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August 9, 2012

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Posted: 08 Aug 2012 12:33 AM PDT
Tim Duy:
US Baseline, by Tim Duy: Every couple of months I revisit my set of baseline expectations for the US economy. This helps me gauge the importance of incoming data and events. This is the bones of the framework I have in mind:
1.) Overly pessimistic or optimistic forecasts continue to fair poorly. To be sure, this depends on your definitions of optimistic and pessimistic, but I continue to think the path of GDP growth is notable for its relative stability over recent quarters:
Gdp2
If you avoid getting lost in the twists and turns of the data, you see that growth is hovering around 2% year over year.
2.) The same story holds for the labor market. Interestingly, the six and twelve mont month averages for nonfarm payroll gains roughly converged with last months 163k gain:
Base1
With the economy growing at around 2%, payrolls increase around 150k per month. Not great, by some measures not a disaster.
3.) I don't expect significant deviations from points one and two in the near-term. I tend to see the recent spate of weaker data that the Federal Reserve concluded meant:
Information received since the Federal Open Market Committee met in June suggests that economic activity decelerated somewhat over the first half of this year.
as further evidence that the Fed's much-anticipated acceleration is simply not in the cards. Indeed, the Federal Reserve's June forecasts for GDP growth stood in the 1.9-2.4% and 2.2-2.8% ranges (central tendency) for 2012 and 2013. I anticipate these will come down a notch in the next forecast. In other words, the Fed's forecast will be about or slightly above 2% for the next two years. That acceleration just keeps getting pushed further into the future.
4.) I see multiple reasons to expect soft growth figures. Government spending is a clear drag:
Base2
Some of the pent up demand in capital goods and auto spending has been satisfied:
Base3
Base4
Deleveraging appears to be continuing in the US:
Base5
Consumer spending has slowed:
Base6
In addition, overseas economies, notably Europe and China, are struggling, which is showing up in manufacturing:
Ism4
I am sure the collected wisdom of the blogosphere can come up with other drags.
5.) From my perspective, housing looks set to support growth. Low inventories will support higher prices and, eventually, construction. To be sure, I would be hesitant to get carried away on this point. Pleny of negatives exist - tighter underwriting standards, shadow inventory, and sustained lower home ownership rates. And I don't expect the same wealth effect we saw at the height of the housing bubble. But the momentum appears to be moving in the right direction, which should mean that housing, on average, continues to support growth.
6.) I remain concerned that even with housing improving, the stage is set for continued tepid growth, which means a persistent output gap:
Base11
And poor labor market outcomes, such as a slow decline in the unemployment rate:
Base7
high long-term unemployment:
Base8
and low wage growth:
Base9
On the upside, temporary hiring continues to grow, which is typically a positive signal:
Base10
7.) Try as I might, I can't get excited about inflation. Inflation will continue to drift at or below 2%:
Base12
I don't see sustaining high inflation in the absence of much higher wage growth. And the economy just will not support such wage growth. And wage growth itself does not necessarily translate into higher prices. It could come at the expense of lower profit margins.
8.) It seems like the risks are generally weighted to the downside. While Europe may avoid financial collapse, I don't think the economy on the other side of the Atlantic will come surging back anytime soon. That seems guaranteed by the ongoing efforts to form an "austerity union" in the Eurozone. Moreover, we seem to face ongoing uncertainty about the path of fiscal policy next year; I believe that a premature tightening of fiscal policy would be ill-advised. On the upside, the housing market may provide more of a broad-based improvement than my baseline expectations.
9.) The combination of points 1-8 should lead to more aggressive monetary easing. The economy continues to settle into a path that is not consistent with either part of the Fed's dual mandate. Moreover, there are very real downside risks to even a tepid outlook.
10.) Point 9 has been true for months, and at least three FOMC meetings. This is frustrating. What in the world is the point of making a big claim to affirm the nature of the dual mandate and then subsequently ignore any forecasts that indicate you have no faith the elements of the dual mandate will be met anytime soon?
11.) There is clear support within the FOMC for additional easing, including open-ended quantitative easing. This is a postive development. Some FOMC members would even support a nominal GDP target and/or inflation greater than 2%. That said, I don't think the center (and certainly the hawks) would support higher inflation targets. Moreover, I am not yet sure that Federal Reserve Chairman Ben Bernanke is ready to pull the middle to the doves; he seems content to pull the middle to the hawks. Primarily, this reflects uncertainty about the effectiveness of additional quantitative easing. There appears to be a push to look for alternatives, perhaps to tools to more directly channel funds to borrowers. Until Bernanke is willing to accept the need for additional policy, the Fed will remain on hold. There may or may not be a political element to Bernanke's resistance, despite claims to the contrary.
12.) Bernanke could switch gears by the next meeting, or not until next year, or never, if the data shifts back toward optimistic. I would like to believe that the doves are sending us a signal that easing is coming soon, but that signal has not been very accurate for the last three meetings. The key is Bernanke, and he seems resistant to additional action until the data turn more decisively downward. I am not sure that will happen by the September meeting.
This isn't meant to be a complete analysis. To be sure, plenty of details are left out (the numbers are rough estimates), with missing pieces on both sides of the outlook. Instead, just a skeleton I can put more meat on later. And something by which to judge incoming data or policy shifts, such as a more aggressive monetary policy. And something to poke holes in as time goes on. I can convince myself of more positive and negative outcomes, but still keep coming back to the middle ground.
Posted: 08 Aug 2012 12:06 AM PDT
Posted: 07 Aug 2012 05:04 PM PDT
Tim Duy:
Tim Duy Smackdown Watch, by Tim Duy: Peter Coy at Bloomberg notes that I misinterpreted Rosengren on the first point of my last post:
Rosengren did not go quite as far as the Boston Globestory implied—that is, he did not specifically mention election-year pressures. The Globe writers, Steven Syre and Andrew Caffrey, paraphrased Rosengren as saying that the Fed should not worry if further easing is seen as influencing the presidential election. I wrote to them for clarification and Syre responded that "Rosengren's quote was his response to a question about any potential political controversy around a fed stimulus vote two months before an election." So it was the reporters who brought up politics, not Rosengren himself. That might seem like a small point, but in the arcane world of Fed politics, it matters. Tim Duy, a University of Oregon economist who blogs on Fed policy, told the Globe, "to pull back the curtain and say, 'They're doing this for the election,' I think is a shift and reflects his level of frustration." That's an overstatement of what Rosengren said.
Small, but very important, point to be sure. Coy could have added "Tim Duy needs to ask better questions."
I likely jumped at the idea as it is one explanation for Fed inaction given the clear statements by doves calling for more policy in the context of the failure of the Fed to meet its dual mandate. But while there may be some lingering concerns at the FOMC of the political appearance, the central reason for inaction is likely Federal Reserve Chairman Ben Bernanke's uncertainty of the cost-benefit analysis. If he thought the benefits outweighed the cost, he could have pulled the FOMC in that direction. But he hasn't, indicating that he see the costs outweighing the benefits.
Bernanke's cost-benefit analysis is clearly become frustrating to those policymakers who see the issue as more clear cut, like apparently Rosengren. He now joins San Francisco Federal Reserve President John Williams and Chicago Federal Reserve President Charles Evans in calling for more aggressive policy, including open-ended quantitative easing. How big that coalition grows between now and September remains to be seen, but the pressure on Bernanke to change course is clearly intensifying.
Posted: 07 Aug 2012 01:21 PM PDT
Via Menzie Chinn at Econbrowser, Paul Wachtel and Moritz Schularick look at the evidence for Bernanke's savings glut hypothesis, and find that "the American credit boom of the 2000s had few direct links to reserve accumulation in emerging markets. The mortgage boom was financed by the US financial sector which intermediated foreign funds from private sources." Thus, if there is blame here, it should be assigned to private markets -- they are not as infallible as some woud like you to believe -- rather than government behavior:
Guest Contribution: The Making of America's Imbalances, by Paul Wachtel and Moritz Schularick: Many observers in the West have embraced a reading of the financial crisis in which global imbalances and the surge in uphill net capital flows from poor to rich countries play a dominant role. ... Such explanations conveniently blame events that took place outside of the advanced economies for at least providing the initial impetus for the economic and financial mess Ben Bernanke's savings glut hypothesis (Bernanke 2005) skillfully argues that a large and sudden rise of desired savings from developing countries – a savings glut – flooded the US economy. The implication is that low American interest rates and, ultimately, the financial crisis were due to the unusual saving behavior elsewhere.
Others disagree with such an imbalance-centered view of the crisis. ... This debate suggests that a closer look at the composition and role of imbalances in the run up to the crisis is warranted. ...
In our new paper -- "The Making of America's Imbalances" -- we examine the evolution of sectoral financial balances in the US economy in the past 50 years using the Flow of Funds accounts. ... What do we find? ... Who financed the household borrowing binge of the 2000s? China and other emerging markets played virtually no direct role in the financing flows behind the American credit bubble. In brief, the U.S. financial sector provided the financing for mortgage-hungry America (until it collapsed with the crisis). But where did Wall Street find the savings to fuel to fire?
In the 2000s, the American financial system fed the credit hunger of the American economy mainly by issuing debt liabilities in international financial markets; but it was the foreign private sector, not foreign governments, that provided most of the fuel for the fire. Foreign official inflows went almost exclusively into Treasury securities while private investors bought bonds and other instruments issued by U.S. financial. In other words, those who are looking for international drivers of the American credit bubble, should not look to Beijing and Riyadh, but to international private capital markets. The capital inflow bonanza of the 2000s that enabled the American credit bubble (Chinn and Frieden 2011) was primarily a private sector inflow... Beijing may have financed the war in Iraq at low cost while Wall Street, foreign banks and private investors fueled the housing bubble. ...
As they emphasize in the paper, "the flows that fed the bubble were private, not official. ... Our results ... stand in clear opposition to arguments that link the bubble in US housing markets in the 2000s with the global glut of savings (Bernanke 2005). The increase in leverage in the US plays as important a role as the capital inflows from the rest of the world."
Posted: 07 Aug 2012 11:41 AM PDT
Why would someone undermine their professional reputation defending Romney's indefensible economic policies? What's the expected payoff?
Posted: 07 Aug 2012 10:59 AM PDT
Ken Rogoff:
...many (if not necessarily all) central banks will eventually figure out how to generate higher inflation expectations. They will be driven to tolerate higher inflation as a means of forcing investors into real assets, to accelerate deleveraging, and as a mechanism for facilitating downward adjustment in real wages and home prices.
It is nonsense to argue that central banks are impotent and completely unable to raise inflation expectations, no matter how hard they try. In the extreme, governments can appoint central bank leaders who have a long-standing record of stating a tolerance for moderate inflation – an exact parallel to the idea of appointing "conservative" central bankers as a means of combating high inflation.
But Bernanke did have this reputation, at least among some on the right, e.g. John Tamney in the NRO when Bernanke's name came up as a possible successor to Greenspan:
a June New York Times article noted Bernanke's belief that the gold standard made the Great Depression worse. Plus, in a 2002 speech, he lauded the ability of the government to use the printing press to "generate higher spending and hence positive inflation." If his adherence to a Phillips Curve orthodoxy made his belief in a price-rule already seem shaky, his direct comments about money should remove all doubt. ... For his views on money, Bernanke has the potential to be very dangerous.
Despite his reputation among the Tamney types, I think Bernanke favors more aggressive policy, but he hasn't been unable to sway others on the committee that further easing is needed. But maybe that gives him too much credit, or credit for a view he doesn't really hold. If Bernanke does believe the Fed should do more, he's kept it pretty well hidden lately and it would be nice to see more leadership from the Fed Chair.
As for Rogoff's claim that "central banks will eventually ... be driven to tolerate higher inflation," I am not as convinced of this as he is where the Fed is concerened. The argument for tolerating higher inflation is strong already, yet the Fed hasn't acted yet, and it appears to be looking for excuses not to act in the future (and some members of the Fed want to raise interest rates now to head off the possibility of future inflation). It's easy to imagine the Fed fighting inflation no matter what, or at least having policy gridlocked by the inflation hawks, and arguing that in doing so it is helping rather than hurting the recovery.

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