October 31, 2004
What Does Accommodative Mean? One Governor's View
On Friday, Governor (and Vice Chairman of the Board) Roger Ferguson gave his view on what the Federal Open Market Committee means by "the stance of monetary policy remains accommodative."
What is needed is a benchmark summarizing the economic circumstances… One way of providing that benchmark is to consider what level of the real federal funds rate, if allowed to prevail for several years, would place economic activity at its potential and keep inflation low and stable. If the actual real rate is below that benchmark level, policy can be viewed as accommodative, in that if that stance were maintained, ultimately pressures on resources would build. If the actual real rate is kept above that benchmark level, policy would seem to be contractionary.
The Governor does worry, however, that the equilibrium real interest rate concept looks better in theory than in practice.
Our knowledge of the workings of the economy is sufficiently imprecise that we could not attach much confidence to any single calculation that one might make of the equilibrium rate.
Where does that leave us? Some place that's sounding familiar by now.
In my judgment, we should remove the current degree of accommodation at a pace that is importantly determined by incoming data and a changed outlook.
The Dollar: Looking Like the Next Big (Bad) Thing?
The Economist last week added to the growing drumbeat of warnings that the time has come for a real honest-to-goodness tanking of the U.S. currency.
Most economists, and this newspaper, have been fretting about America's huge current-account deficit and predicting the dollar's sharp decline for years. The trouble with crying wolf too often is that people stop believing you. After slipping 14% in broad trade-weighted terms since 2002, the dollar had stabilised this year, even as the current-account deficit continued to grow. This has encouraged some economists to offer theories explaining why America's current-account deficit does not matter and why the dollar need not fall further. But the dollar has now started to slide again: this week it hit $1.28 against the euro, within a whisker of its all-time low of $1.29. Trust us, the wolf is real...
Economists at UBS estimate that the dollar's trade-weighted value might need to fall by another 20-30% to trim the deficit by enough to stabilise the ratio of America's external liabilities to GDP. Though it might seem unthinkable, that could imply a rate of around $1.70 against the euro.
A similar concern was discussed in a column by David Wessel, that appeared in the Thursday October 28 edition of The Wall Street Journal (page A2).
... there are fresh warnings. After a brief respite, the dollar is sinking against the euro and yen. Foreign purchases of U.S. stocks and bonds have slipped to a monthly average of $70 billion from the $89 billion pace of early 2004.
The next president, no matter who wins, can't count on continuing what amounts to "low-cost finance for America at a time when savings are low" coupled with "strong exports for those who are providing the finance," as Harvard University President Lawrence Summers put it in a recent International Monetary Fund lecture.
Of course, there are dissenting voices. The Economist notes an argument made by Michael Dooley, David Folkerts-Landau and Peter Garber at Deutsche Bank who have suggested that current circumstances are sustainable for as far as the eye can see.
Asian economies, they argue, have chosen to link their currencies to the dollar at undervalued rates, supported by heavy purchases of dollar reserves. Asian countries want to keep their exports cheap to support rapid growth and are in consequence happy to keep acquiring dollars indefinitely. In turn, by buying Treasury bonds, they reduce interest rates, which supports spending and ensures that American consumers keep buying Asian goods.
And Wessel notes that
The "Why Worry" school sees the flood of foreign money as a sign of American strength: The U.S. is a country that capital is trying to get into.
But Wessel (echoing a point made in class by XP-75er Marcos Nogues) pooh-poohs the "Why Worry" position that investors have a taste for U.S. capital that just can't be sated.
It would also be more comforting if private global investors were putting money in the U.S. But more and more of it comes from Asian central banks, parking huge dollar reserves in U.S. Treasury debt.
And the Economist article emphasizes arguments that, contrary to the Dooley, Folkerts-Landau, and Garber claim, China and other countries will not be willing to absorb Treasury debt at the current pace forever. They conclude with this cheery passage.
In the three years from 1985, the dollar fell by 50% against the other main currencies. Inflation and bond yields rose and, in October 1987, the stockmarket crashed. America's current-account deficit is now almost twice as big as it was then, so the total fall in the dollar—and the fall-out in other financial markets—could well be larger. The wolf is licking his lips.
October 29, 2004
The U.S. Economy Keeps on Keeping On
Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 3.7 percent in the third quarter of 2004, according to advance estimates released by the Bureau of Economic Analysis. In the second quarter, real GDP increased 3.3 percent.
All that, and stable prices too.
The price index for gross domestic purchases, which measures prices paid by U.S. residents, increased 1.8 percent in the third quarter, compared with an increase of 3.5 percent in the second. Excluding food and energy prices, the price index for gross domestic purchases increased 1.5 percent in the third quarter, compared with an increase of 2.5 percent in the second.
You might guess from some in the press, however, that this was pretty bad news. A sampling:
Stocks Are Mixed on Lackluster GDP Report (Associated Press, by way of Forbes)
GDP growth weaker than expected (CNNmoney)
There's just no pleasing some people.
October 28, 2004
And the Beige Book Says...
Reports from the twelve Federal Reserve Districts generally indicated that economic activity continued to expand in September and early October.
... Atlanta cited widespread hurricane-related disruptions. Many reports suggested that higher energy costs were constraining consumer and business spending.
You can read the real thing here, but there's plenty of spin out there if you want it. Take your pick.
Fed: High oil constrains spending (CNNmoney)
Beige Book shows growth, despite energy tab (CBS MarketWatch)
Fed's Beige Book: Economy Continues to Expand (SmartMoney.com)
October 26, 2004
Consumer Sentiment Still on the Skids
Here is the latest from the Conference Board.
The Conference Board’s Consumer Confidence Index, which had declined in September, posted another loss in October. The Index now stands at 92.8 (1985=100), down from 96.7 in September. The Expectations Index declined to 92.0 from 97.7. The Present Situation Index dipped to 94.2 from 95.3...
“Subdued expectations, as opposed to eroding present-day conditions, were the major cause behind October’s decline in consumer confidence,” says Lynn Franco, Director of The Conference Board’s Consumer Research Center. “And, while consumers’ assessment of the labor market this month showed a moderate improvement, the gain was not sufficient to ease concerns about job growth in the months ahead.”
For what it's worth, the Iowa Market still looks bullish on Bush, though.
October 23, 2004
Leading Indicators Drop Again
The Conference Board has released its report on economic indicators for September. The headlines -- including the one on this post -- focused on the fact that the forward-looking index declined for the fourth month in a row. The index on September activity, however, looked pretty good.
The leading index fell again in September, the fourth consecutive decline, and the weakness in the last four months has become more widespread. However, these declines in the leading index have not been large enough nor have they persisted long enough to signal an end to the current economic expansion.
The coincident index, an index of current economic activity, increased again in September and its growth continues to be widespread. Real GDP growth slowed to a 3.3 percent annual rate in the second quarter, but appears to have picked up again in the third quarter.
There is lots of commentary in this article from Bloomberg, including this:
With less than two weeks until the presidential election... economists including Fed Governor Ben S. Bernanke said the economy is reflecting concern about growth prospects. Crude oil prices surged about 67 percent so far this year, which along with higher natural gas prices acted like an $85 billion tax on the economy, Bernanke said.
``The increased cost of imported energy has reduced the growth in U.S. aggregate spending and real output this year by something between half and three-quarters of a percentage point,'' Bernanke said at Darton College in Albany, Georgia.
Governor Bernanke's speech is posted here, but if you are more the aural type, the Bloomberg article has a link to the audio.
October 21, 2004
News From the Fed
Two new economic outlook reports today from the Federal Reserve System. The Federal Reserve Bank of Philadelphia realeased its October Business Outlook Survey.
Philadelphia Federal Reserve Senior Economic Analyst Mike Trebing summarized the survey:
"Current indicators suggest that growth in the region's manufacturing sector is continuing. About 40 percent of the firms reported increases in general activity, new orders, and shipments in October. The indexes for prices paid and prices received remained high, although the index for prices received was slightly lower than last month. Although most indicators of current activity suggest improved business conditions, expectations for the next six months fell notably in October."
Meanwhile, the Chicago Fed National Activity Index for September also hit the streets. Although the index fell slightly in September, the August number was revised upward, and the report's headline reads "CFNAI points to continued economic expansion." Gotta love that good midwestern optimism.
An Economist Picks His Own Set of Shocks
A few weeks ago, the Institute for International Economics' Fred Bergsten published an article in The Economist in which he enumerated his own view on the five major risks to the global economy in the immediate future.
FIVE major risks threaten the world economy. Three centre on the United States: renewed sharp increases in the current-account deficit leading to a crash of the dollar; a budget profile that is out of control; and an outbreak of trade protectionism. A fourth relates to China, which faces a possible hard landing from its recent overheating. The fifth is that oil prices could rise to $60-70 per barrel even without a major political or terrorist disruption, and much higher with one.
Bergsten references former Clinton Treasury Secretary Robert Rubin in describing a current connection between budget deficits, prospects for the dollar, and monetary policy.
The budget and current-account deficits are not “twin”. The budget in fact moved from large deficit in the early 1990s into surplus in 1999-2001, while the external imbalance soared anew. But increased fiscal shortfalls, especially with the economy nearing full employment, will intensify the need for foreign capital. The external deficit would almost certainly rise further as a result.
Robert Rubin, former secretary of the Treasury, also stresses the psychological importance for financial markets of expectations concerning the American budget position. If that deficit is viewed as likely to rise substantially, without any correction in sight, confidence in America's financial instruments and currency could crack. The dollar could fall sharply as it did in 1971-73, 1978-79, 1985-87 and 1994-95. Market interest rates would rise substantially and the Federal Reserve would probably have to push them still higher to limit the acceleration of inflation.
And although there are plenty of people sounding alarms about China doing too well, here's an argument for fearing that China won't do well enough.
Under the best of circumstances, China's expansion will decelerate gradually but substantially from its recent 9-10% pace. When the country cooled its last excessive boom after 1992, growth declined for seven straight years. A truly hard landing could be much more abrupt and severe. Either outcome will, to a degree, counter the inflationary and interest-rate consequences of the other global risks. But a slowdown, and especially a hard landing, in China would sharply reinforce their dampening effects on world growth.
October 20, 2004
Can Media Bias Harm the Economy?
Mark Doms (from the San Francisco Fed) and Normin Morin (from the Board of Governors) have an interesting study of the effect of news reporting on consumer sentiment about the economy. Their first step was to construct measures of what's in the news.
We created an R-word index like The Economist’s with some modifications. First, we require the word “recession” or “economic slowdown” to appear in the headline or first paragraph of the article because we found that these articles tended to portray some negative aspect of the economy, such as high unemployment, budget difficulties, low profits, and how people cope when the economy sours... We also, extended our index to include 28 papers in addition to the Washington Post and The New York Times. Also, we were able to compute a similar index from the nightly news broadcasts for ABC, NBC, and CBS...
We also created a “layoff” index in a similar manner to the R-word index. Like the recession
index, articles that mentioned “layoff” or similar phrases such as “job cuts” and “firings” in the title
or first paragraph tended to focus on some negative aspect of the job market.
The authors also constructed a similar index for positive news. The next step (or one of the next steps) is to examine whether the news indexes helps to explain changes in consumer sentiment (obtained from the University of Michigan's Survey of Consumers) , over and above objective information about economic activity and surveys of professional forecasters. They find
...layoff and recession indexes enter significantly into models for many measures of sentiment. Specifically, the various sentiment measures are negatively related to the recession and layoff indexes and positively related to the economic recovery index. In fact, sentiment models that contain the newspaper information do a noticeably better job of explaining several periods when sentiment dropped suddenly, such as in 1990 and again in early 2001.
The news media affects consumers’ perceptions of the economy through three channels. First, the news media conveys the latest economic data and the opinions of professionals to consumers. Second, consumers receive a signal about the economy through the tone and volume of economic reporting. Last, the greater the volume of news about the economy, the greater the likelihood that consumers will update their expectations about the economy. We find evidence that all three of these channels affect consumer sentiment.
So can media bias harm the economy? Granting the authors' finding, the answer still depends on whether consumer sentiment actually drives behavior. As discussed in this earlier post, that is a complicated, and still controversial, issue.
Is the Dollar on the Brink?
This report comes from today's online edition of the Financial Times.
John Snow, the US Treasury secretary, on Tuesday reaffirmed the Bush administration's support for a strong dollar as the US currency slid to an eight-month low.
A week-long sell-off has seen the dollar slide to its lowest levels since February against the euro and Swiss franc, leading traders to suggest the currency's decline was gaining momentum...
Since January 2002, the US currency has lost 29 per cent of its value against the euro. Strategists said Mr Snow's remarks would do little to support the dollar should traders and investors believe it was back on a weakening trend.
Perhaps not surprisingly, the article conjectures that the dollar may be under pressure from the same uncertainties that seem to be bearing on the economy more generally.
Politics has also weighed on the dollar, with investors reluctant to commit fresh funds to the US ahead of the presidential vote next month.
“There's uncertainty about the effect of new voter registration, there's uncertainty about trade policy and about a possible new Treasury secretary,” said [Terra Capital Partners Marc] Chandler. “It seems that most new Treasury secretaries make several gaffes when they start and this could hit the dollar.”
Ok, then. What do you say we get this election thing over already?