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December 22, 2014

Latest Posts from Economist's View

Latest Posts from Economist's View


Paul Krugman: Conquest Is for Losers

Posted: 22 Dec 2014 03:05 AM PST

War. What is it good for?:

Conquest Is for Losers, by Paul Krugman, Commentary, NY Times: More than a century has passed since Norman Angell, a British journalist and politician, published "The Great Illusion," a treatise arguing that the age of conquest was or at least should be over. He didn't predict an end to warfare, but he did argue that aggressive wars no longer made sense — that modern warfare impoverishes the victors as well as the vanquished.
He was right, but ... Vladimir Putin never got the memo. And neither did our own neocons, whose acute case of Putin envy shows that they learned nothing from the Iraq debacle.
Angell's case was simple: Plunder isn't what it used to be. You can't treat a modern society the way ancient Rome treated a conquered province without destroying the very wealth you're trying to seize. And meanwhile, war or the threat of war, by disrupting trade and financial connections, inflicts large costs over and above the direct expense of maintaining and deploying armies. War makes you poorer and weaker, even if you win. ....
The point is that there is a still-powerful political faction in America committed to the view that conquest pays, and that in general the way to be strong is to act tough and make other people afraid. One suspects, by the way, that this false notion of power was why the architects of war made torture routine — it wasn't so much about results as about demonstrating a willingness to do whatever it takes.
Neocon dreams took a beating when the occupation of Iraq turned into a bloody fiasco, but they didn't learn from experience. (Who does, these days?) And so they viewed Russian adventurism with admiration and envy. ...
The truth, however, is that war really, really doesn't pay. The Iraq venture clearly ended up weakening the U.S. position in the world, while costing more than $800 billion in direct spending and much more in indirect ways. America is a true superpower, so we can handle such losses — although one shudders to think of what might have happened if the "real men" had been given a chance to move on to other targets. But a financially fragile petroeconomy like Russia doesn't have the same ability to roll with its mistakes.
I have no idea what will become of the Putin regime. But Mr. Putin has offered all of us a valuable lesson. Never mind shock and awe: In the modern world, conquest is for losers.

Fed Watch: Asked and Answered. Mostly.

Posted: 22 Dec 2014 12:15 AM PST

Tim Duy:

Asked and Answered. Mostly, by Tim Duy: Last week I had six questions for Federal Reserve Chair Janet Yellen. Here is my attempt to piece together the answers from her post-FOMC press conference:

Question 1: If you want to know what the Fed is thinking at this point, a journalist needs to push Yellen on the secular stagnation issue at next week's press conference. Does she or the committee agree with Fischer? And does she see any inconsistency with the SEP implied equilibrium Federal Funds rates and the current level of long bonds?

Yellen, in answer to Peter Coke of Bloomberg Television: "(The Committee) are optimistic that those conditions will lift. They see the longer-run normal level of interest rates as around 3-3/4 percent. So there's no view in the Committee that there is secular stagnation in the sense we won't eventually get back to pretty historically normal levels of interest rates."

Yellen, in answer to Robin Harding of the Financial Times: "There are a number of different factors that are bearing on the path of market interest rates. I think including global economic developments. It is often the case that when oil prices move down, and the dollar appreciates, that tends to put downward pressure on inflation compensation and on longer-term rates. We also have safe haven flows that may be affecting longer-term Treasury yields. So I can't tell you exactly what is driving market developments. But what I can say is that we are trying to communicate our thoughts as clearly as we can."

The Federal Reserve believes that the current level of long rates is an artifact of safe-haven flows, not an indication of secular stagnation. They must anticipate that the yield curve will not flatten further or invert when they begin raising rates.

Question 2: 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?

Yellen, in answer to Greg Ip of the Economist: "Oh, and longer-dated expectations. Well I would say we refer to this in the statement as inflation compensation, rather than inflation expectations. The gap between the nominal yields on 10-year Treasuries for example. And TIPS have declined -- that's inflation compensation, and five-year, five-year forwards, as you've said, have also declined. That could reflect a change in inflation expectations. But it could also reflect changes in assessment of inflation risks. The risk premium that's necessary to compensate for inflation. That might especially have fallen if the probabilities attached to very high inflation have come down. And it can also reflect liquidity effects in markets and for example, it's sometimes the case that -- when there is a flight to safety, that flight tends to be concentrated in nominal Treasuries, and can also serve to compress that spread. So I think the jury is out about exactly how to interpret that downward move in inflation compensation. And we indicated that we are monitoring inflation developments carefully."

The Federal Reserve does not believe market-based measures of inflation expectations as indicative of actual inflation expectations. Watch surveys, Cleveland Fed-type measures, and actual inflation instead.

Question 3: Considering that recent updates of your optimal control framework now suggest that the normalization process should already be underway, how useful do you believe such a framework is for the conduct of monetary policy? What specific framework are you now using to dismiss the results of your previously preferred framework?

Yellen, in answer to Greg Ip of the Economist: "So you -- your first question is why is it that the committee sees unemployment as declining slightly below its estimate of the longer-run, natural rate? And I think in part, the reason for that is that inflation is running below our objective, and the committee wants to see inflation move back toward our objective over time. And a short period of a very slight under shoot of unemployment below the natural rate will facilitate slightly faster return of inflation to our objective. It is, I should say, a very small undershoot in a situation where there is great uncertainty about exactly what constitutes maximum employment, or a longer-run, normal rate of unemployment."

This is the general story of optimal control - hold unemployment below the natural rate to accelerate return to target inflation. Ignore any overshooting of inflation in such an analysis; Yellen was never really serious about that. Only thing preventing Fed from raising rates now is tweeking the optimal control results to account for still-high unemployment.

Question 4: St. Louis Federal Reserve President James Bullard has defined a specific metric to assess the Fed's current distance from its goals. What is your specific metric and by that metric how far is the Fed from it's goals? What does this metric tell you about the likely timing of the first rate hike of this cycle?

Yellen, in answer to Binyamin Appelbaum of the New York Times: "And with respect to inflation -- and our forecast for inflation, and inflation expectations, let me start by saying I think it's important that monetary policy be forward-looking. The lags in monetary policy are long. And therefore the committee has to base its decisions on how to set the federal funds rate looking into the future. Theory is important, and theories that are consistent with historical evidence will be something that governs the thinking of many people around the table. Typically we have seen that as long as inflation expectations are well-anchored, that as the labor market recovers, we'll gradually see upward pressure on both wages and prices. And that inflation will tend to move back toward 2 percent. I think historically we have seen, as the economy strengthens and slack diminishes, that inflation does tend to gradually rise over time. And as long -- you know, I just -- speaking for myself, that I will be looking for evidence that I think strengthens my confidence in that view, and you know, looking at the full range of data that bears on, whether or not that's a reasonable view of how events will unfold. But it's likely to be a decision that's based on forecasts and confidence in the forecast."

No firm metrics. Raising rates is like pornography - we know it is time when we see it.

Question 5: Why is the Fed setting the stage for raising interest rates next year while inflation measures remain below target? What is the risk, exactly, of explicitly committing to a zero interest rate policy until inflation reaches at least your target?

Yellen, in answer to Greg Ip of the Economist: "But it's important to point out that the committee is not anticipating an over-shoot of its 2 percent inflation objective."

From the Fed's perspective, not an interesting question. Theory says monetary policymakers need to move ahead of seeing inflation at target. If inflation was actually at target, they would be behind the curve in this economic environment. Also refer to San Francisco Federal Reserve President John Williams, via the Wall Street Journal:

"There's no question that core inflation will likely be below 2% when liftoff is appropriate," Mr. Williams said.

You have to love that statement - only an economist could piece together a sentence with "no question" and "likely" in this context. In short, they have no intention of allowing inflation to drift above 2%. The 2% goal is a ceiling, not a target. They are perfectly happy tolerating modestly below-target inflation as long as unemployment is below 6%. If you thought that any mention of above-target inflation was anything more than an acknowledgement of potential forecast errors, you were wrong. As far as the Fed is concerned, 2% inflation was handed down by God. It's in the Bible. Look it up.

Question 6: High yield debt markets are currently under pressure from the decline in oil prices. Are you confident that macroprudential tools are sufficient to contain the damage to energy-related debt? If the damage cannot be contained and contagion to other markets spreads, what does this tell you about the ability to use low interest rate policy without engendering dangerous financial instabilities?

Yellen, in answer to Greg Robb of MarketWatch: "So I mean there is some--you're talking about in the United States exposure? I mean we have seen some impacts of lower oil prices on the spreads for high-yield bonds, where there's exposure to oil companies that may see distress or a decline in their earnings, and we have seen some increase in spreads on high-yield bonds more generally. I think for the banking system as a whole the exposure to oil, I'm not aware of significant issues there. This is the kind of thing that is part of risk management for banking organizations and the kind of thing they look at in stress tests. But the movements in oil prices have been very large, and undoubtedly unexpected.

We--in terms of leverage, and whether or not levered entities could be badly effected by movements in oil prices, leverage in the financial system in general is way down from the levels before the crisis. So it's not a major concern that there are levered entities that would be badly affected by this, but we'll have to watch carefully. There have been large and unexpected movements in oil prices."

I honestly think that Yellen was surprised the rest of us were worried about this. Don't worry, be happy -high yield energy debt problems are contained.

Bottom Line: Final result is data dependent, but nothing at the moment is dissuading the Fed from their intention to hike rates in the middle of 2015.

Links for 12-22-14

Posted: 22 Dec 2014 12:06 AM PST

What is Wrong with Us?

Posted: 21 Dec 2014 07:47 PM PST

I find it incredibly sad that people feel they have to make "The Case Against Torture" (NY Times). What is wrong with us?

'The Net Petroleum Exporter Myth'

Posted: 21 Dec 2014 11:59 AM PST

Bill McBride at Calculated Risk:

Katie Couric and the Net Petroleum Exporter Myth: To understand what the general public is hearing about oil, I watched a Yahoo video yesterday with Katie Couric explaining the decline in oil prices.

In general the piece was very good. Couric started by explaining that the decline in oil prices could be explained in two words: Supply and Demand.  She discussed reasons for more supply and softening demand. ...

But then Couric mentioned a myth I've heard several times recently. She said:

In fact, [the U.S.] is now the world's largest producer of petroleum, and for the last two years, it has been selling more to other countries than it's been buying. Who knew?

"Who knew?"  No one, because it is not true. Yes, the U.S. is the largest producer this year (ahead of Saudi Arabia and Russia), but the U.S. is NOT "selling more to other countries than it's been buying".

The source of this error is that the U.S. is a net exporter of refined petroleum products, such as refined gasoline. Here is the EIA data on Weekly Imports & Exports of crude oil and petroleum products.  The U.S. is importing around 9 million barrels per day of crude oil and products, and exporting around 4 million per day (mostly refined products). The U.S. is a large net importer! ...

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