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December 18, 2007

Economist's View - 5 new articles

McCain: "Economics is Something That I've Really Never Understood"

John McCain says that when it comes to economics he will have to rely upon others because, though he's tried, he doesn't really get it himself:

McCain said ... "The issue of economics is something that I've really never understood as well as I should. I understand the basics, the fundamentals, the vision, all that kind of stuff,'' he said. "But I would like to have someone I'm close to that really is a good strong economist. As long as Alan Greenspan is around I would certainly use him for advice and counsel."

McCain said his staff hates it when he discusses his shortcomings on economics, even though he has read widely and studied the subject. "I've never been involved in Wall Street, I've never been involved in the financial stuff, the financial workings of the country, so I'd like to have somebody intimately familiar with it," he said of a potential vice president. [Note: List of McCain's advisers].

Glenn Rudebusch of FRBSF: National Economic Outlook

With twenty-four supporting graphs, this is a thorough analysis of the outlook or the U.S. economy from Glenn Rudebusch of the SF Fed:

FedViews, by Glenn Rudebusch, Federal Reserve Bank of San Francisco: The FOMC statement released after the December 11 meeting stressed the recent deterioration in financial market conditions and the slowing in economic growth.


Since the middle of this year as the economic outlook has soured, the Fed has eased monetary policy by cutting the discount rate by 150 basis points and the federal funds rate target by 100 basis points. Treasury yields have also fallen—the 2-year rate is down almost 200 basis points from its peak. Markets expect the Fed to continue to cut rates next year.


A key question involves gauging the appropriate stance of monetary policy. The real funds rate now appears to be in the range of its long-run historical average, and such a neutral level may seem appropriate given essentially no slack in the economy and contained core inflation. (For example, in a backward-looking Taylor rule, the output and inflation gaps would essentially be zero, so the real funds rate would be set equal to its neutral level.) However, higher energy prices, an intensifying housing correction, and greater financial market turmoil have lowered the outlook for economic growth and may require an offsetting, easier stance of monetary policy. Furthermore, from a risk management perspective, recent developments in financial markets—tighter credit standards, higher risk spreads, impaired liquidity, dislocations in mortgage markets—imply a significant downside "credit crunch" recessionary risk that may warrant an easier policy.


Conditions in the interbank lending market appear to have deteriorated over the past month, with widening spreads between comparable-maturity LIBOR and OIS rates. In part, the widening spreads may signal heightened concerns about counterparty risk related to commercial bank exposures to subprime mortgage securities. The elevated spreads also may reflect a desire by banks to hoard their liquidity in the face of uncertain future re-intermediation demands on their balance shifts. The latter concerns may be magnified by year-end balance sheet window-dressing. The disruption of interbank lending has the potential to impede the monetary policy transmission process and may require lower rates than would usually be warranted by macroeconomic conditions (or the disruption might be amenable to a more surgical intervention, such as the Fed's new term auction credit facility).


Credit has also become more expensive for many other businesses and consumers. Despite the easing of monetary policy, short-term credit for lower-rated businesses remains about as expensive as it was during the middle of the year. Commercial paper rates for highly rated borrowers have fallen with the funds rate target, but interest rates have increased for second-tier A2/P2 commercial paper, while asset-backed commercial paper, even with a nominal AA rating, has required a significant premium to place in the market.


Although yields on long-term investment-grade corporate bonds have been little affected by the recent financial turmoil, yields on low-grade bonds have surged. The resulting widening credit spreads have likely been driven by a worsening economic outlook as well as a reduced appetite for risk.


There has also been a significant tightening of the financing terms for nonconforming mortgages. In particular, interest rates on jumbo fixed-rate mortgages have remained quite high because of difficulties in securitization.


Equity markets have been buffeted by recent economic and financial developments (and policy announcements) but, on balance, have held up fairly well.


Tightening mortgage financing conditions have helped depress housing demand. Home sales have been very weak, and the stock of unsold homes on the market continues to rise. Indeed, to pare bloated inventories, homebuilders have cut new construction. October housing starts posted a 1.2 million unit annual rate. Based on past trends, starts may not fall much below the 1 million unit mark during the next few quarters. After some past housing market busts—notably in the 1970s—construction surged after its trough; instead, in this cycle, we anticipate a very slow recovery to trend, as in the 1990s.


According to the 10-city Case-Shiller repeat sales price index, home prices have declined 5-1/2 percent over the 12 months ending in September. Futures contracts on this index suggest further declines in the year ahead.


Declines in home prices can cause households to revise their wealth assessments downward and scale back their consumption. Such spillovers to consumption pose a significant risk to the economic outlook.


Household spending was essentially flat in real terms in September and October, and although retail sales improved in November, surveys of consumer sentiment remained very pessimistic.


Household spending has likely been curtailed by the smaller gains in employment and slower growth in income recently. Residential construction lost 20,000 jobs in November, and other housing-related sectors, such as building materials supply, continued to trend down. Another factor restraining household spending is the high price of energy. Although the price of oil has fallen back after flirting with $100 per barrel, households are still facing significantly higher gasoline and fuel oil prices than they did just a few months ago.


In light of the slowing economy and higher financing costs for lower-rated borrowers, businesses appear to have become more cautious about future capital outlays.


The economy grew very quickly during the summer; indeed, the revised estimate of real GDP growth in the third quarter showed a 5 percent increase at an annual rate. To some extent, transitory factors, notably in exports and inventory investment, pushed up growth in the third quarter, and the reversal of these factors appears likely to depress growth in the current quarter. In addition, several shocks, including tightening credit, slumping housing, and higher energy prices, appear to have depressed final domestic demand. All in all, we foresee anemic growth through the spring of next year. There appears to be a significant chance of registering at least one quarter of negative GDP growth, which in the past has often been associated with a recession. (See Rudebusch and Williams, "Forecasting Recessions: The Puzzle of the Enduring Power of the Yield Curve," FRBSF working paper 2007-16, July 2007 at Indeed, the latest Blue Chip survey reports that economic forecasters assess the odds of a recession at around 40 percent.


In 2004 and 2005, headline price inflation was boosted by the effects of higher energy costs. The recent jump in crude oil prices will again push up overall inflation; however, we anticipate little pass-through to other prices. Indeed, we anticipate that core PCE price inflation will remain below 2 percent through next year.


Last month, the FOMC announced a new communications strategy involving expanded and more frequent economic projections. This new strategy is not a change in the way to conduct policy; instead, it is an enhanced means of communicating policy. The genesis of this new communications initiative occurred 1-1/2 years ago when Chairman Bernanke asked Federal Reserve Board Vice Chairman Kohn and Federal Reserve Bank Presidents Stern and Yellen to help organize a wide-ranging review of FOMC communication policies. One of the resulting initiatives, an enhanced role for public FOMC economic projections, was unveiled last month. Specific numerical forecasts of the FOMC participants, which were collected at the time of the October 30-31 FOMC meeting, were released with the minutes of that meeting on November 20.


Given the lags in the operation of monetary policy, central bankers have long emphasized the importance of being forward-looking, but in the past, they often communicated to the public very little or very obscurely. Although the Federal Reserve has published economic projections for almost 30 years, it is only over the past decade or so that a general appreciation of the value of such public central bank forecasts has grown among economists and policymakers. The new appreciation has been part of a veritable revolution in central bank communications, so central bankers often expound on the importance of transparency—most fittingly in new or more frequent central bank Monetary Policy Reports, press conferences, and speeches.


Communicating the Fed's views about where it thinks the economy is likely to go in the future can help inform the public about the Fed's monetary policy strategies and objectives, such as a preferred range for the future rate of inflation, the Fed's assessment of the near-term economic outlook, and the Fed's view about long-run aspects of the economy, such as the natural rate of unemployment. With such information, households and businesses can make better-informed economic decisions. Financial market participants also will be better informed about what the Fed is expecting, so they can respond appropriately to incoming data even before the next scheduled policy meeting. More generally, the added transparency of public central bank forecasts can foster greater accountability and hence legitimacy.


There are a variety of new features of the enhanced FOMC projections. The forecasts will be more frequent, four times a year instead of two. The forecast horizon will be longer, about three years ahead instead of two. A forecast for overall PCE price inflation will be added to the existing forecasts for real GDP growth, the unemployment rate, and core PCE price inflation. The forecast summary will include a discussion of the key factors or influences shaping the FOMC outlook. The summary will also include a discussion of the risks to the economic outlook, including a qualitative assessment of the amount of uncertainty and the balance of that uncertainty around the forecast. Finally, the dispersion of views among the FOMC participants will be detailed.


The projections from the October 2007 FOMC meeting have a number of interesting features. First, the 2008 central tendency of the FOMC real GDP growth forecasts is consistent with a slowdown in economic growth over the next few quarters. Furthermore, most participants judged that there was greater uncertainty around their growth projections than suggested by the average historical uncertainty and that this uncertainty was weighted to the downside. However, the subpar economic growth was not expected to persist, and by 2010, the FOMC viewed the economy as likely to grow at a sustainable pace, which appeared to have been estimated to be about 2-1/2 percent.


Likewise, the unemployment rate is expected to settle in at an estimated natural rate of around 4.8 percent.


Finally, both core and overall inflation are expected to remain well contained going forward, converging to about 1-3/4 percent at the end of the forecast horizon.

"Crazy Views on the Economy"

Dean Baker reviews the economic plans of the Republican presidential candidates:

Creative thinking, by Dean Baker, Comment is Free: Since several of the Republican presidential candidates regard creationism as a serious theory in biology, it should not be surprising that their economic views also have little connection to reality. In fact, the Republicans' test scores in biology are probably somewhat higher than in economics. Creationism is a minority view... By contrast, all of them seem to be spouting some pretty crazy views on the economy.

Of course tax cuts are central to the Republicans' economic story. They have great plans to reduce taxes, especially for people who don't work for a living. For example, Mitt Romney ... insists that anyone with an income of less than $200,000 a year should pay no tax on any income from dividends, capital gains or interest. Under the Romney plan, a person who collects $200,000 a year in interest on $4m held in government bonds would pay zero tax. By contrast, a custodian working two jobs to earn $40,000 a year can look to pay around $4,000 a year in taxes.

In the same vein, Mike Huckabee has proposed the "Fair Tax", which his website claims is "based on wealth", although it is described as a sales tax. Huckabee proposes to have his Fair Tax replace all other forms of taxation... If a national sales tax is to replace all other federal taxes, then it would have to be in the neighbourhood of 25% to 30%. ... If we don't tax items like healthcare and house sales ..., we might be up to 40% with Huckabee's Fair Tax.

But this is where the fun comes in. Typical workers will probably have to pay President Huckabee's Fair Tax on almost everything they buy throughout their life. But, the smart folks who make their money by inheritance, strike it rich on Wall Street or work in highly paid professions can simple skip out on the Fair Tax. ... Their tax burden will get passed on to the teachers, fire fighters, custodians and others who are left behind. What could be fairer?

Fred Thompson also deserves credit for creativity. He proposes the option to pay tax at a marginal rate of 10% for couples on earnings below $100,000 and 25% on earnings over $100,000. This would be a modest cut in taxes for most workers, but it would reduce taxes by more than a third for the richest 1%. ...

All the Republican candidates claim to be devout believers in tax cut creationism: the view that tax cuts pay for themselves due to their effect on stimulating growth. Even Rudy Giuliani and former straight talker John McCain claim to believe that tax cuts pay for themselves.

It is important to understand that this one is not a debatable point, as often claimed in the media. Tax cuts do not come close to paying for themselves. There is no serious dispute among economists on this issue. The Congressional Budget Office recently did a study examining the range of predictions from the available theoretical models on this topic. It found that the most optimistic model showed that growth replaces less than one-third of the lost revenue, and even this gain was only possible for a limited period of time. In short, when the Republicans claim that they can have large tax cuts without any offsetting cuts in spending, they are prescribing a route to really large deficits.

Of course, this suggests an important reason why some people may opt to support the Republican contenders. With the Democrats backing down from plans to end the war in Iraq, the war may continue long into the future if Democrats take the White House. On the other hand, the tax cuts proposed by the leading Republicans could take away the money needed to prosecute the war. In short, when it comes to the war in Iraq, the only way out may be to "starve the beast".

Since I've been noting reality-based Laffer curve reporting lately, I should acknowledge this from Ross Douthat (as pointed out at Crooked Timber, it's helpful to realize that David Frum is one of Giuliani's "senior policy advisers"):

Anti-Intellectualism, the Right, and Rudy, by Ross Douthat: David Frum, on populism and anti-intellectualism:

Conservatives have drawn strength from populism. But you can overdo any good thing —and I am beginning to think that on this one, we've zoomed the car into the red zone.

For me, the lights started flashing in 2005, during the battle over the nomination of Harriet Miers to the Supreme Court of the United States. Defenders of the president's under-qualified nominee began attacking the concept of qualification. One wrote: "The GOP is not the party which idolizes Ivy League acceptability as the criterion of intellectual and mental fitness. Nor does the Supreme Court ideally consist of the nine greatest legal scholars." Harriet Miers, we were told, had a good Christian heart. That was enough ... In the end, it was not quite enough for Ms. Miers. But it may be enough for many voters in 2008.

The currently front-running candidate in Iowa, former Arkansas governor Mike Huckabee, has built his campaign on a plan to abolish the Internal Revenue Service and replace the federal income tax with a national sales tax ... Economists and tax experts virtually unanimously agree that the plan is beyond unworkable -- that it is downright absurd.

... Just a little lower down in the polls is a libertarian candidate named Ron Paul. Paul is best known for his vehemently isolationist foreign policy views. But his core supporters also thrill to his self-taught monetary views, which amount to a rejection of everything taught by modern economists from Alfred Marshall to Milton Friedman.

Huckabee and Paul have not the faintest idea of what they are talking about. The problem is not that their answers are wrong -- that can happen to anyone. The problem is that they don't understand the questions, and are too lazy or too arrogant to learn.

Fair points all: ..., and Frum's larger worry about anti-intellectualism in the contemporary Right is one I share in spades. But if you're going to be hard on the current crop of Republican candidates for making bogus claims about public policy, it seems awfully unfair to leave out the candidate given to running ads in which he announces: "I know that reducing taxes produces more revenue. The Democrats don't know that. They don't believe that." (They don't believe it, of course, because in the current fiscal landscape you can't find a serious conservative economist who thinks it's true.) Or penning op-eds in which he explains that "the meaning of fiscal conservatism" includes the principle that "lower taxes can result in higher revenue." Or telling a GOP debate audience, in response to a question about whether we need to raise taxes to fix up our nation's transportation infrastructure, that the way "to do it sometimes is to reduce taxes and raise more money."

Now it's true that occasionally Rudy Giuliani hedges his bets ("sometimes," "can," and so forth) on this topic, and it's true as well that he may not actually believe the extreme supply-side talking points he's spouting, in the way that Huckabee presumably believes in the Fair Tax and Paul in the gold standard. On the other hand, neither of those ideas are likely to serve as the basis for economic policy in the United States any time soon, and both are marginal even within the right-wing coalition; the "tax cuts raise revenue" canard that Giuliani keeps promoting, on the other hand, is a staple of Bush Administration rhetoric and probably the dominant view among movement conservatives. If you're looking for cases where the Right's anti-elitism has shaded into outright anti-intellectualism - for cases where, in Frum's words, a GOP politician has deliberately failed to "study the problem, master the evidence, and face criticism" - Giuliani's frequent channeling of Larry Kudlow seems like at least as telling an example as anything Mike Huckabee and Ron Paul are peddling.

I don't believe it's "anti-intellectualism," i.e. I don't believe that Giuliani is unaware of the evidence on this issue (and his policy advisers ought to be aware of it - if they aren't, or if they are reluctant to correct his misleading, untrue statements, that's a big worry).

This is a character issue. I don't believe Giuliani has deliberately 'failed to "study the problem, master the evidence, and face criticism"' through a deliberate act of anti-intellectualism. The chances that the campaign is unaware of all the fact checks on this issue are zero. It seems to me that what is deliberate is the willingness to pander to the movement conservative base even if it requires ignoring the evidence and saying things he knows in his heart of hearts aren't true. He's not deliberately ignorant, he's deliberately calculating and we shouldn't excuse it by acknowledging the occasional hedge ("sometimes," "can," and so forth) when the intent is to mislead, or use terms like anti-intellectualism to describe the behavior. We shouldn't just say, "when the Republicans claim that they can have large tax cuts without any offsetting cuts in spending, they are prescribing a route to really large deficits," we should also note that there is an intent to deceive, that they are not telling the truth, or they are so ignorant of the truth that it ought to raise questions about their fitness for office.

Giuliani and others who make this claim know what they are doing. When it comes to, say, selling a war with Iran, reforming Social Security, or other issues, will they also be willing to ignore evidence, to only accept "facts" that confirm their preconceived beliefs instead of objectively reviewing the situation, will they be willing to look you in the eye and mislead in order to convince you to go along with their plans? Those who continue to make misleading claims about tax cuts in spite of the very public debunking of that position have given every indication that the answer is yes.

Fed's Plosser Worries about Inflation Pressure

Charles Plosser, president of the Philadelphia Fed, is interviewed by the WSJ on inflation, risks to growth, and communication (Plosser has doubts about the usefulness of communicating the "balance of risks" between inflation and output growth in the Press Release after rate decisions):

Fed's Plosser: Inflation pressure "more broad based", WSJ Economics Blog: Recent data suggest inflation is becoming more broad-based rather than isolated to energy, a sign of worrisome underlying price pressures, Federal Reserve Bank of Philadelphia president Charles Plosser said.

In an interview with The Wall Street Journal Monday, Mr. Plosser said he doesn't expect a recession, but even if one is due in the next few quarters, easing monetary policy aggressively now won't do much to avert one. On the other hand, it could create a "terribly inflation-risky environment" if the economy is on the road to recovery later next year, as he expects.

Mr. Plosser is one of the Fed's more hawkish officials, but even so his comments suggest a wariness at the Fed about further interest rate cuts in the wake of last Friday's higher-than-expected rise in consumer prices.

Continued inflation pressure "makes our choices more difficult" when faced with a weak economy he conceded.

Mr. Plosser said inflation pressure has persisted because of rapid growth in total nominal spending either in the U.S. or world economy, which might be the lagged effect of overly easy monetary policy in the past. He also disputed that several quarters of below-trend economic growth would push inflation down. "It's a mistake to rely on the slowdown for much disinflationary effect," he said.

Q&A with Mr. Plosser:.. [Q&A is here]

links for 2007-12-18

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