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July 31, 2014

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Posted: 31 Jul 2014 12:06 AM PDT

Fed Watch: FOMC Statement

Posted: 30 Jul 2014 01:19 PM PDT

Tim Duy:

FOMC Statement, by Tim Duy: At the conclusion of this week's FOMC meeting, policymakers released yet another statement that only a FedWatcher could love. It is definitely an exercise in reading between the lines. The Fed cut another $10 billion from the asset purchase program, as expected. The statement acknowledged that unemployment is no longer elevated and inflation has stabilized. But it is hard to see this as anything more that describing an evolution of activity that is fundamentally consistent with their existing outlook. Continue to expect the first rate hike around the middle of next year; my expectation leans toward the second quarter over the third.
The Fed began by acknowledging the second quarter GDP numbers:
Information received since the Federal Open Market Committee met in June indicates that growth in economic activity rebounded in the second quarter.
With the new data, the Fed's (downwardly revised) growth expectations for this year remain attainable, but still requires an acceleration of activity that has so far been unattainable:

FOMCa073014

Despite all the quarterly twists and turns, underlying growth is simply nothing to write home about:

FOMCb073014

That slow yet steady growth, however, has been sufficient to support gradual improvement in labor markets, prompting the Fed to drop this line from the June statement:
The unemployment rate, though lower, remains elevated.
and replace it with:
Labor market conditions improved, with the unemployment rate declining further. However, a range of labor market indicators suggests that there remains significant underutilization of labor resources.
While the unemployment rate is no longer elevated, this is a fairly strong confirmation that Federal Reserve Chair Janet Yellen has the support of the FOMC. As a group, they continue to discount the improvement in the unemployment rate. And as long as wage growth remains tepid, this group will continue to have the upper hand.
The inflation story also reflects recent data. This from June:
Inflation has been running below the Committee's longer-run objective, but longer-term inflation expectations have remained stable...The Committee sees the risks to the outlook for the economy and the labor market as nearly balanced. The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term.
became this:
Inflation has moved somewhat closer to the Committee's longer-run objective. Longer-term inflation expectations have remained stable...The Committee sees the risks to the outlook for economic activity and the labor market as nearly balanced and judges that the likelihood of inflation running persistently below 2 percent has diminished somewhat.
Rather than something to worry over, I sense that the majority of the FOMC is feeling relief over the recent inflation data. It is often forgotten that the Fed WANTS inflation to move closer to 2%. The reality is finally starting to look like their forecast, which clears the way to begin normalizing policy next year. Given the current outlook, expect only gradual normalization.
Finally, we had a dissent:
Voting against was Charles I. Plosser who objected to the guidance indicating that it likely will be appropriate to maintain the current target range for the federal funds rate for "a considerable time after the asset purchase program ends," because such language is time dependent and does not reflect the considerable economic progress that has been made toward the Committee's goals.
We probably should have seen this coming; Philadelphia Fed President Charles Plosser raised this issue weeks ago. Clearly he is not getting much traction yet among his colleagues. I doubt they want to change the language before they have settled on a general exit strategy (which was probably the main topic of this meeting and will be the next). Somewhat surprising is that Dallas Federal Reserve President Richard Fisher did not join Plosser given Fisher's sharp critique of monetary policy in Monday's Wall Street Journal. Note to Fisher: Put up or shut up.
Bottom Line: Remember that we should see the statement shift in response to the data relative to the outlook. In short, the statement needs to remain consistent with the reaction function. The changes in the July statement reflect that consistency. The data continues to evolve in such a way that the Fed can remain patient in regards to policy normalization. We will see if that changes with the upcoming employment report; focus on the underlying numbers, as the Fed continues to discount the headline numbers.

'Unemployment and the 'Skills Mismatch' Story: Overblown and Unpersuasive'

Posted: 30 Jul 2014 08:01 AM PDT

Gary Burtless:

Unemployment and the "Skills Mismatch" Story: Overblown and Unpersuasive, by Gary Burtless, Brookings: The jobless rate has dipped to 6.1 percent, and businesses are already complaining about a skills shortage. ... To an economist, the most accessible and persuasive evidence demonstrating a skills shortage should be found in wage data. ...
Where is the evidence of soaring pay for workers whose skills are in short supply? We frequently read anecdotal reports informing us some employers find it tough to fill job openings. What is harder to find is support for the skills mismatch hypothesis in the wage data..., there is little evidence wages or compensation are increasing much faster than 2% a year [i.e. outpacing inflation]. Even though unemployment has declined, there are still 2.5 times as many active job seekers as there are job vacancies. At the same time, there are between 3 and 3½ million potential workers outside the labor force who would become job seekers if they believed it were easier to find a job. The excess of job seekers over job openings continues to limit wage gains, notwithstanding the complaints of businesses that cannot fill vacancies. ...
It is cheap for employers to claim qualified workers are in short supply. It is a bit more expensive for them to do something to boost supply. Unless managers have forgotten everything they learned in Econ 101, they should recognize that one way to fill a vacancy is to offer qualified job seekers a compelling reason to take the job. Higher pay, better benefits, and more accommodating work hours are usually good reasons for job applicants to prefer one employment offer over another. When employers are unwilling to offer better compensation to fill their skill needs, it is reasonable to ask how urgently those skills are really needed. ...

'Real GDP increased at 4.0% Annualized Rate in Q2'

Posted: 30 Jul 2014 07:44 AM PDT

Bill McBride at Calculated Risk:

BEA: Real GDP increased at 4.0% Annualized Rate in Q2, by Bill McBride: From the BEA: Gross Domestic Product: Second Quarter 2014 (Advance Estimate) Annual Revision: 1999 through First Quarter 2014

Real gross domestic product ... increased at an annual rate of 4.0 percent in the second quarter of 2014... In the first quarter, real GDP decreased 2.1 percent (revised).
...
The increase in real GDP in the second quarter primarily reflected positive contributions from personal consumption expenditures (PCE), private inventory investment, exports, nonresidential fixed investment, state and local government spending, and residential fixed investment. Imports, which are a subtraction in the calculation of GDP, increased.

The advance Q2 GDP report, with 4.0% annualized growth, was above expectations of a 2.9% increase. Also Q1 was revised up.

Personal consumption expenditures (PCE) increased at a 2.5% annualized rate - a decent pace. Private investment rebounded with residential investment up 7.5% annualized, and equipment up 5.3%. Change in private inventories added 1.66 percentage points to growth after subtracting 1.16 in Q1.

Overall this was a solid report. I'll have more later on the report and revisions.

Update: Dean Baker:

Economy Rebounds in Second Quarter Based on Inventories and Cars: GDP grew at a 4.0 percent annual rate in the second quarter after shrinking at a 2.1 percent rate in the first quarter. Much of the shift was due to a considerably more rapid pace of inventory accumulation. Inventory changes which had subtracted 1.16 percentage points from first quarter growth added 1.66 percentage points to growth in the second quarter. New car sales added another 0.42 percentage points to growth, after adding just 0.13 percentage points in the first quarter. Equipment investment, which grew at a 7.0 percent rate, added another 0.4 percentage points to growth for the quarter.
Another positive item in this report was continued slow growth in health care costs. After a reported drop in the first quarter, health care costs grew at a 2.6 percent annual rate. They stand just 3.0 percent above their year-ago level.
On the negative side, the trade deficit expanded again last quarter rising to an annual rate of $564.0 billion. It subtracted 0.61 percentage points from growth in the quarter.
While the 4.0 percent growth is a sharp turnaround, it was very much in line with expectations. It means that for the first half of the year, the economy the economy grew at less than a 1.0 percent annual rate. The economy will have to sustain a growth rate of more than 3.0 percent over the second half of the year just to reach 2.0 percent growth for the year as a whole. This means 2014 will likely be another disappointing year for growth.

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