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June 23, 2014

Latest Posts from Economist's View

Latest Posts from Economist's View

Paul Krugman: The Big Green Test

Posted: 23 Jun 2014 12:33 AM PDT

Are Republicans willing to settle for second best solutions to climate change?:

The Big Green Test, by Paul Krugman, Commentary, NY Times: On Sunday Henry Paulson, the former Treasury secretary and a lifelong Republican, had an Op-Ed article about climate policy... In the article, he declared that man-made climate change is "the challenge of our time," and called for a national tax on carbon emissions... Considering the prevalence of climate denial within today's G.O.P., and the absolute opposition to any kind of tax increase, this was a brave stand to take.
But not nearly brave enough. Emissions taxes are the Economics 101 solution to pollution problems... But that isn't going to happen in the foreseeable future. ... Yet there are a number of second-best things ... that we're either doing already or might do soon. ... Let me give some examples of what I'm talking about.
First, consider rules like fuel efficiency standards, or "net metering" mandates requiring that utilities buy back the electricity generated by homeowners' solar panels. Any economics student can tell you that such rules are inefficient compared with the clean incentives provided by an emissions tax. But we don't have an emissions tax, and fuel efficiency rules and net metering reduce greenhouse gas emissions. So a question for conservative environmentalists: Do you support the continuation of such mandates, or are you with the business groups (spearheaded by the Koch brothers) campaigning to eliminate them and impose fees on home solar installations?
Second, consider government support for clean energy via subsidies and loan guarantees. ... Are you O.K. with things like loan guarantees for solar plants, even though we know that some loans will go bad, Solyndra-style?
Finally, what about the Environmental Protection Agency's proposal that it use its regulatory authority to impose large reductions in emissions from power plants? ... Are you willing to support this partial approach? ...
In policy terms, climate action — if it happens at all — will probably look like health reform. That is, it will be an awkward compromise dictated in part by the need to appease special interests... It will be the subject of intense partisanship, relying overwhelmingly on support from just one party, and will be the subject of constant, hysterical attacks. And it will, if we're lucky, nonetheless do the job.
Did I mention that health reform is clearly working, despite its flaws?
The question for Mr. Paulson and those of similar views is whether they're willing to go along with that kind of imperfection. If they are, welcome aboard.

Fed Watch: Inflation Hysteria

Posted: 23 Jun 2014 12:24 AM PDT

Tim Duy:

Inflation Hysteria, by Tim Duy: It appears that a case of inflation hysteria is gripping Wall Street. Joe Weisenthal at Business Insider sums up the current state of play:
Here's what's on Wall Street's mind right now: Inflation is finally happening, and the Fed will end up being behind the curve.
...there were two big moments this week.
1) There was the jump in Core CPI that was the biggest since 2009.
2) And then there was the Janet Yellen press conference, in which she said that the CPI jump could be just "noise" and that the recent drop in the unemployment rate was not actually reflective of the true state of the labor market (which she regards as considerably weaker due to measures of worker discouragement).
In other words, despite data showing that the Fed is getting close to hitting its economic goals, Yellen doesn't believe the numbers.
But Wall Street does believe the numbers. 
Hence the view that the Fed will be behind the curve.
Goodness, you would think it is 1975. It is probably instructive to stop and see what all the fuss is about:


Missed it?  Maybe we should zoom in:


Although core-CPI is about to brush up on 2%, core-PCE remains well below, and it is the latter that is most important to policy. You might note that the Fed was raising interest rates in the late 1990s despite sub-2% core PCE, apparently responding to high CPI inflation. But that episode needs to be considered in light of the job market at the time, which, if you recall, was clearly on fire. There was no concern that broader measures of unemployment were signalling excess slack:


The current situation is different - there is excess slack in the labor market, as revealed by restrained wage growth. This is important. Wall Street might believe the CPI numbers that Yellen dismissed, but that is jumping the gun in any event.  As Across the Curve explains succinctly:
The labor market remains less than robust and wage gains are stagnant. Until we see consistent wage gains which would foster spending which fosters revenue and net income and then the virtuous cycle fulfills itself via business investment it is hard to imagine that we get a sustained uptick in inflation.
Which is essentially what Federal Reserve Chair Janet Yellen explained in her press conference:
You know, I see compensation growth broadly speaking as having been very well contained. By most measures, compensation growth is running around 2 percent. So that's real wage growth or real compensation growth that's essentially flat rather than rising, and real wage growth really has not been rising in line with productivity. My own expectation is that as the labor market begins to tighten, we will see wage growth pick up some to the point where real wage growth, where compensation or nominal wages are rising more rapidly than inflation, so households are getting a real increase in their take home pay. And within limits--well, that might be signs of a tighter labor market. Within limits, it's not a threat to inflation because consistent with the level of inflation we have for our 2 percent inflation objective, we could see wages growing at a more rapid rate and a somewhat more rapid rate. And indeed, that would be part of my forecast of what we would see as the labor market picks up. If we were to fail to see that, frankly I would worry about downside risk to consumer spending. So I think part of my confidence and the fact we'll see a pickup in growth relates to the fact that I think consumer spending will continue to grow at a healthy rate. And in part, that's premised on some pickup in the rate of wage growth so that it's rising greater more than inflation.
So what is going on here?  Inflation is not a sustained phenomenon in the absence of participation from wage dynamics.  If inflation accelerates while wage growth remains stagnant, demand will soften and so too will any incipient price pressures. Hence why Yellen sees the potential for downside risk for consumer spending in the absence of stronger wage growth.  Moreover, as she notes, wage growth itself is not inflationary. We would expect wage growth should exceed inflation such that real wages grow to account for rising productivity. We might then expect inflation to be correlated with unit labor costs, and it is:


If you expect to see sustained higher inflation, you need to see sustained higher unit labor cost growth.  No way around it. And even then you need to assume that firms respond by raising prices, rather than seeing profit erode.  Note in particular sustained high unit labor cost growth in the late 1990s. 
In short, you shouldn't be looking at the inflation numbers without understanding the underlying wage dynamic. It isn't until wages start to push higher that inflation becomes a more interesting issue.  
So how should we be thinking about this? The Fed recognizes that they are coming closer to meeting their goals based on their traditional unemployment metrics. They are discounting those metrics for the moment, and with good reason. In the absence of accelerated wage growth, pops of inflation are just noise. They anticipate that wage growth will not emerge more forcefully until after underemployment measures fall to more normal levels. Hence as the measures approach normal levels - sometime next year - they will begin raising interest rates. I suspect this will be prior to a substantial acceleration in wage growth, on the assumption that they will feel a need to be somewhat ahead of the curve.  
What would accelerate this process? First, a more rapid improvement in underemployment. Second, sufficient wage acceleration such that they are confident labor market slack has been eliminated prior to normalization of unemployment measures (in essence, the acceptance of permanent damage from the recession). If conditions one and two hold, but core-PCE measures hold below 2.25%, they will likely raise rates gradually. If core-PCE accelerates beyond 2.25%, the pace of rate increases will accelerate. 
Finally, the Fed will likely be watching 5-year, 5-year forward inflation expectations as a gauge of how far they are falling behind the curve. I can't imagine they are worried yet:


Bottom Line:  Tighter policy is coming. If you are worried the Fed will accelerate the timing and pace of tightening (and I do believe the risk is weighted in this direction), your focus should be on the labor market and wage growth dynamic. Note too that if Wall Street believes the Fed will need to tighten more aggressively than currently planned on the basis of recent inflation readings, market participants must clearly expect that Yellen and Co. take the 2% inflation target more than seriously.  

Links for 6-23-14

Posted: 23 Jun 2014 12:06 AM PDT

Is Monetary policy Keeping Real Wages and Productivity Low?

Posted: 22 Jun 2014 10:24 AM PDT

Simon Wren-Lewis:

...suppose that at the moment real wages or inflation begin to rise, the central bank tightens monetary policy. This would raise the cost of capital, and could be interpreted as an attempt to prevent real wages rising. ... Monetary policy, which in theory is just keeping inflation under control, is in fact keeping real wages and productivity low.
Monetary policy makers would describe this as unfair and even outlandish. A gradual rise in interest rates, begun before inflation exceeds its target, is designed to maintain a stable environment. ...  
I also have another concern about a monetary policy which tightens as soon as real wages start increasing. What little I know about economic history suggests an additional dynamic. As long as the firm is employing labour rather than buying a machine, there is no incentive for anyone to improve the productivity of machines. The economy where real wages and labour productivity stay low may also be an economy where innovation slows down. The low productivity economy becomes the low productivity growth economy.

[The extract does not fully reflect the argument in the post -- see here for more.]

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