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October 30, 2014

Latest Posts from Economist's View

Latest Posts from Economist's View


Fed Watch: FOMC Recap

Posted: 30 Oct 2014 12:24 AM PDT

Tim Duy:

FOMC Recap, by Tim Duy: In broad terms, the FOMC meeting concluded as I had expected. To the extent there were any surprises, they were on the hawkish side. Or, I would say, hawkish mostly if you believed the events of the last few weeks justified a radical revision of the Fed's anticipated policy path. I didn't, but was too busy those same past few weeks to scream into the wind.

As I anticipated, the Fed dismissed the decline in market-based inflation expectations. They clearly believe financial markets over-reacted to the decline in oil prices, and that that decline would ultimately prove to be a one-time price shock rather than the beginning of a sustained disinflationary process.

This is why we watch core-inflation.

And note that the Fed sent a pretty big signal along the way. In contrast to conventional wisdom, they do not hold market-based measures of inflation expectations as the Holy Grail. Especially with unemployment below 6%, pay more attention to survey-based measures. And recognize they will discount even those if they feel they are unduly affected by energy prices in either direction.

Somewhat more hawkish than I anticipated, they did not explicitly hold out the hope of future asset purchases. The statement shifts directly to the issue of rate hikes. On that point, they did as I had expected, emphasize the data-dependent nature of future policy:

However, if incoming information indicates faster progress toward the Committee's employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated. Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated.

In my opinion, this suggests that they want to retain the baseline expectation of a mid-2014 rate hike with the option for an earlier hike. I don't think they see recent data or market action as by itself justifying the shift to the latter part of 2015. If anything, remember that recent data is pointing to accelerating growth and a rapid decline in unemployment.

And that rapid decline in unemployment is important, as I have trouble imagining a scenario in which the Fed is content to watch unemployment fall below 5.5% without at least beginning the rate hike cycle. Remember that they think that even as they increase rates, they believe that policy will continue to be accommodative. In other words, they do not fear raising rates as necessarily a tightening of policy. They will view it as a necessary adjustment in financial accommodation in response to a decline in labor market slack. Hence the line:

The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.

I anticipated at least one dissent. In all honesty, this would have been a more impressive call if I had also indicated the direction of the dissent. I expected a hawk to reject the retention of the considerable time language. No such luck - quite the opposite, with noted-dove Minneapolis Federal Reserve President Narayana Kocherlakota protesting both the considerable time language (wanting a more firm commitment to ZIRP) and the decision to end QE. The hawks, in contrast, were generally comfortable with the direction of the discussion. Expect Dallas Federal Reserve President Richard Fisher to say as much soon.

The acceptance of the hawks with the general tone of the meeting is also important. Clearly hawkish in contrast with the shift in market expectations. Time will tell.

Bottom Line: Despite the market turbulence of recent weeks, the general outlook of monetary policymakers remain generally unchanged. In general, they continue to see the direction of activity pointing to a mid-year rate hike. The actual date is of course data dependent, but they have not seen sufficient data in either direction to change that baseline outlook.

Summers: Reflections on the new 'Secular Stagnation hypothesis'

Posted: 30 Oct 2014 12:15 AM PDT

In case you just can't get enough of Larry Summers talking about secular stagnation:

Reflections on the new 'Secular Stagnation hypothesis', by Larry Summers, Vox EU: The notion that Europe and other advanced economies are suffering secular stagnation is gaining traction. This column by Larry Summers – first published in the Vox eBook "Secular Stagnation: Facts, Causes and Cures" – explains the idea. It argues that a decline in the full-employment real interest rate coupled with low inflation could indefinitely prevent the attainment of full employment.

Summers_fig1a_0

Here's the end of a relatively long discussion:

3 Conclusions and Implications

 The case made here, if valid, is troubling. It suggests that monetary as currently structured and operated may have difficulty maintaining a posture of full employment and production at potential and that if these goals are attained there is likely to be price paid in terms of financial stability. A number of questions come to mind:

  • How great are the risks?

Alvin Hansen proclaimed the risk of secular stagnation at the end of the 1930s only to see the economy boom during the and after World War II. It is certainly possible that either some major exogenous event will occur that raises spending or lowers saving in a way that raises the FERIR in the industrial world and renders the concerns I have expressed irrelevant. Short of war, it is not obvious what such events might be. Moreover, most of the reasons adduced for falling FERIRs are likely to continue for at least the next decade. And there is no evidence that potential output forecasts are being increased even in countries like the US where there is some sign of growth acceleration.

  • What about Hysteresis?

On their own, secular stagnation ideas do not explain the decline in potential output that has been a major feature of the experience throughout the industrial world. The available evidence though is that potential output has declined almost everywhere and in near lockstep with declines in actual output; see Ball (2014) for a summary. This suggests a way in which economies may equilibrate in the face of real rates above the FERIR. As hysteresis theories which emphasize the adverse effects of recessions on subsequent output predict, supply potential may eventually decline to the level of demand when enough investment is discouraged in physical capital, work effort and new product innovation.

Perhaps Say's dubious law has a more legitimate corollary – "Lack of Demand creates Lack of Supply". In the long run, as the economy's supply potential declines, the FERIR rises restoring equilibrium, albeit not a very good one.

  • What about global aspects?

There is important work to be done elucidating the idea of secular stagnation in an open economy context. The best way to think about the analysis here is to treat it as referring the aggregate economy of the industrial world where – because of capital mobility – real interest rates tend to converge (though not immediately because of the possibility of expected movements in real exchange rates). If the FERIR for the industrialized economies were low enough one might expect capital outflows to emerging markets which would be associated with a declining real exchange rates for industrial countries, increased competitiveness and increased export demand. The difficulty is that this is something that emerging markets will accept only to a limited extent. Their response is likely to be either resistance to capital inflows or efforts to manage currency values to maintain competitiveness. In either case the result will be further downward pressure on interest rates in industrial countries.

4.What is to be done?

Broadly to the extent that secular stagnation is a problem, there are two possible strategies for addressing its pernicious impacts.

  • The first is to find ways to further reduce real interest rates.

These might include operating with a higher inflation rate target so that a zero nominal rate corresponds to a lower real rate. Or it might include finding ways such as quantitative easing that operate to reduce credit or term premiums. These strategies have the difficulty of course that even if they increase the level of output, they are also likely to increase financial stability risks, which in turn may have output consequences.

  • The alternative is to raise demand by increasing investment and reducing saving.

This operates to raise the FERIR and so to promote financial stability as well as increased output and employment. How can this be accomplished? Appropriate strategies will vary from country to country and situation to situation. But they should include increased public investment, reduction in structural barriers to private investment and measures to promote business confidence, a commitment to maintain basic social protections so as to maintain spending power and measures to reduce inequality and so redistribute income towards those with a higher propensity to spend.

Links for 10-30-14

Posted: 30 Oct 2014 12:06 AM PDT

The Economics of Inequality: Emmanuel Saez and Laura Tyson

Posted: 29 Oct 2014 10:56 AM PDT

"In a panel discussion moderated by Dean Rich Lyons, Laura Tyson, professor of business administration and economics at the Haas School of Business, and Emmanuel Saez, economics professor and head of the Center for Equitable Growth at UC Berkeley, focus on income inequality, drawing from ideas central to Thomas Piketty's bestselling book Capital in the Twenty-First Century."

[Note: The discussion is summarized here.]

'Riksbank and ECB: Reverse Asymmetry'

Posted: 29 Oct 2014 10:25 AM PDT

Antonio Fatás:

Riksbank and ECB: reverse asymmetry: The Swedish central bank just lowered interest rates to zero because of deflation risks. This action comes after ignoring repeated warnings from Lars Svensson who had joined the bank in 2007 and later resigned because of disagreements with monetary policy decisions. What it is interesting is the parallel between Riksbank decisions and ECB decisions. In both cases, these central banks went through a period of optimism that make them raise interest rates to deal with inflationary pressures. In the case of Sweden interest rates were raised from almost zero to 2% in 2012. In the case of the ECB interest rates were raised from 1% to 1.5% during 2011. Also, in both cases, after a significant expansion in their balance sheets following the 2008 crisis, there was a sharp reduction in the years that followed. ... Their policies stand in contrast with those of the US Federal Reserve and the Bank of England...
The consequences of the policies of the ECB and Riksbank are clear: a continuous fall in their inflation rates that has raised the risk of either a deflationary period or a period of too-low inflation. What is more surprising about their policy actions is their low speed of reaction as the data was clearly signaling that their monetary policy stance was too tight for months or years. ...
What we learned from these two examples is that central banks are much less accountable than what we thought about inflation targets. And they ... use ... a policy that is clearly asymmetric in nature. Taking some time to go from 0% inflation to 2% inflation is ok but if inflation was 4% I am sure that their actions will be much more desperate. In the case of the ECB their argument is that the inflation target is defined as an asymmetric target ("close to but below 2%"). But this asymmetry, which was never an issue before the current crisis, has very clear consequences on the ability of central banks to react to deep crisis with deflationary risks.
What we have learned during the current crisis is that an asymmetric 2% inflation target is too low. Raising the target might be the right thing to do but in the absence of a higher target, at a minimum we should reverse the asymmetry implied by the ECB mandate. Inflation should be close to but above 2% and this should lead to very strong reaction when inflation is persistently below the 2% target.

'Is (Teaching) Economics Doing More Harm Than Good?'

Posted: 29 Oct 2014 10:25 AM PDT

Brian Lucey:

Is (teaching) Economics doing more harm than good?: Every September thousands of students enter into universities and institutes of higher education. A large number of these take some economics courses. ... Economists also typically teach courses such as statistics, or introductory mathematics for social scientists. And yet, we have no idea whether or not this does any good. Much worse, we have no idea whether or not this does harm. Maybe we should find out? ...

He goes through a large body of evidence showing that "Economists are different," and how student attitudes may be changed by taking economics courses.

'Digital Divide Exacerbates US Inequality'

Posted: 29 Oct 2014 10:25 AM PDT

The digital divide:

Digital divide exacerbates US inequality, by David Crow, FT: The majority of families in some of the US's poorest cities do not have a broadband connection, according to a Financial Times analysis of official data that shows how the "digital divide" is exacerbating inequality in the world's biggest economy. ...
The OECD ranks the US 30th out of 33 countries for affordability...
There is a very strong correlation with race and income. Just 45 per cent of households with an income of less than $20,000 a year have broadband whereas the rate for those earning $75,000 or more is 91 per cent. About a third of African American and Hispanic households are unconnected compared to 20 per cent for white households and 10 per cent for Asian households.

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