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December 13, 2014

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Posted: 13 Dec 2014 12:06 AM PST

Fed Watch: Data Supportive of Fed Plans

Posted: 12 Dec 2014 11:24 AM PST

Tim Duy:

Data Supportive of Fed Plans, by Tim Duy: Incoming data in the second half of this week continues to support the Federal Reserve's plans to begin normalizing policy in the middle of next year, with the removal of "considerable time" language next week a likely first step.
Retail sales for November were unquestionably strong and reveal an acceleration in the pace of core sales:

CORERETAIL121214

You were right if you dismissed the early earnings on the holiday shopping season as useless noise. Similarly, consumer confidence is pushing to pre-recession levels:

MICHSENT121214

And note this from Reuters:
"Expected wage gains rose to their highest level since 2008, and consumers voiced the most favorable buying attitudes in several decades," survey director Richard Curtin said in a statement.
As I have said before, nothing interesting happens until we get unemployment below 6%. Be prepared for a better equilibrium.
Even as the economic data improve, however, Wall Street remains on edge. Lower oil prices and the resulting impact on high yield bonds are resonating throughout credits markets while equity prices struggle. Despite warnings from Fed officials about the likely path of policy, long-dated US Treasury yields continue to remain under pressure. It is difficult to assess the impact on policy-making at this point. Fed officials will be torn between the market turmoil and expectations that lower energy prices will boost an already accelerating economy. And note that New York Federal Reserve President William Dudley was very dismissive of the idea that the Fed would respond to every financial market disruption as policy moved toward normalization:
Because financial market conditions affect economic activity only slowly over time, this suggests that we should look through short-term volatility and movements in financial markets. We should not respond until we become convinced that the movements will likely, without action on our part, prove sufficiently persistent to conflict with achievement of our objectives. Often, financial markets can be quite volatile and move a lot without disturbing underlying economic performance.
Similarly, he has been dismissive of market-based measures of inflation expectations.
In assessing inflation expectations, I currently put more weight on survey-based measures of inflation expectations as opposed to market-based measures. Survey-based measures have been generally stable, consistent with inflation expectations remaining well-anchored. However, market-based measures, such as those based on breakeven inflation derived from the difference between yields on nominal versus Treasury Inflation-Protected Securities (TIPS), have registered declines over the past few months, even on a 5-years forward basis. Research done by my staff suggests that much of this decline in market-based measures of inflation compensation reflects a fall in the inflation risk premium—that is, what investors are willing to pay to protect themselves against inflation risk. Adjusting for the fall in the inflation risk premium, inflation expectations appear to have declined much less than implied by TIPS inflation breakeven measures.
Market participants believe the Fed leans heavily on the 5-year, 5-year forward inflation metric. That measure is heading toward lows last seen on the eve of operation twist:

5Y5Y121214

The Fed dares not defy this chart. Or do they? Jim O'Sullivan at HFE accurately notes that the 5-year, 5-year forward breakeven has been inordinately driven by oil prices:
Why Fed prefers "survey based:" 5y5yf TIPS swing with oil even tho current infl irrelevant for pic.twitter.com/StxfsvubNh
— Jim O'Sullivan (@osullivanEcon) December 12, 2014
The Fed may be losing faith in these measures. As Dudley suggests, they may feel that such metrics are too simplistic, and find themselves favoring metrics like that offered by the Cleveland Fed that shows a firming of inflation expectations in recent months:

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Note also that the resilience of survey-based metrics of inflation expectations. Back to Reuters and the confidence report:
The survey's one-year inflation expectation rose to 2.9 percent from 2.8 percent, while its five-year inflation outlook also rose to 2.9 percent from 2.6 percent last month.
And that leads me to my bottom line - another question for Federal Reserve Chair Janet Yellen at next week's post-FOMC press conference.
Bottom Line: I would like a journalist to press Yellen on her interpretation of the 5-year, 5-year forward breakeven measure of inflation expectations. Does she see this measure as important or too noisy to be used as a policy metric? What is her preferred metric?

'Symmetric Application of Dynamic Scoring'

Posted: 12 Dec 2014 11:09 AM PST

Menzie Chinn:

Symmetric Application of Dynamic Scoring: Republicans are keen to sacrifice CBO's role as impartial arbiter of fiscal measures on the altar of "dynamic scoring" of tax measures.[0] But there is no economic reason for restricting this approach to only tax measures.
First, on tax measures,... there is a tremendous amount of uncertainty — model and parameter — associated with the intertemporal models necessarily used dynamic scoring of tax policies. See also this discussion of the Bush Administration's foray, in this post. (Of course, I am skipping nonsensical analyses such as the Heritage Foundation's Center for Data Analysis of, for instance, the Ryan plan [1] [2] [3]).
Second, as pointed out by Alan Auerbach, there is no reason to only analyze tax policies. For instance, spending on Head Start which might enhance labor productivity should in principle be scored dynamically. And, so too should infrastructure. Consider this assessment from the IMF's Research Department, regarding public investment. ...
Notice that debt declines 4 percentage points of GDP in response to an exogenous 1 percentage point of GDP increase in public investment. In addition output increases 1.5 percentage points relative to baseline. Now, one could argue — particularly with respect to debt-to-GDP — the response is only statistically significantly different from zero in the short term. However, one has even less empirical evidence regarding statistical significance for tax revenue responses to tax rate changes in many instances.
So, let's think twice about dynamic scoring…

'Why America’s Middle Class is Lost'

Posted: 12 Dec 2014 10:14 AM PST

Part 1 of Tankersley's series on the problems facing the middle class ("Liftoff & Letdown: The American middle class is floundering, and it has been for decades. The Post examines the mystery of what's gone wrong, and shows what the country must focus on to get the economy working for everyone again. Monday: The devalued American worker."):

Why America's middle class is lost, by Jim Tankersley, Washington Post: ... Yes, the stock market is soaring, the unemployment rate is finally retreating after the Great Recession and the economy added 321,000 jobs last month. But all that growth has done nothing to boost pay for the typical American worker. Average wages haven't risen over the last year, after adjusting for inflation. Real household median income is still lower than it was when the recession ended.
Make no mistake: The American middle class is in trouble.
That trouble started decades ago, well before the 2008 financial crisis, and it is rooted in shifts far more complicated than the simple tax-and-spend debates that dominate economic policymaking in Washington. ...
In this new reality, a smaller share of Americans enjoy the fruits of an expanding economy. This isn't a fluke of the past few years — it's woven into the very structure of the economy. And even though Republicans and Democrats keep promising to help the middle class reclaim the prosperity it grew accustomed to after World War II, their prescriptions aren't working. ...
The great mystery is: What happened? Why did the economy stop boosting ordinary Americans in the way it once did?
The answer is complicated, and it's the reason why tax cuts, stimulus spending and rock-bottom interest rates haven't jolted the middle class back to its postwar prosperity. ...

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