances implies bringing the former in line with the latter. Of course, the speed of the adjustment process matters, as explained by James Hamilton here. But it is the process nonetheless.
Is this the perspective of Fed policy makers? I have suggested so in the past, and I believe this is the story Greenspan is currently spinning. Some relevant excerpts from his speech earlier this week:
If indeed this is the case, the implied increase over the past decade in consumption expenditures financed by home equity extraction, rather than by income and other assets, would account for much of the decline in the personal saving rate since 1995….
…Nonetheless, it is difficult to dismiss the conclusion that a significant amount of consumption is driven by capital gains on some combination of both stocks and residences, with the latter being financed predominantly by home equity extraction.
If so, leaving aside the effect of equity prices on consumption, should mortgage interest rates rise or home affordability be further stretched, home turnover and mortgage refinancing cash-outs would decline as would equity extraction and, presumably, consumption expenditure growth. The personal saving rate, accordingly, would rise.
Carrying the hypothesis further, imports of consumer goods would surely decline as would those imported intermediate products that support them. And one would assume that the U.S. trade and current account deficits would shrink as well, all else being equal.
How significant and disruptive such adjustments turn out to be is an open question. Nonetheless, as I have pointed out in previous commentary, their economic effect will, to a large extent, depend on the flexibility inherent in our economy. In a highly flexible economy, such as the United States, shocks should be largely absorbed by changes in prices, interest rates, and exchange rates, rather than by wrenching declines in output and employment, a more likely outcome in a less flexible economy.
In this speech, Greenspan is detailing his view on the importance of home equity extraction in fueling consumption growth and pushing the savings rate into negative territory. But read carefully into what Greenspan is suggesting. This is not the traditional view that households have fundamentally changed their saving behavior as a result of increased wealth. Instead it is the more subtle point that:
Because the personal saving rate is measured relative to personal disposable income, any purchases financed with the proceeds of capital gains will increase personal consumption expenditures but not income, and therefore the measured saving rate will decline.
So here is my interpretation of Greenspan’s view: Suppose my (hypothetical) household saves 10% of its income annually. Now suppose that I sell my house and extract $10,000 in equity as cash to spend on a new sailboat. From my perspective, I still save 10% of my income, but the Bureau of Economic Analysis doesn’t agree. They count only my spending on the sailboat, but don’t recognize the equity cash as income.
Should the housing market change in such away that reduces equity cash outs, then consumption will fall and savings will rise. Savings doesn’t rise, however, because I made a conscious decision to save more as my marginal propensity to save out of current income is the same. Instead it rises because my non-income resources have been constrained.
Why is such a subtle distinction important? Because it implies that Greenspan believes that the savings rate can rise in the absence of significant drop in household wealth from sliding home values. Traditionally, the story is that the savings rate will rise in response to the wealth effect when the property bubble (assuming it exists) pops. Greenspan is outlining another – and more benign – path. All you need is the housing market to change in such a way that refinancings and cash outs slow, not the bottom falling out. Moreover, even if prices slide a bit, it won’t be a big blow to wealth anyway:
In summary, it is encouraging to find that, despite the rapid growth of mortgage debt, only a small fraction of households across the country have loan-to-value ratios greater than 90 percent. Thus, the vast majority of homeowners have a sizable equity cushion with which to absorb a potential decline in house prices. In addition, the LTVs for recent homebuyers appear to be lower in those states that have experienced the most explosive run-up in house prices and that, conceivably, could be at risk for the largest price reversal. That said, the situation clearly will require our ongoing scrutiny in the period ahead, lest more adverse trends emerge.
Also note that under the Greenspan scenario, the current account deficit will improve – again, two sides of the same coin.
I believe this all ties into how the Fed (or at least a Greenspan-helmed Fed) believes the economy will evolve as the next year passes. To recap the story so far, the Fed has shown concern that economic slack has evaporated, and, with rising energy prices in the background, inflationary pressures are building. To stem these pressures, they have tightened policy to reduce growth. They are not targeting the housing market directly, but recognize that since housing has been a driving force in the expansion, it will likely be the recipient of the brunt of their policy efforts.
A cooling of the housing market, however, is not undesirable, and a major decline in values is unlikely. After all, haven’t their critics complained that excessively loose monetary policy caused a bubble to begin with? And, under the Greenspan scenario, a housing slowdown is necessary to trigger a needed rebalancing of economic activity. Moreover, with excess slack drying up, some sector needs to pull back, especially with any sense of fiscal discipline long gone.
Won’t a worried consumer upset this whole plan? I doubt the Fed is all that focused on the consumer confidence numbers. First, they will discount numbers that appear hurricane induced. The same holds for personal consumption spending. Indeed, most of the decrease in August spending was a fall in auto sales. This is just another chapter in the continuing story of Detroit’s woes, fundamentally a structural problem and outside the Fed’s purview. Detroit’s profits rely on cars that guzzle gas. Rising gas prices have soured consumers on those cars. The Fed can cut rates to zero, but it won’t make more gas – it will only raise the price of gas further.
Second, and more importantly, I doubt Greenspan & Co. believe that consumption fluctuations fundamentally drive business cycles. Instead, Fed policymakers will have their eyes glued on the investment numbers. And last week’s durable goods report for August likely eased any fears in that direction. I also suggest paying attention to a little reported figure in the durable goods report, unfilled orders for nondefence, nonair capital goods:
With unfilled orders continuing to pile up, I can’t see the Fed panicking about investment yet. The series last rolled over in September 2000 (the Fed had paused in May, and did not ease until January 2001). And don’t forget today’s ISM numbers, which revealed a surge in manufacturing activity in September – perhaps a precursor to another strong durable goods report.
But won’t higher interest rates sap firm’s ability to invest? This is the not problem, according to Greenspan:
Softness in intended investment, however, is also part of the story. In the United States, for example, capital expenditures have been restrained for some time relative to the very substantial level of corporate cash flow. That development likely reflects the business caution that was apparent in the wake of the stock market decline and the corporate scandals early this decade.
Plenty of cash to finance investment, just not enough commitment from firms. The upshot it that the economy evolves in such a way that consumption slows, savings rises, and, as long as investment spending continues to grow, we avoid a recession.
I understand that this appears to be a very benign story, but note that it is being spun by the man who is trying to trigger the whole series of events. If Greenspan didn’t believe he was putting the economy on a course to glide into sustainable growth (over time), he would signal a halt in rate hikes. No such hope there.
Overall, I think it very possible that this path will result in slower growth, especially in consumption spending, than people believe Greenspan or his colleagues are comfortable with. This game is complicated by the increase in energy costs, which policymakers clearly view as an inflation threat and are willing to sacrifice growth to ensure it remains a threat, not a reality. But while this makes the game more risky, it is the game nonetheless.
UPDATE (by Mark Thoma): Bloomberg's John M. Berry says rates are headed up.
Tax Reform and Better Porridge
Massive Estate Tax Cut Unseemly in Any Season, by Gene Sperling, Bloomberg: The award for candor in the post- Hurricane Katrina era has to go to Senate Finance Chairman Chuck Grassley, who observed that ''it's a little unseemly to be talking about doing away with or enhancing the estate tax at a time when people are suffering.'' ... The advocates trot out ... mom-and-pop stores and family farms that must be broken up and sold off to pay estate taxes. Never mind that they have never been able to cite even a handful of such cases. The Congressional Budget Office found that with a $7 million per-couple exemption, only 65 family farms would pay the estate tax ... Those in favor of retaining the tax ... started calling for dropping the top rate to 15 percent from 45 percent ... While these new proposals are designed to look less costly and less slanted in favor of the richest families, they're neither. ... The so-called Kyl compromise would benefit less than 10,000 wealthy families a year. But the cost would be high, at $595 billion over the next decade ... With terrorism threats still looming, deficits escalating, wages stagnating and poverty rising, ... lowering the estate tax for America's most fortunate families is more than a little unseemly in any season.
Next, Kevin Hassett expresses confidence Bush will deliver on tax reform
Why Bush Will Deliver on His Vow to Reform Taxes, by Kevin Hassett, Bloomberg: ...Tax reform can happen next year for three reasons. First, while Republicans ... still possess enough power to pursue ambitious legislation if the spirit moves them. ... Second, the Democrats should be highly motivated to pursue tax reform next year. ... because of a silly thing called the Alternative Minimum Tax ... The third and best reason [is] that tax reform ... is widely acknowledged to be a good idea. The academic community had a civil war over Social Security, but almost everyone ... will recognize a good plan for change once it emerges. ... Even the bitterest partisan would have to concede that the stars are aligned for tax reform. When the commission report finally appears, that will become apparent to everyone.
Just one note. The academic community will also recognize a bad plan if that is what emerges. Caroline Baum is next. She discusses Greenspan's "return" to his Randian roots as he attempts to influence his legacy and is less than impressed with his effort:
Greenspan, Term Ending, Returns to Randian Roots, by Caroline Baum, Bloomberg: ...Alan Greenspan ... surely wants to have some say in how he'll be remembered. Perhaps that's why ... he returned to his philosophical roots in a speech last week... Greenspan provided a brief history of the changing attitudes toward the government's role in the economy ... and the ultimate triumph of free markets ... Greenspan was present at the creation of Ayn Rand's masterpiece as part of the free-market philosopher's inner circle in the 1950s. ... The last third of Greenspan's speech last week ... left Ms. Rand to fend for herself ... While Greenspan's topic last week was ostensibly how greater flexibility has enabled the U.S. economy to handle shocks, the speech was really ''an attempt to rewrite history and can only be titled, 'Damn, I'm Good,''' ... Rand believed that individuals, including investors, act in their own self-interest. Greenspan is certainly acting in his. On that score, at least, his mentor would be proud.
Some say Greenspan exercised too much discretion, others too little, that he may have stayed the course too long, or that he should stay the current course of low interest rates longer. I have been critical of his politics and his failure to loudly connect the budget deficit to its implications for monetary policy, and of course there is the continuing debate over his connection to and responsibility for the stock market and housing bubbles. The porridge is too hot, the porridge is too cold, and as the cook prepares to retire everyone has suggestions for the next cook on how to make the porridge better. Hardly anyone says the porridge was just right, though some did in the past, and that's understandable as everyone vies to change the recipe more to their liking. But whatever his shortcomings, we could have done a lot worse. When the new cook arrives, we might love the new and improved porridge. But then again, the day could come when we miss that old porridge even if we were never quite sure how it was made.
Krugman: Miserable by Design
Miserable by Design, by Paul Krugman, NY Times: ...Start with health care, where conservative senators, generally believed to be acting on behalf of the White House, have blocked bipartisan legislation that would provide all low-income victims of Katrina with health coverage under Medicaid...
According to Krugman, the worry over extending Medicaid benefits to all poor victims of the Hurricane is political. If Medicaid is expanded it will create a precedent that will open the doors for future claims of similar need, something the White House does not want to occur, and it may also lead to discussions of national health care which the administration wants to avoid:
In a letter urging Senate leaders to reject the bill, Mike Leavitt, the secretary of Health and Human Services, warned that it would create "a new Medicaid entitlement."
People with medical needs will need to be treated somewhere and the effect of this policy is to shift the costs to the states:
...surveys show that many destitute survivors of Katrina are being denied Medicaid, and some are going without medicines they need. Local hospitals and doctors will often treat Katrina victims even if they can't pay. But this means that communities that have welcomed Katrina refugees will, in effect, be financially punished for their generosity...
Krugman next discusses housing. After noting that both conservatives and liberals are in wide agreement that housing vouchers are superior to housing projects (here's my support), he notes:
...But the administration has chosen, instead, to focus its efforts on the creation of public housing in the form of trailer parks, which ... will almost surely be more expensive than a voucher program and may create long-term refugee ghettoes. Even Newt Gingrich calls this "extraordinarily bad policy" that "violates every conservative principle."
So why is the administration abandoning long-held conservative principles? Why trailer parks? Why is medical care for victims of Hurricane Katrina being delayed or denied, something even many in the GOP such as senator Grassley do not favor (see GOP resists Grassley's more caring plan for aid from The Des Moines Register). How can we understand the administration's post-Katrina policy? Krugman explains:
...President Bush['s] ... mission ... is to dismantle or at least shrink the federal social safety net ... Mr. Bush can't avoid helping Katrina's victims, but he doesn't want to legitimize institutions that help the needy ... As a result, his administration refuses to use those institutions, even when they are the best way to provide victims with aid. More generally, the administration is trying to treat Katrina's victims as harshly as the political realities allow, so as not to create a precedent for other aid efforts. As the misery of the hurricane's survivors goes on, remember this: to a large extent, they are miserable by design.
UPDATE: Health Care for Katrina Victims, Editorial, NY Times: The White House has now spent nearly three weeks blocking a bipartisan effort to pay for medical care for the impoverished victims of Hurricane Katrina. On Sept. 16, Senators Charles Grassley and Max Baucus, the Republican and Democratic leaders of the Senate Finance Committee, introduced a bill that would extend Medicaid health coverage for five months to low-income childless adults from Katrina-struck areas. In addition, the bill would expand the pool of traditional Medicaid recipients to include pregnant women, children and the disabled ... The bill would also commit the federal government to paying 100 percent of victims' Medicaid bills rather than requiring the states to pay a share. Full federal payment is vital... without assurance of 100 percent coverage by the federal government, states that treat evacuees could be penalized by getting stuck with all or part of the bill. ... The administration also does not want the federal government to pick up the states' share for Medicaid costs incurred in Louisiana, Mississippi or Alabama in the post-Katrina period. Those three states would also have to pick up other states' costs to treat evacuees ... The Grassley-Baucus bill set the stage for efficiently providing much-needed medical care to Katrina's victims. But a few senators, widely seen to be carrying the administration's water, have thus far blocked a vote. The Senate majority leader, Bill Frist, could clear the way for a vote by the full Senate this week. What is he waiting for?
I've Got Robospurs that Jingle, Jangle, Jingle...
Ride 'em, Robot, WSJ: ...The camel-racing world in Qatar ... was on the brink of turmoil. Although a minimum age of 15 years for jockeys was set in 1980 across the Gulf, antislavery groups estimate that thousands of underage jockeys are still used in the region. ... Two years ago the U.S. State Department and human-rights groups began sharply criticizing the use of children as jockeys, and last year the United Nations urged prosecution of adults involved in it. Qatar, along with the United Arab Emirates, raised the minimum age to 18, and expressed a new determination to enforce it. But that's left camel racing in a quandary. To get the most out of their camels, camel racers say, jockeys should weigh less than 60 pounds. That rules out even teenage boys... Known as the "sport of sheiks," camel racing is a multimillion-dollar industry in the Gulf. Camels are valued for the role they played in the deserts of the Gulf -- transporting Bedouins and their belongings in the days before the region found statehood and wealth -- and racing them is considered part of the national heritage... With heritage, big business and the country's reputation at stake, Qatar's prime minister, Sheik Abdullah bin Khalifa Al-Thani, assured his population ... that some way would be found to save this "indispensable sport." Soon he called Sheik Abdullah bin Saud Al-Thani, chairman of the Qatar Industrial Development Bank and a prominent member of the clan that rules the country, floating the idea of developing a robot jockey. Mr. Al-Thani, ... organized a Robotic Jockey Committee ... After speaking with breeders, trainers, racers and psychologists, the committee summarized the relationship between the camel and jockey ... Camels' eyes, for example, roll back far enough to see directly behind them. This meant any robotic jockey would have to bear some resemblance to a human. Camels also have exceptional hearing and might be spooked by mechanical sounds ... The committee concluded that what was needed was a remotely controlled robot with a human form and voice. ... Back in Switzerland, it took months at the drawing board to adjust balance and shock-absorption and to protect against heat. ... The final product is a 59-pound, human-shaped droid. Mechanical arms and legs help it lean, balance and pull at the reins. The robots are fixed to the special camel saddle, equipped with straps, hooks and clips to keep them in place. They receive orders from trainers riding along behind via a remote-control system attached to the back of the camel. Equipped with a global positioning system, cameras and microphones, the devices allow trainers to track the animal's heart rate ... the sounds they make and even their facial expression. And the trainer can use a microphone to deliver such exhortations as the typical "haey hej'in!" The camel trainer uses a joystick on a laptop-size control box to give commands... The robot can also operate a whip, and a button on the joystick sends a signal to pull the reins sharply for an emergency stop. After initial skepticism, some camel owners are warming to the robojocks. "They listened to us and kept coming back to show us what they were making and to ask our input," says trainer Omar Al-Bakher. "And it's good what they've made." The government is providing camel owners complimentary two-day training courses in robot jockeying, for which demand is increasing. Over 50 Qatari camel trainers, out of perhaps 100 in all, have received diplomas. Qatar will sell the saddles at subsidized prices, and rent out the robots by the race. The robots will make their debut when the six-month camel-racing season begins later this month.
October 02, 2005
Has the IMF Been Asleep at the Wheel?
The Fund appears to be sleeping at the wheel, Comment by Morris Goldstein and Michael Mussa, Financial Times: Frustrated with the lack of meaningful exchange rate adjustment by China and some other Asian economies, the US Treasury has called on the International Monetary Fund to be more ambitious in its surveillance of exchange rates and warned that the “perception that the IMF is asleep at the wheel on its most fundamental responsibility – exchange rate surveillance – is very unhealthy both for the institution and the international monetary system”. We agree ... But continued acrimony between the IMF and its largest shareholder would not be helpful – especially when the world economy faces critical challenges in reversing large and rapidly rising payments imbalances. ... the Fund has repeatedly emphasised that the massive US external deficit and the corresponding surplus of the rest of the world must start declining. The IMF has rightly focused on many of the policy adjustments important for reducing payments imbalances ... This includes pressing the US for a more responsible fiscal policy.
But ...[while] the Fund has ... endorsed general calls for China and other Asian economies to adopt “more flexible” exchange rate regimes ...[it] has failed to emphasise the need for significant exchange rate appreciation to help reduce global imbalances. ... Massive, sustained, one-way intervention in the foreign exchange market ... has kept the renminbi from appreciating meaningfully against the dollar in nominal terms and has induced moderate depreciation in China’s real effective exchange rate. Many other Asian economies have also limited the appreciation of their currencies. In contrast, the market-determined exchange rates of European countries and of Australia, Canada and New Zealand have appreciated very substantially against the dollar since early 2002. ... Moreover, large-scale, prolonged, one-way intervention by several Asian countries to resist meaningful appreciation is clearly contrary to the IMF’s stated principles for the guidance of members’ exchange rate policies. Yet, the IMF has held no special consultations with Asian countries on their exchange rate policies. Nor has it provided explicit and public advice on the extent of necessary policy adjustments. ... Against this background, it is simply not credible for Rodrigo de Rato, the Fund’s managing director, to claim the IMF has been “well ahead of the curve” in its exchange rate advice to China, that there is “no evidence” that China has been running foul of IMF exchange rate guidelines, ... The key issue is that present exchange rate levels in Asia are not consistent with the need to reduce global payments imbalances in a way that minimises risks of financial disruption and supports sustainable global growth. The IMF has a clear responsibility to address this. More sound bites on the need for “greater flexibility” in currency regimes will not suffice...
If the IMF fails in these duties, others will take up the task. This is apparent in the widespread Congressional support for the Schumer-Graham bill that would impose high US tariffs on Chinese imports to offset the estimated undervaluation of the renminbi. Down this route lies a potential trade war and international chaos. The only viable alternative is to insist that the IMF does its assigned job as the vigorous, competent, unbiased, international umpire of exchange rate policies.
I am in general agreement so long as this is not used to justify past, present, or future U.S. fiscal deficits.
Posted by Mark Thoma on Sunday, October 2, 2005 at 03:34 PM
Sales Pitch or Just Another Speech?
A font of wisdom on Social Security, David Hendricks, San Antonio Express-News: President Bush ought to hire Harvard University economics professor Martin Feldstein as the White House spokesman for the administration's Social Security reform plan. With clarity and grace, Feldstein can ... articulate an understandable argument for adding personal investment accounts to Social Security's existing annuity program. ... And he did it in a way that puts to shame the muddled presentations that Bush Cabinet secretaries have delivered... Feldstein also offers something neither the Bush administration nor Congress has yet — a detailed plan for personal accounts. ... Feldstein's plan starts with the 10.6 percent payroll tax that funds Social Security's main retirement benefits. The total tax is 12.4 percent, divided equally between employees and employers, but the difference is set aside for the Social Security Administration's disability and survivor benefits programs. Feldstein's plan would carve out 1.5 percentage points from that 10.6 percent payroll tax. If a worker opted in, the government would match that amount as an incentive to start the private investment account. Workers could invest in a handful of investment funds — all broadly invested in stocks and bonds ... that over the past 50 years have averaged an annual yield of 7 percent. That return is not guaranteed, Feldstein stressed. But even if only half of that materialized, retirees still would receive 95 percent of the benefits promised under current formulas. The plan sounds plausible, but it would have to withstand a great deal of national scrutiny and analysis. Where the money would come from for the government match is one question. Feldstein said it may not be the best plan, but at least it helps the public better understand what Bush is urging, in principle. Until Bush provides this kind of detail, it's doubtful workers will rally behind his general proposal. ... Bush, it turns out, may need Feldstein for a bigger role than Social Security reform spokesman. Feldstein is a former chairman of the Council of Economic Advisers under President Reagan, and he's ... being mentioned as a potential replacement for Federal Reserve Chairman Alan Greenspan ... Feldstein said ... that he would serve if appointed by Bush.
Sadly, 'It is Not Even Wrong'
Not Even Wrong: Pauli and Not Even Wrong: When I first started thinking about using “Not Even Wrong” as the title of a book, I did some research to try and find out where the supposed Pauli quote came from. No one seemed to have any information about this, other than the attribution to Pauli, and various different stories existed about the context in which he had used the phrase. I started to worry that these stories, like many of the best ones about Pauli, might be apocryphal, so I contacted a few physicists who had some connection to Pauli to ask them about this. Prof. Karl von Meyenn, the editor of Pauli’s correspondence, wrote back to tell me that the phrase doesn’t occur in his correspondence. He pointed me to a biographical notice about Pauli written soon after his death by Rudolf Peierls as the best source for the story of Pauli using the phrase. Peierls writes
No account of Pauli and his attitude to people would be complete without mention of his critical remarks, for which he was known and sometimes feared throughout the world of physics … No doubt many of the stories of this kind circulated about him are apocryphal, but the examples below come from reliable sources or from conversations at which the writer was present … Quite recently, a friend showed him the paper of a young physicist which he suspected was not of great value but on which he wanted Pauli’s views. Pauli remarked sadly 'It is not even wrong.'
The Peierls article is in
Biographical Memoirs of Fellows of the Royal Society, Vol. 5 (Feb. 1960), 174-192.
Posted by Mark Thoma on Sunday, October 2, 2005 at 01:20 AM in Science
Inflation Models and Their Shortcomings
ff = a + b(y-y*) + c(π-π*)
where ff indicates the federal funds rate, y* and π* are the target values of output and inflation, y and π are the actual values, and a, b, and c are policy parameters chosen by the Fed. The Taylor principle says that c should be greater than one, i.e. a 1% increase in inflation should be met with an aggressive larger than 1% increase in the federal funds rate (more generally the Taylor rule is forward looking so that it is expected inflation rather than actual inflation relative to target that matters, though this is not a settled area and just one of many considerations, some of which are noted below).
While policy has appeared to work fairly well, Kohn notes there is plenty left to learn. In particular, he would like to see a more formal role for input cost determination in the models (energy costs in particular) so that the Fed can better understand why the relationship between input costs and inflation has seemingly changed over the last twenty years. Is it policy? Is it information technology or some other structural change? It is clear he is not confident the Fed knows how to respond optimally to energy price shocks. The other issues he cites as needing further research are expectation formation and credibility. Are expectations rational? Is learning important when policy changes? How does credibility interact with other elements in the models? Another issue, a key one since wages play a key role in most New Keynesian models, is wage setting behavior. Again, his remarks indicate the Fed is not satisfied with its understanding of the wage-setting process and in turn its understanding of why wages appear less responsive to changes in productivity than in the past. Last, he notes a variety of data issues which hinder our ability to investigate these issues.
He concludes by issuing a caution that policymakers not become overconfident in their ability to manage the economy, one that is worth repeating because policymakers have made that mistake in the past, notably with the discovery of the Phillips curve in the early 1960s. The increased macroeconomic stability in recent years known as the Great Moderation may have little to do with policymakers after all, instead it may have arisen from good luck and important structural changes in information and other technology. Policymakers and researchers must not become complacent in their search to understand of the policy process. Here are his remarks:
Inflation Modeling: A Policymaker’s Perspective, by Governor Donald L. Kohn At the Quantitative Evidence on Price Determination Conference, September 29, 2005: An occasion like this one is a natural opportunity to reflect on how policymakers' understanding of the inflation process has progressed over time. Clearly we have come a long way since the early 1970s. Most important, we have absorbed the central lesson of Milton Friedman's 1968 address to the American Economic Association--that any tradeoff between inflation and unemployment is only temporary because of the dynamic nature of expectations. We have also taken on board the practical application of this lesson that monetary policy must be vigilant about anchoring inflation expectations. Operationally, maintaining price stability requires abiding by the Taylor principle of raising nominal interest rates more than one for one in response to movements in inflation, especially those movements perceived as persistent. It also requires that policy tighten or ease systematically to bring aggregate demand in line with the economy's productive potential, not only because output stabilization is a policy objective in its own right but also because such actions help to head off undesirable changes in inflation down the road. These basic precepts, embraced by central bankers everywhere, have almost certainly contributed to the improved performance of inflation over the past decade or two, and this better price performance probably has helped to damp business cycles. ... Still, when it comes to inflation modeling and policymaking, as my grade school report cards used to say: There is room for improvement. ... What properties am I looking for in a model of inflation and the economy overall?
First, the model should provide a coherent analytical framework that the policymaker can use to interpret incoming data and to choose a proper policy response. Second, the model should provide an accurate empirical description of the economy... My experience on the Federal Open Market Committee (FOMC) as a ... suggests that work remains to be done on both fronts--and, in particular, on meeting both objectives with the same model.
As regards the first property, the ... informal--framework that many policymakers like to use is largely "bottom up" and ... starts with wages and the prices of other inputs ... after taking into account productivity, it sees prices set as a markup over unit costs. Wage determination plays a key role in this framework and is influenced by such factors as inflation expectations, productivity, and labor market slack; the markup, too, is important because it varies over time depending on changes in the competitive environment, expected future costs, and other factors. At first glance, the empirical structural models currently favored in academic research ... such as the New Keynesian Phillips curve--appear to conform to the informal policymaker model: ... On closer inspection, however, one sees that the specifications of these models typically ignore important factors bearing on the inflation outlook. One category of neglected factors is price shocks ... in the levels of key inputs, such as energy or imports. ... As a policymaker, I can assure you that any model of inflation that did not take account of these effects, and how they might or might not affect ongoing rates of inflation, would have been of little practical use to the FOMC over the past few years.
Reduced-form regressions suggest that the response of core inflation to energy prices has diminished over the past twenty years. Does this ... reflect a change in the expectations formation process that has come about because the public perceives that inflation will remain low, perhaps because the monetary authority is now seen to be more vigilant in reacting to price pressures? Or does it reflect a reduction, from the late 1970s until a couple of years ago, in the persistence of energy price movements that has prompted firms to be less worried about passing temporary cost increases onto customers? ... But economists are not well positioned to provide much evidence on this issue, given the relative paucity of empirical work on expectations formation. Certainly the standard approach used to estimate structural models is not that helpful because it simply assumes an answer--rational expectations, typically accompanied by full central bank credibility. But how well does this assumption match reality? ... we ... observe asset price levels, volatility, and implied risk premiums that are sometimes difficult to understand. And I doubt that any central bank has achieved perfect credibility in the markets. ... If plausible departures from rational expectations and full credibility are empirically verified, then our structural models need to take that into account. A new set of questions would then be on the table in policy analysis... Another area needing further attention is wage setting. My impression ... is that many of the newer empirical structural models of price inflation posit a central role for real marginal cost but seem to have little to say about its determination or that of its main component, labor compensation. ... Many economists ... think that the acceleration in labor productivity in the mid-1990s subsequently helped to restrain the rate of price inflation. ... I would be more comfortable with this hypothesis if it were supported by a structural model of wage determination that was firmly grounded in theory and microevidence.
As noted earlier, the design of sound structural models is only a start. ... Nonstructural specifications, despite their shortcomings with regard to the desirable model properties ... do have an important role to play in policymaking--in particular, forecasting. ... Such models often include energy- and import-price terms along with measures of slack and expectations... Data measurement issues add to the challenge of developing better empirical models for policy work. One important example concerns hourly labor compensation. The measure reported in the national accounts is often revised significantly, displays substantial volatility from quarter to quarter, and has components that may not coincide with the labor costs relevant to business pricing decisions. ... An unpleasant implication of these various data problems is that they may make difficult the development of structural models incorporating wage behavior that are reliable enough for policy analysis, despite their attractiveness to policymakers like me. ... Many inflation models ... include some measure of resource utilization ... such as the gap between the unemployment rate and the non-accelerating inflation rate of unemployment (NAIRU). And as we know, the latter cannot be directly observed. ... policymakers should be cautious about responding aggressively to estimated movements in economic slack. ... In addition, the staff's experience ... illustrates some of the problems inherent in using real-time wage data.
...[W]e would do well to be cautious about attributing the good macroeconomic performance entirely to good monetary policy. Decomposing the sources of the Great Moderation is a difficult business, and a number of researchers interpret the evidence as suggesting that... Luck as well as structural changes in the economy may have had a lot to do with the current low level and apparent stability of U.S. inflation...
October 01, 2005
Putting the Gini Back in the Bottle
Chinese Officials Vow to Spread Growth Benefits, by Edward Cody, Washington Post: The ruling Communist Party vowed Friday to spread the benefits of economic growth more fairly among all levels of Chinese society, seeking particularly to close the yawning income gap between farmers and city dwellers. The pledge, issued by the Politburo, the country's top policymaking body, was seen in part as a response to growing unrest, especially in small towns and villages, ... "In the next five years, China should pay more attention to social fairness and democracy and earnestly solve the problems closely related to the people's interests," ... The statement ... reported on a meeting of the 25 Politburo members ... in Beijing under President Hu Jintao, who is general secretary of the Central Committee and thus the senior party leader. ... Hu and his premier, Wen Jiabao, have strongly emphasized the need for more equitable wealth distribution since taking over the Chinese leadership nearly three years ago. Nevertheless, the gap between rich and poor has continued to widen ... The Politburo's call for more determination to attack the problem reflected growing awareness ... that widespread dissatisfaction over the glaring inequalities has become a potentially troublesome political issue. The number of violent incidents across the country has shot up dramatically over the last year ... most stem from economic grievances against local authorities. ... Study Times, the party school's official organ, warned last week that the alliance between party and business, often greased by corruption, itself is a big reason for the income inequality that has farmers so upset. Citing a study published by the Labor and Social Security Ministry, the paper said incomes gaps have reached "the yellow light alarm level" and within five years could reach a "dangerous red light level" that could result in "destabilizing social phenomena" unless something is done to change the trend. Some Chinese academics interpreted that comment as an attempt by concerned government officials to make sure the issue received a prominent place on the Central Committee agenda and in the next Five-Year Plan. Judging from the report published Friday, their tactic was partially successful--the income gap got a prominent spot, but corruption was not mentioned...
Note: Gini coefficient definition.
Hooked on Chopsticks
Korean golf secret exposed, Asiapundit: Korean female golfers continue to excel in the Lady's Professional Golf Association (LPGA). In fact out of the top 30 female professional golfers, 10 of them are Korean. You may be asking yourself, how is a small country like Korea able to dominate women's professional golfing? What is the secret to their success? Is there some kind of advanced training regimen or some mystic Korean herbal tea that is giving them such an advantage? Well look no further, the Korea Times has leaked the ancient Korean secret to becoming a master golfer; the ability to use chopsticks:
Hankooki.com > The Korea Times > Sports > Dexterity Enables Korean Lady Golfers to Dominate US LPGA: What enables South Korean lady golfers to be so formidable in the U.S. LPGA Tour? It is nothing less than the Koreans’ talent to make things skillfully with their hands, a trait handed down from generation to generation for thousands years. Celadon in Koryo and the Yi dynasty are world famous for blue and white china in quality, and you know that pottery involves the same skills as playing golf. Not to change the subject, South Koreans’ special talent to make things skillfully with their hands is also believed to greatly contribute to their making almost a clean sweep of the World Skills Competition. By the same token, Koreans are good at various sports that are played chiefly with the hands: handball, archery and table tennis, to name a few. Professor Hwang Woo-suk of the Seoul National University who led the first cloning of embryonic human stem cells told in a public lecture that one of his assistants surprised the stem cell big shots of the world with his skills, which were beyond their imagination but actually nothing for Koreans. Professor Hwang, referring to the use of chopsticks, mentioned that the Koreans’ skill with their hands contributed to their success in cloning embryonic human stem cells. An editor golf fan of an English daily newspaper mentioned that one of the root causes for Korean ladies to play such great golf in the U.S. is closely connected to dexterity, which is also critical to preparing delicious Kimchi, a Korean side dish loved by the people around the world.
That is right folks, chopsticks! With the ability to use chopsticks you can become a top professional golfer, make pottery, play handball, become a master archer, and if you still got some time left you can do a little embryonic stem cell cloning on the side. This is not to mention the fact you can be a skilled maker of Kimchi. ... Something else to consider before you start practicing your chopstick skills, don't practice using them like the Chinese or Japanese, follow only the Korean technique for using chopsticks and food preparation:
Japanese, who also use chopsticks like Koreans, once produced a golf great named Ayako Okamoto, who became a member of the LPGA Tour in 1981 and won 17 events between 1982 and 1992. She was recorded as the first woman from outside the U.S. to top the LPGA tour's money list in 1987. ... Despite this, the Japanese do not surpass Koreans in the golf world possibly because they ... use sashimi knife in preparing raw fish, their all-time favorite, instead of directly using hands as Koreans do. Similarly, the Chinese do not distinguish themselves as much as Koreans in the LPGA tour of America because they do not stress the role of hands in making foods. ... Mostly they use fire to create taste instead of using their hands. ... Of course, there are some other factors that make all the great achievements possible including tenacity and indomitability, two characteristics of Koreans, along with quite a lot of synergy among the South Korean golfers. But without the dexterity unique to Koreans their great success would be hard to imagine.
For those not familiar with the Korean media, these type of articles are very common to reinforce Korean pride and sense of superiority, especially over the Japanese and the Chinese. Everything seems to revolve around Kimchi, chopsticks, and Dokto. My only question is how did Annika Sorenstam become so dominant without Kimchi, chopsticks, and Dokto? If you haven't had enough chopsticks and Kimchi you can read more about it over at Cathartidae.
The Decline in Manufacturing Jobs
Industrial Metamorphosis, The Economist: For the first time since the industrial revolution, fewer than 10% of American workers are now employed in manufacturing. And since perhaps half of the workers in a typical manufacturing firm are involved in service-type jobs, such as design, distribution and financial planning, the true share of workers making things you can drop on your toe may be only 5%. ... Our figure of 10% comes from dividing the number of manufacturing jobs—just over 14m, say the latest figures—by an estimated total workforce (including the self-employed, part-timers and the armed forces) of 147m. In 1970, around 25% of American workers were in manufacturing. The share of manufacturing has also been falling in all other developed economies since 1970... (see chart 1).
Indeed, the actual number of manufacturing jobs has fallen by half since 1970. ... Most people today work in services: in America, as many as 80%. But this trend is hardly new. As early as 1900, America and Britain already had more jobs in services than in industry. Even at its peak, early in the 20th century, employment in manufacturing never exceeded one-third of America's workforce. What is new is the recent absolute decline in factory employment. Although manufacturing has long been shrinking as a proportion of America's expanding workforce, the number of industrial jobs stayed more or less the same between 1970 and the late 1990s. Since then, however, manufacturing employment has fallen in every year. Chart 2 shows that since 1996 the number of manufacturing jobs has shrunk by close to one-fifth in America, Britain and Japan. In the euro zone, the average loss has been only 5%. Similarly, manufacturing output has fallen as a proportion of GDP (measured in current prices)...
... Any analysis of labour-market trends soon gets bogged down in a statistical swamp. For instance, a small part of the fall in manufacturing jobs is a statistical illusion caused by manufacturers contracting out services. If a carmaker stops employing its own office cleaners and instead buys cleaning services from a specialist company, then output and employment in the service sector appear to grow overnight, and those in manufacturing to shrink, even though nothing has changed. More generally, the line between manufacturing and services is blurred. McDonald's counts as a service company, but a visit to any of its restaurants puts one in mind of an industrial assembly line, turning out cooked meat products. Similarly, an increasing slice of value-added in manufacturing consists of service activities, such as design, marketing, finance and after-sales support. Last but not least, Britain's number-crunchers stick The Economist, along with the whole publishing and printing industry, in manufacturing, even though almost all our staff are engaged in service-like activities...
Rose-Colored CBO Glasses
CBO: Hurricanes' Economic Hit Less Severe, by Andrew Taylor, AP: Cost estimates are incomplete and the data is still coming in, but it seems clear that the economic fallout from the twin hurricanes that hit the Gulf Coast may be less severe than previously feared ... The CBO estimated that the hurricanes' overall impact on the economy would be about one-half of a percentage point for the second half of the year. That compares with a CBO analysis on Sept. 6 that said the impact could be as much as a percentage point. ... When considering private and government support for recovery and rebuilding, the storms will not affect growth in the gross domestic product over the final three months of 2005, Holtz-Eakin said. In fact, economic growth "could even be somewhat higher than was projected before the hurricanes," said Holtz-Eakin, head of the nonpartisan agency that provides economic and budget data to Congress. Most of the economic losses _ as much as 1.5 percentage points _ would come in the July through September period. ... On inflation, the CBO predicted a greater impact than previously seen, almost entirely due to higher energy and gasoline prices. The consumer price index may be almost 1 percentage point higher for the period between the fourth quarter of 2004 and the fourth quarter of this year than previously expected..."But consumer price inflation should revert to pre-Katrina rates in the first half of 2006 ..." CBO said.
Posted by Mark Thoma on Saturday, October 1, 2005 at 01:06 AM in Economics
Tax Reform Panel Report Delayed
Bush's Tax-Simplification Plan Pushed Back, AP: A White House commission that's supposed to recommend ways to make income taxes fairer and simpler has been given another extension... When President Bush created the President's Advisory Panel on Federal Tax Reform in January, he told members to report back to him by July 31. In June, that date was pushed back to the end of September. On Friday, the president said the new date is Nov. 1 to finish the report and Nov. 15 to close down their operation. ... The commission has been examining the possibility of basing taxes on spending rather than income, which could mean a national sales tax or a European-style value-added tax, or recommending some combination of income and consumption taxes.