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March 7, 2015

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Posted: 07 Mar 2015 12:06 AM PST

Fed Watch: 'Patient' is History

Posted: 06 Mar 2015 11:58 AM PST

Tim Duy:

Patient' is History: The February employment report almost certainly means the Fed will no longer describe its policy intentions as "patient" at the conclusion of the March FOMC meeting. And it also keep a June rate hike in play. But for June to move from "in play" to "it's going to happen," I still feel the Fed needs a more on the inflation side. The key is the height of that inflation bar.

The headline NFP gain was a better-than-expected 295k with 18k upward adjustment for January. The 12-month moving average continues to trend higher:

NFPa030615

Unemployment fell to 5.5%, which is the top of the central range for the Fed's estimate of NAIRU. Still, wage growth remains elusive:

NFPb030615

Is wage growth sufficient to stay the Fed's hand?  I am not so sure. I recently wrote:

My take is this: To get a reasonably sized consensus to support a rate hike, two conditions need to be met. One is sufficient progress toward full-employment with the expectation of further progress. I think that condition has already been met. The second condition is confidence that inflation will indeed trend toward target. That condition has not been met. To meet that condition requires at least one of the following sub-conditions: Rising core-inflation, rising market-based measures of inflation compensation, or accelerating wage growth. If any were to occur before June, I suspect it would be the accelerating wage growth.

I am less confident that we will see accelerating wage growth by June, although I should keep in mind we still have three more employment reports before that meeting. Note, however, low wage growth does not preclude a rate hike. The Fed hiked rates in 1994 in a weak wage growth environment:

NFPg030615

And again in 2004 liftoff occurred on the (correct) forecast of accelerating wage growth:

NFPf030615

So wage growth might not be there in June to support a rate hike. And, as I noted earlier this weaker, I have my doubts on whether core-inflation would support a rate hike either. That leaves us with market-based measures of inflation compensation. And at this point, that just might be the key:

NFPe030615

If bond markets continue to reverse the oil-driven inflation compensation decline, the Fed may see a way clear to hiking rates in June. But the pace and timing of subsequent rate hikes would still be data dependent. I would anticipate a fairly slow, halting path of rate hikes in the absence of faster wage growth.

Bottom Line:  "Patient" is out. Tough to justify with unemployment at the top of the Fed's central estimates of NAIRU. Pressure to begin hiking rates will intensify as unemployment heads lower. The inflation bar will fall, and Fed officials will increasingly look for reasons to hike rates rather than reasons to delay. They may not want to admit it, but I suspect one of those reasons will be fear of financial instability in the absence of tighter policy. June is in play.

'Connections in the Modern World: Network-Based Insights'

Posted: 06 Mar 2015 10:19 AM PST

Research on networks could be very helpful in determining when financial systems are under the type of stress that could lead to a major collapse:

Connections in the modern world: Network-based insights, by Matthew O. Jackson, Brian Rogers, and Yves Zenou, Vox EU: There have been 24 outbreaks of the Ebola virus since it first appeared in 1976. Most were limited to dozens of cases, or at most hundreds – but the 2014 outbreak reached tens of thousands (Global Alert and Response, World Health Organization 2014). Although this latest outbreak now appears to be contained, the world may have dodged a dangerous bullet. If the disease had gotten a toehold in one of the many large urban slums throughout the world, the toll could have been dramatically larger. The same year saw an outbreak of measles in the US unlike any in decades, as a combination of complacency and fears of side effects led to lapses in vaccinations that allowed for susceptibility to contagion. Indeed, even small percentages of unvaccinated people – especially children – can lead small seeds of a very virulent disease to snowball into widespread infection. 

The combination of world population growth and an increasingly interconnected society is producing new dynamics. Of course, deadly pandemics are not new. The Black Death (bubonic plague) wiped out tens of millions of people between the 14th and 19th centuries. Modern medicine and especially vaccinations have helped the world mitigate and even prevent many such catastrophes. But a changing world brings new challenges. Social distances between individuals currently average less than five degrees (Ugander et al. 2011) so that it is typically possible to go from one person via a friend to another friend, and another – and within five steps or so reach much of the rest of the world.

Historical data suggest that this closeness is indeed a modern phenomenon. For instance, using data from the spread of the bubonic plague, Marvel et al. (2013) estimate that in the Middle Ages average social distances between people were many times higher than they are today. The plague spread relatively slowly from one area to the next, taking four years to travel across Europe at a pace of less than a thousand kilometers per year, as people interacted mostly in limited local patterns. In contrast, modern travel means that a healthcare worker exposed to Ebola in a village in Sierra Leone can easily be in London or New York before showing symptoms. A child who catches measles in Anaheim, California can board a plane and bring it home thousands of miles away. Increased mobility combined with tightly clustered interactions (e.g. children in schools), mean that small pockets of vaccination lapses can generate heavy outbreaks. Limiting the terrible costs that can be imposed by contagious diseases including Ebola, measles, HIV, and many others, remains an important priority. What are the most effective ways to employ preventative measures, treatment for the ill, and barriers to contagion – including travel bans and the like? Properly addressing such questions requires understanding the complex networks of interactions that govern transmission, and a systematic framework for trading off the costs and benefits of policies. 

Disease is but one example of diffusion through connections. As we have seen recently, despite the advantages of modern financial systems they are susceptible to systemic failures – a downturn in one country can lead to cascading downturns in others. In the EU the largest 50 or so banking institutions are now highly connected, with interbank exposures exceeding one trillion euros, more than their total Tier 1 capital (Alves et al. 2013). While disease and financial contagion share certain similarities, they differ in fundamental respects. Financial contagion is less well studied and the challenge of how to 'vaccinate' an institution without slowing the economy is significant. How can we identify which institutions are really 'too connected to fail'? Which financial institutions require regulation and how should regulatory policy be guided? Should financial integration be encouraged or discouraged? Again, answering these questions necessitates a network-based approach.

The increasing connectedness of the world also has many benefits: it enhances trade, increases the efficiency of investment, spreads prosperity and education, and fosters peace. For example, despite the poverty that still exists in the world, and the continued political and military conflicts that we endure, the world has been an order of magnitude more peaceful over the past few decades. Jackson and Nei (2015) find that the number of wars per pair of countries has been more than ten times lower in the period since 1950 than from the period of 1820 through 1950 – a decrease that mirrors a growth in trade. Networks of trade and political alliances have become denser and more stable in the period since the Second World War. How can understanding patterns of trade, employment, and growth help us to better understand conflict and prevent wars, both interstate and civil?

Insights from network science are poised to enable great progress on the questions posed above, among others. In a recent paper (Jackson et al. 2015), we describe many such insights about how network patterns of interactions impact contagion, diffusion, learning, markets, and behaviour. We outline fundamental principles by distinguishing between:

  • Macro/global/aggregate network characteristics, which include the overall density of connections in a network as well as segregation patterns between people with different characteristics, and
  • Micro/local/individual characteristics, including measures such as the extent to which two people have friends in common, whether a person's friends are connected to each other, and how central or influential is a specific node in a network. 

Macro patterns of a network play primary roles in processes of diffusion, contagion, and social learning, as well as in determining the extent to which disparate norms or cultures can exist within a society. Beyond the straightforward observation that denser networks (i.e. those having more interactions per individual) promote contagion, there are other robust insights that emerge from examining macro patterns. For example, financial settings differ in essential ways from simple epidemiological settings – not only does increasing the connectedness of institutions enable greater contagion, it also diversifies the risks held by individual institutions. Thus, the most dangerous network patterns for financial networks tend to have an intermediate density, being connected enough to diffuse distress from one institution to another but sparse enough that many institutions are poorly diversified and at risk from a neighbor's distress. 

A second macro characteristic of a network, with many implications, is the extent of segregation or homophily (the tendency of individuals to associate with others who share common traits). Homophily concentrates interactions among subpopulations and so, for example, can allow a disease or behaviour to take root among a subgroup who interact intensely with each other, while that disease or behaviour would not take root if the population were evenly mixing. For example, if there are many children in the same place at the same time (e.g. Disneyland), even a small percentage of unvaccinated individuals is enough to help an epidemic take root. This can then spread among them given that some parents have recently worried more about side-effects of vaccinations than the diseases they protect against – leaving some schools with substantial pockets of unvaccinated students and again having tight interactions among similarly susceptible individuals.   Beyond its effects on contagion, homophily can also enable very different customs and norms of behaviour to exist in different parts of a network, and thus plays a role in phenomena like persistent inequality and poverty traps among people of different ethnicities.

'Micro' patterns of a network, such as identifying central or influential nodes, are of crucial importance in understanding how, for example, to effectively seed a program or how best to avoid a contagion.  The relevant notion of centrality or influence depends on the application, but there are many tractable and natural measures of network centrality.   Some measures capture how important a node is as a connector – bridging different parts of a network and potentially serving as an intermediary.   Other measures track how influential a node is in terms of influencing others' behaviours, for instance in identifying 'key players' who are most influential in a criminal network.  Yet other measures track how well-placed an individual is to initiate diffusion of a product or idea.   Each such measure has an intuitive relationship to the network, and understanding the multitude of measures of social influence, and which ones have proven useful in which circumstances, can help in shaping many policies – from controlling disease, to improving economic development, to guiding financial bailouts.  

As we discuss at length in Jackson, Rogers and Zenou (2015), network science is at an exciting juncture: the modern world increasingly demands a unified understanding of networks, and the science is rapidly developing to deliver easy-to-articulate principles and concepts that are proving useful.

References

Alves, I, S Ferrari, P Franchini, J Heam, P Jurca, S Langfield, F Liedorp, A Sanchez, S Tavolaro and G Vuillemey (2013), "The structure and resilience of the European interbank market," European Systemic Risk Board (ESRB) Occasional Paper No. 3.

Jackson, M O, and S Nei (2015), "Networks of military alliances, wars, and international trade," SSRN discussion paper 2389300.

Jackson, M O, Rogers, B W, and Y Zenou (2015), "The economic consequences of social network structure", CEPR Discussion Paper 10406.

Marvel, S A, Martin, T, Doering, C R, Lusseau, D, and M E J Newman (2013), "The small-world effect is a modern phenomenon," preprint: http://arxiv.org/abs/1310.2636.

Ugander, J, Karrer, B, Backstrom, L, and C Marlow (2011), "The anatomy of the Facebook social graph", preprint.

How Inequality Harms Health -- and the Economy

Posted: 06 Mar 2015 10:18 AM PST

At MoneyWatch:

How inequality harms health -- and the economy: One of the hottest topics around lately concerns the widespread effects of inequality. For example, evidence suggests that when inequality is very large, it can lower economic growth. But there's quite a bit of uncertainty about how this occurs. What are the pathways that connect large disparities in income and wealth to economic growth?
Recent research (summarized here) from UCLA's Fielding School of Public Health provides evidence that income inequality is associated with inequality in health. In particular, lower income is associated with "high levels of stress, exhaustion, cardiovascular disease, lower life expectancy and obesity." These factors alone could lead to lower economic growth than we would have if the work force were healthier.
Also important when thinking about the impacts on long-run growth are the potential intergenerational impacts. As Dr. Linda Rosenstock, the UCLA paper's senior author, noted, these health effects aren't limited to the parents -- children are also affected.
Does this matter for economic growth and intergenerational mobility? Some research says it does. ...

Paul Krugman: Pepperoni Turns Partisan

Posted: 06 Mar 2015 09:58 AM PST

Why are Republicans in the grips of "Big Pizza"?:

Pepperoni Turns Partisan, by Paul Krugman, Commentary, NY Times: If you want to know what a political party really stands for, follow the money. ... Major donors ... generally have a very good idea of what they are buying, so tracking their spending tells you a lot.
So what do contributions in the last election cycle say? The Democrats are, not too surprisingly, the party of Big Labor (or what's left of it) and Big Law: unions and lawyers are the most pro-Democratic major interest groups. Republicans are the party of Big Energy and Big Food: they dominate contributions from extractive industries and agribusiness. And they are, in particular, the party of Big Pizza.
No, really. ... And pizza partisanship tells you a lot about what is happening to American politics as a whole. ...
The rhetoric of this fight is familiar. The pizza lobby portrays itself as the defender of personal choice and personal responsibility. It's up to the consumer, so the argument goes, to decide what he or she wants to eat, and we don't need a nanny state telling us what to do. ...
But..., anyone who has struggled with weight issues ... knows that this is a domain where the easy rhetoric of "free to choose" rings hollow. Even if you know very well that you will soon regret that extra slice, it's extremely hard to act on that knowledge. Nutrition, where increased choice can be a bad thing,... it ... is one of those areas — like smoking — where there's a lot to be said for a nanny state.
Oh, and diet isn't purely a personal choice, either; obesity imposes large costs on the economy as a whole.
But you shouldn't expect such arguments to gain much traction. For one thing, free-market fundamentalists don't want to hear about qualifications to their doctrine..., and partisan orientation: heavier states tend to vote Republican...
At a still deeper level, health experts may say that we need to change how we eat, pointing to scientific evidence, but the Republican base doesn't much like experts, science, or evidence. Debates about nutrition policy bring out a kind of venomous anger ... that is all too familiar if you've been following the debate over climate change.
Pizza partisanship, then, sounds like a joke, but it isn't. It is, instead, a case study in the toxic mix of big money, blind ideology, and popular prejudices that is making America ever less governable.

'Job Growth Remains Strong in February'

Posted: 06 Mar 2015 09:16 AM PST

Dean Baker on the employment report (subtitle: The strongest wage growth is showing up in the lowest-paying sectors):

Job Growth Remains Strong in February (CC): The labor market had another strong month in February, with employers adding 295,000 in the month. While there were small downward revisions to the January numbers, this still left the three month average at 288,000 jobs. The unemployment rate dropped to 5.5 percent, its lowest level since May of 2008, the early days of the recession. The employment-to-population ratio (EPOP) remained at 59.3 percent, more than 3.0 percentage points below its pre-recession level.
The February performance is especially impressive given that an unusually severe winter might have been expected to dampen job growth, especially in sectors like construction and restaurants. Construction added 29,000 jobs and restaurants added an extraordinary 58,700 jobs. Of course, some of the weather effect may show up in the March data, since the worst weather came towards the end of the month, after the reference week for the survey.
The gain in construction brings the average over the last four months to 38,000 jobs. This comes to a 7.5 percent annual growth rate in a context where reported construction spending has been relatively flat. This suggests that there could be some serious measurement issues in the data. Manufacturing employment growth slowed to 8,000 after averaging 28,000 the prior three months. Retail continues to show strong growth, adding 32,000 jobs, bringing its average since August to 29,900. The professional and technical services category, which tends to be higher paying, again showed strong growth, adding 31,800. This is roughly even with its 30,800 average over the last four months.
There were some anomalies in the data that are likely to be reversed. The courier sector added 12,300 jobs, while education services reportedly added 21,300 jobs. Data in both sectors are highly erratic and almost certain to be largely reversed in future months. The temp sector lost 7,800 jobs in February, its second consecutive decline. Health care job growth fell back to 23,800, compared to an average of 39,250 over the prior four months. The 58,700 jobs added in the restaurant sector was the largest monthly gain since November of 2000.
The data in the household survey was mostly positive. Involuntary part-time employment fell by another 175,000 in February and is now 570,000 below its year-ago level. There was a small rise in the number of people who have voluntarily chosen to work part-time. It is now 750,000 above its year-ago level and almost 900,000 higher than in February of 2013, before the exchanges from the Affordable Care Act came into existence.
The percentage of people unemployed because they voluntarily quit their job rose from 9.5 percent to 10.2 percent, its highest level since May of 2008. This is still close to 2.0 percentage points below the pre-recession levels.
The recovery continues to disproportionately benefit less educated workers. The unemployment rate for workers without a high school degree edged down by 0.1 percentage point to 8.4 percent, 1.4 percentage points below its year-ago level.  The current unemployment rate for this least educated group of workers is roughly a percentage point above its pre-recession level, while the unemployment rate for college grads is 0.7 percentage points higher at 2.7 percent. However, the contrast in EPOP is striking. The EPOP for workers without high school degrees is down by roughly a percentage point from its pre-recession level, while the EPOP for college grads is down by close to four percentage points.

 

jobs-2015-03

Reported wage growth for the month was weak, as expected, following a large reported gain in January. Taking the average for the last three months compared to the prior three months, the annual rate of growth was just 1.8 percent, down from 2.0 percent over the last year. The data on wage growth continue to indicate there is still a large amount of slack in the labor market. There is some evidence of more rapid wage growth in the lowest paying sectors, which is to be expected as workers can increasingly find better jobs elsewhere, but higher-paying sectors continue to show very weak wage growth.
If the economy can sustain job growth in the neighborhood of 300,000 per month, by the end of the year we may start seeing substantial wage gains.

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