- Paul Krugman: A Cross of Rubber
- Fed Watch: Underappreciated Data
- links for 2011-01-30
- "Do for Households What the Fed Sought for the Banks"
- Taxes and Labor Supply
Posted: 31 Jan 2011 12:36 AM PST
Central bank authorities should not give in to demands for higher interest rates:
A Cross of Rubber, by Paul Krugman, Commentary, NY Times: Last Saturday, reported The Financial Times, some of the world's most powerful financial executives were going to hold a private meeting with finance ministers in Davos... The principal demand of the executives ... would be that governments "stop banker-bashing." Apparently bailing bankers out after they precipitated the worst slump since the Great Depression isn't enough — politicians have to stop hurting their feelings, too.
But the bankers also had a more substantive demand: they want higher interest rates ... because they say that low rates are feeding inflation. And what worries me is the possibility that policy makers might actually take their advice.
To understand the issues, you need to know that we're in the midst of ... a "two speed" recovery, in which some countries are speeding ahead, but ... advanced nations — the United States, Europe, Japan — have barely begun to recover. ... To raise interest rates under these conditions would be to undermine any chance of doing better; it would mean, in effect, accepting mass unemployment as a permanent fact of life.
What about inflation? High unemployment has kept a lid on the measures of inflation that usually guide policy. ... But food and energy prices — and commodity prices in general — have ... been rising lately. Corn and wheat prices rose around 50 percent last year; copper, cotton and rubber prices have been setting new records. What's that about?
The answer, mainly, is growth in emerging markets ... — China in particular — ... has created ... sharply rising global demand for raw materials. Bad weather ... has also played a role in driving up food prices.
The question is, what bearing should all of this have on policy at the Federal Reserve and the European Central Bank? First of all, inflation in China is China's problem, not ours. ... Neither China nor anyone else has the right to demand that America strangle its nascent economic recovery just because Chinese exporters want to keep the renminbi undervalued.
What about commodity prices? The Fed normally focuses on "core" inflation, which excludes food and energy... And this focus has served the Fed well in the past. ... It's hard to see why the Fed should behave differently this time...
So why the demand for higher rates? Well, bankers have a long history of getting fixated on commodity prices. Traditionally, that meant insisting that any rise in the price of gold would mean the end of Western civilization. These days it means demanding that interest rates be raised because the prices of copper, rubber, cotton and tin have gone up, even though underlying inflation is on the decline.
Ben Bernanke clearly understands that raising rates now would be a huge mistake. But Jean-Claude Trichet, his European counterpart, is making hawkish noises — and both the Fed and the European Central Bank are under a lot of external pressure to do the wrong thing.
They need to resist this pressure. Yes, commodity prices are up — but that's no reason to perpetuate mass unemployment. To paraphrase William Jennings Bryan, we must not crucify our economies upon a cross of rubber.
Posted: 31 Jan 2011 12:24 AM PST
Tim Duy sees optimistic signs in the 4th quarter GDP report:
Underappreciated Data, by Tim Duy: I must admit that I surprised by the tepid response to the advance release of the 4q2010 GDP data. Mark Thoma catalogues the most common critiques – the negative contribution from government spending and the minimal reduction in the output gap. My review of the data differs. In my opinion, this is the first GDP report since the recession "ended" that offers a certain optimism, a glimmer of hope that perhaps that light at the end of the tunnel is not simply an oncoming train. If it is an oncoming train, it not the train of sagging government spending, but instead a train of imports blasting forward.
It is no secret that this recovery, to date, has been anything but vigorous. Certainly nothing like the "Morning in America" of the mid-80's. Real final sales – GDP excluding inventory effects – outperformed for quarter after quarter during that period as demand clearly outstrip the pace of capacity growth. In comparison, real final sales during the most recent recovery has been almost laughable:
But real final sales surged in the final quarter of 2010:
Looks like the economy shook off the summer slowdown, putting order back on the uptrend. Somewhat disappointing was the partial reversal of recent improvement in initial unemployment claims. That said, looking at the four-week moving average, the downtrend looks intact:
Of course, if final demand is growing at a 7.1 percent pace, the overall improvement in the final months of 2010 should come as no surprise. Finally, also not surprisingly, the Case-Shiller Index reported ongoing home price weakness. Housing has offered almost nothing to the recovery and, quite frankly, is yesterday's story. Housing is returning to its appropriate place in the economy – a product that provides a service, not an investment or, worse yet, a gamble.
Bottom Line: The GDP report revealed what could be, the glimmers of hope of a V-shaped recovery. If final demand even near the 4q2010 could be maintained, Federal Reserve policymakers makers would be forced to take notice by mid-year. Still, setting aside the usual risk factors (including the fresh possibility that Mideast unrest triggers a fresh oil shock) the sustainability of this final demand is directly dependent upon the evolution of the external accounts. If this demand surge is satisfied with an import surge in coming quarters, we can expect the recovery will remain tepid in comparison to previous deep recessions. If rebalancing were to maintain some traction, this could be simply the first in a long-waited string of data that would proved a clear exit to the current period of relative economic stagnation.
Posted: 30 Jan 2011 10:01 PM PST
Posted: 30 Jan 2011 10:08 AM PST
Vernon Smith, who is not a fan of government intervention, makes familiar arguments about how to escape from balance sheet recessions:
Mired in Disequilibrium, by Vernon Smith, Newsweek: ...Some 23 percent of homeowners owe more than their home is worth on the market, and their demand for goods is restrained by the need to pay down debt. This is the essence of a balance-sheet recession, and is what underlies the so-called Keynesian liquidity trap. ...
There are three routes to restoring equilibrium:
• Inflate the prices of all other goods, including labor, while housing demand remains stuck in its negative equity loop. Fed policy has been consistent with this objective since 2008 with no evidence of success, as is typical in severe balance-sheet recessions.
• Allow the household deleveraging process to grind through an extended period of low GDP growth and high unemployment until we gradually recover. This option will surely succeed in due course, but not without high annual opportunity cost in terms of lost wealth creation. This was the path followed in the Depression.
• Do for households what the Fed sought for the banks: the Treasury (facilitated by Fed monetary ease and bank capital requirements) finances the banks to restate the principal on current negative-equity mortgage loans, restoring them to new mark-to-market zero-equity baselines.
The last option, in principle, seeks to reboot homeowners' damaged balance sheets in an effort to arrest a prolonged deleveraging process and more quickly restore household demand to levels no longer dominated by negative home equity. It is analogous to a mortgage "margin call" with public funding of the restored household balance sheets.
I regard the third option as far better than the stimulus, while recognizing that forgiving debt—whether bank or household debt—is never good policy. But please keep in mind that we have had no good options. (Since total negative equity is now about $700 billion, it is cheaper than was the stimulus.) ...
Where we differ is that I would do this in addition to fiscal policy, rather than dropping fiscal stimulus and doing this instead. That is, I see this as a complement rather than a substitute for other policies.
One more note. I have made similar arguments, but I've come to believe that household relief must be broad based in order to receive the public support it needs (the proposal above addresses all households that are in a negative equity position, not just those near or at default, so it is broader based than many competing proposals along these lines). If we only bail out the households who made the worst choices and are in danger of default, and do nothing for the households who have taken large losses through no fault of their own, but are still surviving and making payments, the public resentment will undermine the policy.
Posted: 30 Jan 2011 09:45 AM PST
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