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July 30, 2015

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Posted: 30 Jul 2015 12:06 AM PDT

Fed Watch: FOMC Recap

Posted: 29 Jul 2015 12:37 PM PDT

Tim Duy:

FOMC Recap, by Tim Duy: The July FOMC meeting yielded the widely expected outcome of no policy change. Very little change in the statement either - pulling out any useful information is about as easy as reading tea leaves or chicken bones. But that won't stop me from trying! On net, I would count it was somewhat more hawkish as the Fed gears up to hike rates later this year. By no means, however, did the statement make any definitive signal about September. The Fed continues to hold true to its promise to make the next move about the data. The era of handholding fades further into memory.
The first paragraph contained nearly all of the changes in the statement. Using the Wall Street Journal's handy-dandy Fed tracker:

FOMCa072915

In my opinion, this represents a not trivial upgrade of their thoughts on the labor market. Job growth is "solid," unemployment continues to decline, and a much more forceful conclusion on underemployment. No longer has underutilization diminished by a wishy-washy "somewhat." It now conclusively "has" diminished. Hence, it seems like the Fed is closer to declaring victory over one impediment to hiking rates - Fed Chair Janet Yellen's concerns about the high degree of underemployment.
I tend to regard the exclusion of the "energy prices appear to have stabilized" as the elimination of an artifact from the June statement. Energy prices are not in free-fall as the were at the end of last year, and have instead been tracking within a range since the beginning of the year. Hence the Fed can later repeat the inflation forecast as:
"...the Committee expects inflation to rise gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of earlier declines in energy and import prices dissipate."
Some may interpret it as a more dovish signal in light of the recent declines in oil prices. I am wary of that interpretation.
The only other change to the statement was in the third paragraph:

FOMCb072915

The addition of the determiner "some" fits nicely with the changes to the first paragraph. The labor market has now shown sufficient improvement such that the bar to a rate hike is actually quite low. Essentially, meeting participants believe the economy is closing in on full employment. And that in and of itself will raise their confidence on the inflation outlook.
There was some early chatter regarding the continued description of the risks to the outlook as "nearly" balanced. This was taken as dovish. Had they said the balance is weighted toward inflation, however, the Fed would have essentially been promising a rate hike in September, and they have been very clear they do not want to make such a promise. So the failure to change the balance of risks should not be that surprising. In that vein, I suspect that when they do hike, they will say something like "with today's action, the risks to the outlook remain balanced" such that they leave no signal regarding the timing or the magnitude of the next move.
Bottom Line:  All else equal, the next two labor reports will factor strongly into the Fed's decision in September. A continuation of recent labor trends is likely sufficient to induce them to pull the trigger. Further signs of stronger wage growth would make a September move a certainty.

What Is 'Price Theory'?

Posted: 29 Jul 2015 11:27 AM PDT

Glen Weyl at Marginal Revolution:

What Is "Price Theory"?: ... I have an unusual relationship to "price theory". As far as I know I am the only economist under 40, with the possible exception of my students, who openly identifies myself as focusing my research on price theory. As a result I am constantly asked what the phrase means. Usually colleagues will follow up with their own proposed definitions. My wife even remembers finding me at our wedding reception in a heated debate not about the meaning of marriage, but of price theory.
The most common definition, which emphasizes the connection to Chicago and to models of price-taking in partial equilibrium, doesn't describe the work of the many prominent economists today who are closely identified with price theory but who are not at Chicago and study a range of different models. It also falls short of describing work by those like Paul Samuelson who were thought of as working on price theory in their time even by rivals like Milton Friedman. Worst of all it consigns price theory to a particular historical period in economic thought and place, making it less relevant to the future of economics.
I therefore have spent many years searching for a definition that I believe works... This process eventually brought me to my own definition of price theory as analysis that reduces rich (e.g. high-dimensional heterogeneity, many individuals) and often incompletely specified models into 'prices' sufficient to characterize approximate solutions to simple (e.g. one-dimensional policy) allocative problems. This approach contrasts both with work that tries to completely solve simple models (e.g. game theory) and empirical work that takes measurement of facts as prior to theory. Unlike other definitions, I argue that mine does a good job connecting the use of price theory across a range of fields of microeconomics from international trade to market design, being consistent across history and suggesting productive directions for future research on the topic. ...

He goes on to explain.

FOMC Press Release

Posted: 29 Jul 2015 11:14 AM PDT

Not much to say about this, policy is unchanged, and not as much guidance on what to expect going forward as some expected (i.e., to get people ready for a rate increase in September):

Press Release, Release Date: July 29, 2015: Information received since the Federal Open Market Committee met in June indicates that economic activity has been expanding moderately in recent months. Growth in household spending has been moderate and the housing sector has shown additional improvement; however, business fixed investment and net exports stayed soft. The labor market continued to improve, with solid job gains and declining unemployment. On balance, a range of labor market indicators suggests that underutilization of labor resources has diminished since early this year. Inflation continued to run below the Committee's longer-run objective, partly reflecting earlier declines in energy prices and decreasing prices of non-energy imports. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations have remained stable.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators continuing to move toward levels the Committee judges consistent with its dual mandate. The Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced. Inflation is anticipated to remain near its recent low level in the near term, but the Committee expects inflation to rise gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of earlier declines in energy and import prices dissipate. The Committee continues to monitor inflation developments closely.
To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.
The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committee's holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.
When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. 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.
Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Charles L. Evans; Stanley Fischer; Jeffrey M. Lacker; Dennis P. Lockhart; Jerome H. Powell; Daniel K. Tarullo; and John C. Williams.

'Using Math to Obfuscate — Observations from Finance

Posted: 29 Jul 2015 10:52 AM PDT

More from Paul Romer on "mathiness" -- this time the use of math in finance to obfuscate communication with regulators:

Using Math to Obfuscate — Observations from Finance: The usual narrative suggests that the new mathematical tools of modern finance were like the wings that Daedalus gave Icarus. The people who put these tools to work soared too high and crashed.
In two posts, here and here, Tim Johnson notes that two government investigations (one in the UK, the other in the US) tell a different tale. People in finance used math to hide what they were doing.
One of the premises I used to take for granted was that an argument presented using math would be more precise than the corresponding argument presented using words. Under this model, words from natural language are more flexible than math. They let us refer to concepts we do not yet fully understand. They are like rough prototypes. Then as our understanding grows, we use math to give words more precise definitions and meanings. ...
I assumed that because I was trying to use math to reason more precisely and to communicate more clearly, everyone would use it the same way. I knew that math, like words, could be used to confuse a reader, but I assumed that all of us who used math operated in a reputational equilibrium where obfuscating would be costly. I expected that in this equilibrium, we would see only the use of math to clarify and lend precision.
Unfortunately, I was wrong even about the equilibrium in the academic world, where mathiness is in fact used to obfuscate. In the world of for-profit finance, the return to obfuscation in communication with regulators is much higher, so there is every reason to expect that mathiness would be used liberally, particularly in mandated disclosures. ...
We should expect that there will be mistakes in math, just as there are mistakes in computer code. We should also expect some inaccuracies in the verbal claims about what the math says. A small number of errors of either type should not be a cause for alarm, particularly if the math is presented transparently so that readers can check the math itself and check whether it aligns with the words. In contrast, either opaque math or ambiguous verbal statements about the math should be grounds for suspicion. ...
Mathiness–exposition characterized by a systematic divergence between what the words say and what the math implies–should be rejected outright.

'Spare Tire? Stock Markets, Banking Crises, and Economic Recoveries'

Posted: 29 Jul 2015 10:52 AM PDT

From Ross Levine, Chen Lin, and Wensi Xie at Vox EU:

Spare tire? Stock markets, banking crises, and economic recoveries: Do stock markets act as a 'spare tire' during banking crises, providing an alternative corporate financing channel and mitigating the economic severity of crises when the banking system goes flat?

In 1999, Alan Greenspan, then Chairman of the Federal Reserve System, argued that stock markets could mitigate the negative effects of banking crises, including more fragile businesses and greater unemployment. Using the analogy of a spare tire, he conjectured that banking crises in Japan and East Asia would have been less severe if those countries had built the necessary legal infrastructure so that their stock markets could have provided financing to corporations when their banking systems could not. If firms can substitute equity issuances for bank loans during banking crises, then banking crises will have less harmful effects on the public.

But researchers have not evaluated the spare tire view. Although official entities and others discuss the spare tire argument (e.g. US Financial Crisis Inquiry Commission 2011, Wessel 2009), we are unaware of systematic assessments of the testable implications emerging from Greenspan's view of how financial markets can ease the effects of systemic banking failures.

In a recent paper, we provide the first assessment of the spare tire view... The findings are consistent with the three predictions of the spare tire view. ... The estimated economic effects are large...

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