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August 20, 2015

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Fed Watch: FOMC Minutes Give No Clear Signal
Posted: 20 Aug 2015 12:24 AM PDT

Tim Duy:
FOMC Minutes Give No Clear Signal, by Tim Duy: The FOMC minutes from the July 28-29 FOMC meeting were released today. Arguably they are stale. Arguably they have been overtaken by events. And because the Fed has been very good about not signaling their exact intentions, arguably you can read anything into them you want. If you want to take a hawkish view, I think you focus on this and similar portions of the minutes:
During their discussion of economic conditions and monetary policy, participants mentioned a number of considerations associated with the timing and pace of policy normalization. Most judged that the conditions for policy firming had not yet been achieved, but they noted that conditions were approaching that point. Participants observed that the labor market had improved notably since early this year, but many saw scope for some further improvement. Many participants indicated that their outlook for sustained economic growth and further improvement in labor markets was key in supporting their expectation that inflation would move up to the Committee's 2 percent objective, and that they would be looking for evidence that the economic outlook was evolving as they anticipated.
When considering a rate hike, "many" participants were willing to dismiss current low inflation if they believe evidence of stronger growth supports their conviction that inflation would trend toward target over time. The data since the July meeting tends to support that view. July retail sales were healthy, and revisions to previous months points toward upward revisions to second quarter GDP growth to 3.0 percent or higher. Industrial production was higher, perhaps starting to move past the declines related to the sharp drop in oil prices. Single family housing starts continued their slow but steady rise, reaching a level last seen in 2007. Homebuilder confidence is up. While manufacturing has been soft, the service sector as measured by the ISM non-manufacturing measure is picking up the slack. And the employment report was yet another in a long line of employment reports suggesting slow yet steady gains. Overall, a picture generally supportive of sustained growth and further improvement in labor markets.
A dovish view, however, could be easily derived from the following sentences and similar portions:
However, some participants expressed the view that the incoming information had not yet provided grounds for reasonable confidence that inflation would move back to 2 percent over the medium term and that the inflation outlook thus might not soon meet one of the conditions established by the Committee for initiating a firming of policy. Several of these participants cited evidence that the response of inflation to the elimination of resource slack might be attenuated and expressed concern about risks of further downward pressure on inflation from international developments. Another concern related to the risk of premature policy tightening was the limited ability of monetary policy to offset downside shocks to inflation and economic activity when the federal funds rate was near its effective lower bound.
Many market participants took this and related comments specifically referring to China and currency prices to argue that September was all but off the table. I would not be so quick; the former view is held by "many," whereas the latter was held by "some." Moreover, I find it hard to believe that any would think it a surprise that some officials explicitly discussed China and currencies. How could they not? How could you not think that in a wide-ranging discussion they had not discussed all that is both good and bad in the economy? That said, as I noted earlier, the minutes are stale. The depreciation of the yuan and further declines in commodity prices since the last FOMC meeting give reason to believe that the ranks of "some" has grown.
The latter points also appealed to those inclined against a rate hike. For instance, prior to the release of the minutes, the prescient Cullen Roche argued:
There is still a lot of chatter about the potential for a September rate hike by the Fed. I have to be honest – I think this is nuts at this point.
After the minutes he added:
My guess is that the odds of a Sept rate hike are fast approaching 0%.
— Cullen Roche (@cullenroche) August 19, 2015
I am clearly sympathetic to the view that the Fed looks to be rushing with the rate hike talk. That said, it is what many officials are talking about since the last FOMC meeting while looking at the same data we are. Via John Hilsenrath at the Wall Street Journal:
Officials speaking since the July meeting have sent conflicting signals about where the group as a whole is most likely to go. In an interview with The Wall Street Journal earlier this month, Atlanta Fed President Dennis Lockhart said he was inclined to move in September. St. Louis Fed President James Bullard said in an interview with Market News International on Wednesday he would push for it. But in an opinion piece written in The Wall Street Journal on Wednesday, Minneapolis Fed President Narayana Kocherlakota said it would be a mistake and Fed governor Jerome Powell said earlier this month a decision hadn't been made.
Lockhart is seen as swaying with the general consensus, which argues for September. Bullard arguably shouldn't be pushing for a rate hike given his path tendency to follow the direction of market-based inflation expectations, but the neo-Fisherians seem to be making some traction with him. Powell is wisely keeping his cards close to his chest. They should not, after all, have made any decisions yet. And I would say that if Kocherlakota feels so strongly a need to argue against a rate hike in the Wall Street Journal, he must think the momentum is shifting the other direction.
Former Federal Reserve Governor Lawrence Meyer is also interesting here:
"What are you worrying about, September or December? It doesn't matter. Just pull the trigger," said Laurence Meyer, co-founder of Macroeconomic Advisers, a research firm, in an interview before the release of the minutes.
Just sick of the debate and wanting to move on? Or a real conviction that the Fed is set to move?
Bottom Line: I have believed that there was a better than 50% chance that the Fed would move in September and am hesitant to move much below 50%. I didn't expect the minutes would give a clear signal regarding September, and am not surprised by the dimensions of the general discussion. And I am wary the Fed may be less responsive to financial market disruption than during most of the post-crisis era given than the economy is close to their estimate of full employment. This is shaping up to be one of the most contentious meetings since the tapering debates. We will soon learn more exactly what data the Fed is data dependent on.

FRBSF: The Economic Outlook
Posted: 20 Aug 2015 12:15 AM PDT

The economic outlook according to Michael Bauer of the SF Fed:
FedViews: Michael Bauer, senior economist at the Federal Reserve Bank of San Francisco, states his views on the current economy and the outlook.
GDP growth rebounded from slow Q1
  • Revised estimates indicate that real GDP rose by 0.7% at an annualized rate in the first quarter of 2015, wiping out the previously reported contraction. A first estimate of 2.3% growth in the second quarter is consistent with an ongoing moderate expansion of the U.S. economy, confirming that the first-quarter weakness was largely due to transitory factors.
  • We expect the U.S. economy to grow slightly above its 2% long-term trend for the next four quarters, and then return to trend by the end of 2016. Positive fundamentals include both rising asset prices, which bolster wealth and balance sheets, and a strengthening labor market, which supports household income and consumer spending. However, the stronger dollar over the past year constitutes a headwind for net exports and a drag on growth. Uncertain economic conditions abroad, including in China and Europe, pose some risks to this outlook, but overall we view upside and downside risks as roughly balanced.
Solid job growth continues
Economy near full employment
  • Labor market conditions have continued to improve, and the economy is nearing full employment. Job growth has been strong and consistent, jobless claims are near a 40-year low, and the unemployment rate of 5.3% in July indicates that there is very little slack in labor markets. While significant growth in wages and compensation has yet to appear, we expect a pickup in wage growth as labor markets tighten further.
Inflation expected to return to target
  • Inflation remains below the Federal Open Market Committee's 2% long-run target. We may see some further weakness in overall inflation in the second half of the year due to lower oil prices and a stronger dollar. However, we expect inflation to gradually move back to the target over the medium term as energy prices and the value of the dollar stabilize or reverse direction and as the slack in product and labor markets diminishes.
Financial conditions are supportive
  • Financial conditions have modestly tightened in the first half of this year, as evidenced by a stronger dollar, modestly wider credit spreads, and more volatile global equity prices. However, overall they remain very supportive of aggregate demand and should continue to positively affect economic growth.
Global decline in long-term rates
  • U.S. long-term interest rates have fallen over the past 30 years and are near historic lows. Three facts stand out about this secular decline: First, it has been a global phenomenon, as the decline in the United States was paralleled by a similar trend in most developed countries. Second, the decline was largely unexpected, and forecasters consistently overestimated the future level of interest rates at various points in the past. Third, the decline was evident not only in nominal interest rates but also, and more importantly, in real (that is, inflation-adjusted) interest rates, which drive saving and investment decisions.
Nominal and real rates both falling
  • Structural long-lived changes in the world economy have played an important role in this decline in long-term interest rates. In particular, trend growth of output and productivity has markedly slowed in developed countries—the phenomenon of so-called secular stagnation—which has reduced investment demand. Also, the global saving glut, mostly due to fast-growing emerging market economies with excess saving due to large trade surpluses, has exerted downward pressure on real interest rates. Another important contributing structural factor is the shortage of "safe" assets, such as high-quality government securities, the supply of which is failing to keep up with strong global demand.
  • Cyclical, transitory factors are also keeping long-term interest rates down. In particular, easy monetary policy in developed countries, implemented through low policy rates and quantitative easing, has kept short-term and long-term interest rates low.  In addition, uncertainty surrounding the ongoing euro-area crisis and other related risks has led to precautionary savings and flight-to-safety demand. Finally, deleveraging by households and firms in the aftermath of the financial crisis in order to reduce their debt levels and improve their balance sheets has contributed to the global supply of savings.
  • The eventual reversal of the cyclical factors affecting investment and saving in financial markets should lead to some normalization of long-term interest rates. However, the structural factors are not expected to change rapidly. Hence, there is likely to be a new normal for long-term real rates, which will be different—and lower—than in the past.
  • In such an environment, borrowers would benefit from lower interest rates. On the other hand, savers seeking higher returns may take on more risk. A low interest rate environment would also give less potential room for monetary policy to stimulate economic growth through policy rate changes. In sum, lower real interest rates involve both benefits and risks.     

Links for 08-20-15
Posted: 20 Aug 2015 12:06 AM PDT

'Reform and Revolution in Macroeconomics'
Posted: 19 Aug 2015 12:31 PM PDT
This is something I've stressed with respect to the failure of macroeconomic models, the failure to ask the right questions prior to the crisis. There was no shortage of tools, though some -- like the restrictions imposed by representative agent modeling needed to be improved to better handle heterogeneous agents -- needed further development. The problem was that we had been told by the eminent thought leader(s) within the profession that the problem of deep recessions had been solved (if not by policy, then by the improvement in the operation of the economy brought about by modern technology -- markets were thought to function sufficiently well so as to avoid such problems, especially financial markets with their digital technology and physics brains). Thus, theoretical questions about deep recessions induced by financial panics were ignored or shunted off to the side (they seemed to lack empirical relevance at that time) and the profession focused on how to conduct policy in a "Great Moderation". So to answer why important questions were left largely unaddressed by mainstream models and thinking, it was a combination of the belief that the questions were unimportant combined with sociology within the profession that placed a lower value on pursuits that might have allowed us to be better prepared when the recession hit.
Simon Wren-Lewis argues there was ample reason to ask these questions if we had been more attention to empirical evidence:
Reform and revolution in macroeconomics: ...While it is nonsense to suggest that DSGE models cannot incorporate the financial sector or a financial crisis, academics tend to avoid addressing why some of the multitude of work now going on did not occur before the financial crisis. It is sometimes suggested that before the crisis there was no cause to do so. This is not true. Take consumption for example. Looking at the (non-filtered) time series for UK and US consumption, it is difficult to avoid attaching significant importance to the gradual evolution of credit conditions over the last two or three decades (see the references to work by Carroll and Muellbauer I give in this post). If this kind of work had received greater attention (which structural econometric modellers would almost certainly have done), that would have focused minds on why credit conditions changed, which in turn would have addressed issues involving the interaction between the real and financial sectors. If that had been done, macroeconomics might have been better prepared to examine the impact of the financial crisis. ...
[His main point is much broader.]

'Musing on Right-Wing Affinity Fraud in Politics and Economics...'
Posted: 19 Aug 2015 09:45 AM PDT

Brad DeLong:
Musing on Right-Wing Affinity Fraud in Politics and Economics...: One reaction to the rise of Donald Trump in Republican presidential primary polls has been the extraordinary hurry with which many other candidates have fallen all over themselves to endorse self-deportation.
Note, however, that by "self-deportation" I do not mean what Mitt Romney meant by the phrase: make life so unpleasant for undocumented immigrants in the United States that they decide to leave. What I mean by "self-deportation" is candidates adopting policies that would deport themselves.
Piyush Jindal's parents were Indian citizens in the United States on student visas. Ted Cruz was born in Canada to a Cuban-citizen father. Both of Marco Rubio's parents were Cuban citizens when he was born. Columba Bush--wife of JEB! Bush--was born a Mexican citizen in Mexico, and Wikipedia at least claims that as of her wedding she did not speak English.
Yet all are now denouncing as unforgivably lax the birthright citizenship constitutional guarantee and the naturalization laws by which they or their spouse claim American citizenship.
This is affinity fraud: saying, "I'm just like you! I think as you do! I hate immigrants! Why, I'd have applauded if the U.S. were to have deported me as a baby!" And the very non-sensicality of the claim is what makes it more credible.
But the most interesting thing to me this morning is that this sort of affinity fraud--pretending to believe, or convincing even oneself that one does believe, patently unbelievable things in order to demonstrate group allegiance--is the way America's right-wing is carrying on its internal and external discussion of economics. Paul Krugman provides three examples:
(1) Claiming to believe or actually convincing oneself that inflation is just around the corner...
(2) Claiming to believe or even believing that recessions are outbreaks of collective laziness on the part of workers and collective forgetting on the part of entrepreneurs...
(3) Claiming to believe or actually believing that doubling down on failed intellectual bets is the right strategy--that if statistical tests reject your models, so much the worse for statistical tests because the models are good...
More from Paul Krugman:
Pension-cutters and Privatizers, Oh My: I wrote Monday about the strange phenomenon of Republicans lining up to propose cuts to Social Security, a deeply unpopular policy that is, however, also a really bad idea. How unpopular? Lee Drutman has the data: only 6 percent of American voters support Social Security cuts, while a majority want it increased. I argued that this apparent act of political self-destructiveness probably reflected an attempt to curry favor with wealthy donors, who are very much at odds with the general public on this issue:...
Now we have another example: Marco Rubio has announced his health care plan, and it involves (a) greatly shrinking the tax deductibility of employer health benefits and (b) turning Medicare into a voucher system. Part (a) is favored by many economists, although I would argue wrongly, but would be deeply unpopular; part (b) is really terrible policy — proposed precisely at the moment when Medicare is showing that it can control costs better than private insurers! — and also deeply unpopular.
The strategy here, surely, is to propose things that voters would hate if they understood what was on the table, but hope that Fox News plus "views on shape of planet differ" reporting elsewhere will keep them confused, while at the same time pleasing mega-donors. It might even work, especially if Trump can be pushed out of the picture and the Hillary-hatred of reporters overcomes professional scruples. But it's still amazing to watch.
'Tax cuts for the wealthy will help you too!' worked pretty well as a deception, so why not try it elsewhere?

The MC and MB of Habits
Posted: 19 Aug 2015 09:15 AM PDT

"The brain's habit-forming circuits may also be wired for efficiency":
Wired for habit, by Elizabeth Dougherty, McGovern Institute for Brain Research August 19, 2015: We are creatures of habit, nearly mindlessly executing routine after routine. Some habits we feel good about; others, less so. Habits are, after all, thought to be driven by reward-seeking mechanisms that are built into the brain. It turns out, however, that the brain's habit-forming circuits may also be wired for efficiency.
New research from MIT shows that habit formation, at least in primates, is driven by neurons that represent the cost of a habit, as well as the reward. "The brain seems to be wired to seek some near optimality of cost and benefit," says Ann Graybiel, an Institute Professor at MIT and also a member of the McGovern Institute for Brain Research.
This study is the first to show that cost considerations are wired into the learning of habits. ...
"To know there are other brain signals like cost hiding under the reward signal is very exciting," says Yael Niv, an associate professor of psychology at Princeton University and an affiliate of the Princeton Neuroscience Institute who was not involved in this work. "This study suggests that we should not be blinded by reward. Reward is only one side of the coin. The other side is how much do you have to pay for it."...

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