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The Atlanta Fed's macroblog provides commentary on economic topics including monetary policy, macroeconomic developments, financial issues and Southeast regional trends.

Authors for macroblog are Dave Altig and other Atlanta Fed economists.


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November 30, 2005


Is It Gangbusters Yet?

James Hamilton's latest post takes a good hard look at incoming economic data, and provides lots of reasons to put on a happy face.  And that didn't even include today's revisions to third quarter GDP growth.  The short story, from MarketWatch:

The U.S. economy grew at a 4.3% annual rate in the third quarter, the Commerce Department said Wednesday in its first revision of gross domestic product estimates.

It was the fastest growth since the first quarter of 2004. The economy grew at a 3.3% pace in the second quarter and has now grown faster than 3% for 10 straight quarters. The economy has grown 3.7% in the past four quarters. Read the full release.

A month ago, the government agency estimated real (inflation-adjusted) growth in the period July through September at an annualized 3.8%.

The upward revision in GDP was largely due to higher spending on nondurable goods, and to more investments in homes and in business equipment and software.

People were impressed.

"The fact that we added a 10th quarter of above-average growth amidst the hurricane devastation and the highest energy prices ever recorded is awesome," said Ken Mayland, president of ClearView Economics.

From Bloomberg:

"The economy is booming,'' said Mike Englund, chief economist at Action Economics LLC in Boulder, Colorado. Englund correctly forecast third-quarter growth. ``As much as people may have been concerned about gas prices, consumers took the hit and now gas prices are falling.''

From the Wall Street Journal:

"My suggestion would be that people just recognize how well the economy is performing," [Alan Skrainka, chief market strategist with Edward Jones] said.

Around the blog-horn, Kash concludes "all in all, a strong report", and Bizzy Blog says "Ka-boom."
VoluntaryXchange is a little less effusive, but still bumps the economy's grade up to a B.

Were there any discouraging words?  Sure. General Glut processes the rising share of consumption, and suggests that the economic house may be built on sand.  A related concern shows up in the London Times Online:

Joe Liro, an economist at Stone & McCarthy Research, said: “Third-quarter economic growth was once again supported by strong consumer spending. Unfortunately, the consumer is not in position to provide such support in the fourth quarter, thus we anticipate a sharp slowing of fourth-quarter economic growth.”

And Bizzy Blog catches the New York Times seizing on every opportunity to not join the party:

For every encouraging sign, there is an explanation and concern for the future. Consumer confidence is bouncing back from what were arguably some of its worst readings in years...

Many economists do not expect the party to continue, especially if the Federal Reserve continues taking the punchbowl away and raises interest rates. That could further slow the housing market, damp consumer spending and crimp corporate profits.

But today's news on the inflation front was also pretty darn good.  From Reuters:

The report also showed inflation was milder than first thought. A price gauge favored by the Federal Reserve -- personal consumption expenditures excluding food and energy -- rose just 1.2 percent in the July-to-September period, down from the originally reported 1.3 percent pace.

That was the lowest rate of core inflation in more than two years.

Countering that was what was perceived as a less sanguine-sounding report from the Federal Reserve Banks:

The Federal Reserve also raised a small inflation flag in its "beige book" summary of economic conditions, noting that some businesses were able to pass on higher costs for energy, raw materials and transportation to consumers. Upward pressure on wages, however, was modest.

And so the guessing game on monetary policy proceeds.  From the Reuters article:

"The Fed can see there are price pressures early in the process, but companies are able to offset that through increased productivity ... and it's just not showing up as higher inflation at the core consumer level," he said.

Thayer said Wednesday's data reinforced expectations that the Fed would raise interest rates in December and possibly in January, taking borrowing costs to 4.5 percent, but could then likely stand pat as inflation pressures receded.

From the MarketWatch article:

"We see little likelihood that the economy will undergo a meaningful slowdown anytime in the foreseeable future without significantly higher interest rates," said David Greenlaw, an economist for Morgan Stanley.

And from the Financial Times:

“The report should remove thoughts that the Fed will pause any time soon in its monetary tightening,” said Augustine Faucher, an analyst at Economy.com. “With growth well above the economy’s potential of about 3.5 per cent in the third quarter and conditions pointing to above trend growth in the quarters ahead, the Fed will remain concerned about inflation pressures.”

That's a lot of news for one day.

In addition: William Polley has more on the beige book.   So does Ben Jones. pgl notes that the news is good in Europe too.

UPDATE:   William Polley endorses VoluntaryXchange's grading curve (and has interesting things to say about putting the latest GDP figure in perspective).  James Hamilton digs into the report, and says keep an eye on the shifting fortunes of sectors of the economy that produce internationally tradable goods versus those that do not. 

November 30, 2005 in Data Releases | Permalink

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The economy's long range potential of 3.5% shouldn't really apply with productivity rates at current levels should they?

Posted by: Lord | December 01, 2005 at 01:31 PM

David,

Checking the fine print in the PCE report, income down, disposable income down, consumption expeditures up, sounds like a nice stagflation squeeze to me.

Yet the hook in mouth media "glory boys" trumpeted "a lowered PCE chain deflator, signaling that core inflation is in check."

This is another econometric canard that is being foisted on an unsuspecting and gullible public.

http://naybob.blogspot.com/2005/12/pce-chain-deflator-cousin-of-cpi.html

Posted by: The Nattering Naybob | December 01, 2005 at 08:45 PM

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More Advice For The ECB (And Everyone Else)

The OECD has issued Economic Outlook No. 78 and, while the news is generally good, the decision makers at the European Central Bank get some (presumably unsolicited) advice.  From the Wall Street Journal (page A2 of the print edition):

World economic growth is strengthening yet faces obstacles from worsening global imbalances, including U.S. deficits, and an interest-rate increase the European Central Bank plans as early as tomorrow, according to a report by the Organization for Economic Cooperation and Development.

The ECB shouldn't raise interest rates for the 12-nation euro zone until late next year to avoid smothering Europe's fledgling recovery, the OECD said. The Paris-based organization, which comprises 30 developed countries, stressed that it saw no evidence or prospect of inflation's spreading.

The OECD's challenge to the ECB follows warnings by the International Monetary Fund and top European politicians that the euro zone's economy remains weak, and inflation there remains benign.

"What you want to avoid is a situation where you have some tightening at a stage which may prove premature," said the OECD's chief economist, Jean-Philippe Cotis. "The problem is that we've had several episodes of aborted recovery" in the euro zone, he said.

Edward Hugh links to the story from the Financial Times, suggesting the response will be something like "thanks, but no thanks":

The ECB is expected on Thursday to risk a backlash by raising rates by a quarter percentage point to 2.25 per cent, the first rise in five years.

In the holiday spirit, perhaps, the OECD observers appear willing to accept that just this once:

Jean-Philippe Cotis, the OECD’s chief economist, said: “A one-step increase will not by itself have much effect. It will be interesting to get a fuller view of what the ECB strategy is.”

And here is an interesting twist:

It recommended that the US Federal Reserve continue to raise rates by another 0.75 percentage point to 4.75 per cent, but urged restraint in Japan until 2007.

The rationale for all this?  This is from Mr. Cotis' accompanying editorial:

In the United States, where aggregate demand is buoyant, there is a clear need for early fiscal retrenchment and tax reform to redress the saving/investment balance in conjunction with the current tightening of monetary policy. In Japan, mounting public spending pressures associated with ageing call for faster fiscal tightening, while monetary policy should keep a very easy stance until the output gap moves squarely into positive territory and deflation is definitively uprooted.

In the euro area, where underlying inflation has been steadily declining and economic slack remains entrenched, monetary tightening should wait until the recovery gathers enough momentum and becomes more resilient, which may take a few more quarters.

I guess fine-tuning and fiscal/monetary coordination are back in style. Apparently concerns about inverted yield curves are not.

November 30, 2005 in Europe, This, That, and the Other | Permalink

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"I guess fine-tuning and fiscal/monetary coordination are back in style. Apparently concerns about inverted yield curves are not".

Well this is a point I've been arguing for some weeks now Dave, IMHO the inversion in the yield curve is not an indicator of an impending US recession at all, something here has changed (and we'll probably get the theory to explain the reality post hoc), and it is the interest rate differentials differentials and the rising dollar which are driving the inversion more than anything else.

This is why the central banks in Japan and Frankfurt want to raise sooner rather than later, so the Fed doesn't have to stop 'too early', and why the domestic politicians who are worried about growth and fiscal deficits are threatening to take away central bank independence. An interesting situation :).

Posted by: Edward Hugh | December 01, 2005 at 07:09 AM

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November 29, 2005


The Yield Curve Takes Center Stage

This morning's Wall Street Journal (page C6 in the print edition) brought this news:

Bond investors, worried about slackening home sales, nudged the threat level on their economic early-warning system a notch higher yesterday.

In an unusual event known as a partial inversion of the yield curve, investors kept buying five-year Treasury notes until their yield, which reflects expectations of how the economy will fare over the next several years, fell below the yield on two-year notes, which tracks expectations of what the Federal Reserve will do with interest rates in the shorter term.

As is often the case, things looked a little different at the end of the day.  This is from tomorrow's Wall Street Journal -- miraculously available at 9:21 PM the day before:

A surge in new-home sales last month and more confident consumers yet again helped blur the longer-term outlook on the economy and interest rates.

That weighed heavily on U.S. Treasurys yesterday and reversed a trend toward higher prices and lower yields that had emerged over the past few weeks.

That prompted this:

"There are a lot of important questions plaguing the bond market right now, and nobody has the definitive answers," said Jason Evans, head of government-bond trading at Deutsche Bank in New York...

By Monday, fears that the Federal Reserve might be dangerously close to pushing interest rates too high and further choking off growth caused a partial inversion of the yield curve, a rare occurrence in the bond market that usually warns of recession ahead. That inversion reversed yesterday, with the five-year note yielding a sliver more, rather than less, than the two-year note at 4.406%.

But a steady stream of bullish economic data now has some questioning that outlook. An increase in consumer confidence this month, propelled by falling gas prices, hearty online spending, strong chain-store retail sales and a record 13% increase in new-home sales in October, has reminded investors of the Fed warning that future monetary policy will be highly data-dependent.

Not everyone is so sanguine.  Kash at Angry Bear documents the fact that, yes, the spread between long and short maturity Treasury yields is pretty darn low, and puts "this in the category of Not-Very-Good-Signs for the economy in 2006."  And James Hamilton -- who has been warning about the possibility of an inversion -- explains exactly why this might be a Not-Very-Good-Sign. 

Furthermore, some are convinced that the economic news is something less than advertised.  Ben Jones tracks down a MarketWatch analysis that comes with a warning that "the new-home sales report is well known for its revisions" and "according to the Commerce Department, it's not certain that sales rose at all during October."  And Barry Ritholtz says don't believe the hype about retail sales, the housing boom is done and consumer spending is going with it.

Not that there aren't optimists out there. Calculated Risk thinks that "pronouncements of the demise of the housing market now appear premature."  At Bloomberg, the economy is described as "buoyant" (hat tip, Michael Mandel).  Although slightly less enthusiastic, William Polley still thinks it was "a pretty good day for economic date."

Can the optimistic outlook carry the day?  Sure. But as I noted yesterday, financial market participants seem to be anticipating a federal funds rate by March that is better than 25 basis points above the current 10-year Treasury yield.  I'm not sure which one it is, but one piece of this puzzle just doesn't seem to fit. 

November 29, 2005 in Data Releases, Federal Reserve and Monetary Policy, Interest Rates | Permalink

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» 2005Q3 GDP growth revised to 4.3% from William J. Polley
From the Wall Street Journal: The Commerce Department reported Wednesday that gross domestic product, the broadest measure of U.S. economic activity, grew at a seasonally adjusted annual rate of 4.3% in July through September. That was stronger than th... [Read More]

Tracked on Nov 30, 2005 12:57:40 PM

» More Pressure on the Yield Curve from A Few Euros More
One of the things about targeting expectations, and factoring-in changes, is that the world moves on at a very rapid clip these days. So the ECB rate rise in now, really, yesterday's news. The big issue today is the fact... [Read More]

Tracked on Dec 2, 2005 5:45:42 AM

» More Pressure on the Yield Curve from A Few Euros More
One of the things about targeting expectations, and factoring-in changes, is that the world moves on at a very rapid clip these days. So the ECB rate rise in now, really, yesterday's news. The big issue today is the fact... [Read More]

Tracked on Dec 2, 2005 6:13:31 AM

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November 28, 2005


Fed Funds Probabilities: A Peek At March

It's Monday, and that means it's time to report the Carlson-Craig-Melick estimates of what the folks who make their livings in the market for options on federal funds futures think the Federal Open Market Committee is soon to do.  At this point, there's not much question about the December meeting...



December_9


... and scant more for the January meeting:



January_6



So, we'll have to find what excitement we can in the March meeting.



March


That may not actually seem that exciting, but today the 10-year Treasury note closed at 4.4%.  If that doesn't change, and the market  prediction for the federal funds rate holds true, that could at least be interesting.

UPDATE: Ooops.  I neglected to post the data files this week.  Here they are:
Download implied_pdf_december_112505.xls
Download implied_pdf_january_112505.xls
Download Imp_pdf_slides_for_blog_112505.ppt

November 28, 2005 in Fed Funds Futures | Permalink

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» Facing the latest economic data from Econbrowser
Here are a few thoughts about some of the economic news that's been coming in over the last few weeks. [Read More]

Tracked on Nov 30, 2005 9:37:02 AM

» Subprime Mortgage Market News from Comments From Left Field
Daniel Gross, reading the Wall Street Journal (no link available), pulls out two interesting factoids that suggest that things are not quite hunky dory in consumer land despite the good headline numbers that we are seeing. [Read More]

Tracked on Dec 3, 2005 10:35:58 AM

» Looking Forward to an Inverted Yield Curve from Brad DeLong's Website
Macroblog looks at the forthcoming likely inversion of the yield curve: macroblog: Fed Funds Probabilities: A Peek At March: It's Monday, and that means it's time to report the Carlson-Craig-Melick estimates of what the folks who make their livings in ... [Read More]

Tracked on Dec 9, 2005 12:47:51 PM

Comments

"today the 10-year Treasury note closed at 4.4%. If that doesn't change, and the market prediction for the federal funds rate holds true, that could at least be interesting."

There's a very interesting discussion of the issues this raises here:


http://www.morganstanley.com/GEFdata/digests/20051128-mon.html#anchor3

Posted by: Edward Hugh | November 29, 2005 at 07:59 AM

A commenter at that blog posted a link to a very interesting discussion about interest rates at Morgan Stanley:
http://www.morganstanley.com/GEFdata/digests/20051128-mon.html#anchor3

Posted by: liberal | December 02, 2005 at 10:09 AM

Very interesting site I congratulate

Posted by: Cell | July 31, 2006 at 03:28 AM

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November 25, 2005


Mirror, Mirror, On The Wall, Who's The Most Hawkish Central Bank Of All?

I guess the answer, for now, is the Federal Reserve.  From Reuters:

The dollar edged toward recent 2-year peaks against the yen on Friday and rose versus the euro on the U.S. interest rate advantage over Japan and the euro zone.

The U.S. Federal Reserve's campaign of credit tightening, with expectations for further increases, has helped drive the dollar up more than 15 percent against the euro and yen this year.

On first review, that story may seem a bit puzzling light of this news, from the Financial Times:

Japan’s core consumer prices stopped falling in October, raising expectations that the world’s second-biggest economy may be on the verge of hauling itself from more than seven years of damaging deflation.

But the plot thickens:

Instead of celebrating, politicians lined up to remind the Bank of Japan that it was too early to declare deflation dead or to ditch its super-loose monetary policy.

Heizo Takenaka, the powerful internal affairs minister, told the central bank it should set monetary policy in conjunction with the government. In a repeat of stern remarks made by another senior politician this month, he warned the BoJ that its independence could be stripped away if it tightened policy prematurely.

As we have been discussing here at macroblog, that sort of "advice" certainly seems to be all the rage these days.  This report from the Wall Street Journal (page A9 in the print edition)...

Corporate confidence faltered in key areas of Europe this month, underscoring the fragility of economic conditions across the region.

A drop in Germany's bellwether index reflected a darkening view of current business conditions and the outlook for the coming year. On Thursday, the Ifo institute said its business-sentiment index for November fell to 97.8 from 98.8 in October. Last month, a dramatic improvement in the survey data had been hailed as a harbinger of better things in store for euro-zone companies.

In Belgium, the central bank reported a sudden downturn in business confidence to -4.3 in November, after a gradual improvement over the previous three months. The survey is another litmus test of business confidence across the 12-nation euro zone owing to Belgium's heavy dependence on exports.

Both declines reflected a marked deterioration in the retail sector.

... certainly illuminates this, from Bloomberg:

ECB President Jean-Claude Trichet told newspapers in Italy, Germany and France in an interview published yesterday that he doesn't see the need for "repeated'' increases. That follows his comments Nov. 18 when he said the Frankfurt-based central bank is ready to "moderately augment'' its benchmark rate from a six- decade low of 2 percent.         

"Trichet has emphasized that we're not going to get a series and we may just get a one-off,'' said Wilkes. "The Fed will continue to raise next year.''         

This is the point where I remind you that exchange rates are pretty complicated animals.  While it is certainly true that short-term interest rates have their impact, they are wrapped up into a bundle with confidence about future inflation rates, beliefs about the pace of economic growth, expectations about the changes required to bring about balance in a country's international trade position over time, and myriad other elements that are hard to disentangle. 

What seems to me to be the most obvious feature of the global economic environment for now is the pretty remarkable resilience of the US economy.  That may help explain why the Federal Reserve appears to be the only central bank among the big three that isn't receiving lots of input from the rest of the government on how monetary policy ought to be run.  And that may help explain why the dollar is appreciating , despite lots of reasons to believe that it should be moving in the opposite direction.

November 25, 2005 in Asia, Europe, Exchange Rates and the Dollar, Federal Reserve and Monetary Policy | Permalink

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"And that may help explain why the dollar is appreciating , despite lots of reasons to believe that it should be moving in the opposite direction."

As you once said, we are about to live in very interesting times. On the plus side there is a lot we can learn, if we are able to listen that is.

Great review of the stae of play :). Now lets see what next week brings. Dismal science, pah!

Posted by: Edward Hugh | November 25, 2005 at 09:13 AM

The Fed's dollar index is currently up just 3.5% from the monthly average low recorded in Dec 2004. An argument designed to explain the "strong" dollar may be based on a false premise.

I would prefer to say that EUR is weak. In 2004 EUR went up because it was not the dollar. And then folks discovered that Europe is a place, not just a numeraire. And these guys don't just sound french, some of them actually are french. Yikes.

Even the dollar can beat esperanto money, so far. Yayyyyyyy, we suck less, grace au Reserve Federale. But not even the Fed can protect the dollar from the mighty CAD, MXN and BRL these days.

Posted by: Gerard MacDonell | November 25, 2005 at 10:51 PM

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Yuan Appreciation Watch

From this morning's Wall Street Journal Online (subscription required):

China's central bank on Friday executed a deal in the domestic foreign-exchange market in what traders interpreted as a signal that a mild appreciation in its currency will be tolerated over the next year.

The People's Bank of China's "swap" with state banks allows it to buy $6 billion in 12 months at an exchange rate of 7.85 yuan. To make the deal attractive for the central bank, the yuan would need to rise at least 2.9% from current levels, not including interest. Traders said the central bank could therefore be trying to telegraph its expectations that the yuan will edge higher over the coming year.

The swap transaction was the first ever conducted by China's central bank and marks the latest advancement in the system's market orientation. More swaps could follow in the next few weeks and provide further clues of the central bank's thinking.

Here is the "however" part:

While Friday's swap transaction could signal there will be more flexibility in the currency in coming months, traders also said the central bank just as easily could have been trying to temper enthusiasm for a stronger yuan. Before the swap with what Dow Jones Newswires said were 10 banks, foreign exchange derivatives markets were already pricing in expectations the yuan would rise about 4% versus the U.S. dollar over the course of the year. Other non-deliverable forward derivatives contracts traded in Singapore and elsewhere outside China quickly matched the narrow appreciation level suggested by the swap transaction.

Meanwhile the evolution of the financial markets continues:

In another move that suggested China intends to introduce additional flexibility into the currency-exchange-rate system, the central bank said late Thursday it will tap market makers for dollar-yuan trading in 2006.

A market maker system could be a step toward relaxing the direct control China's central bank maintains over the yuan's value. Analysts say active participation by market-making firms could eventually replace the buying and selling of yuan often attributed to the People's Bank of China. Still, until China's yuan is fully convertible, the central bank would be expected to retain indirect control over the currency exchange rate by requiring qualified markets to follow certain instructions that would limit foreign-exchange volatility.

Note: If you are unfamiliar with currency swaps, you can find several simple definitions here, and a more extensive discussion here.

November 25, 2005 in Asia, Exchange Rates and the Dollar | Permalink

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» Daily linklets 28th November from Simon World
A bumper Monday edition: Hong Kongs smog claims the Kitty Hawk. Nude chat is almost not illegal in China. The general fallacy in Western analysis of China. Can Bush solve Chinas Yasukuni problem? Maybe its Japans Yasukuni problem. I... [Read More]

Tracked on Nov 28, 2005 2:31:50 AM

» Why the RMB USD swap is set at 7.85 from sun bin
So let's try to understand whether it is fair deal to the banks, or if not who is going to be benefited if RMB appreciates (or depreciates). [Read More]

Tracked on Nov 29, 2005 4:28:39 PM

Comments

Andy Xie also has some ineteresting observations on how changes in the value of the Yen could affect yuan expectations, and what this might mean for 'hot money'. He makes the point that with capital controls, and exports at a level of 70% of GDP, the easiest way of 'getting round' the controls is over- and under-invoicing. This means - given the volume of exports and the difficulty of control - that money can leave very quickly, and looking at the way people are leaving Harbin right now, I can't help thinking about your Higgins and Humpage link.

http://www.morganstanley.com/GEFdata/digests/20051125-fri.html#anchor1

Takehiro Sato, commenting on the Japanese price index says this:

"The wild cards are oil prices and the (US) dollar/yen rate. Our scenario could crumble if these prove stronger than we expect. In truth, there is massive uncertainty about where prices will be a year from now."

When he talks of massive uncertainty, and you say "Perhaps the uncertainty will lift sooner than later.", I can't help thinking that maybe what we really need is a level of uncertainty index :).

Posted by: Edward Hugh | November 25, 2005 at 09:08 AM

PBoC has entered into similar contracts with state banks before, although it was an option with a different strike price.

http://sun-bin.blogspot.com/2005/08/how-much-would-rmbusd-rate-drift-ii.html

my gut feeling is that the change in exchange rate implied by such transaction will be just short of making the NDF speculation profitable, for obvious reason.

http://sun-bin.blogspot.com/2005/07/how-much-would-rmb-peg-drift.html

Posted by: sun bin | November 28, 2005 at 05:13 AM

somehow trackback doesn't work. :(

i finally did the swap calculation. 7.85 just reflected the difference in interest rates

http://sun-bin.blogspot.com/2005/11/why-rmb-usd-swap-is-set-at-785.html

Posted by: sun bin | November 29, 2005 at 03:19 PM

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November 24, 2005


More Ado About M3

The fallout continues from the Federal Reserve Board's recent announcement that they will soon discontinue publication of the M3 monetary aggregate, and many of its components.  Tom Iacono -- who must surely need a new name for his blog any day now -- has a good review of recent commentary on the subject. (A tip of the hat to Dave Iverson.)  I'm still somewhat surprised by the sentiment that the Board's decision is, at least in part, motivated by the desire to downplay a statistic that appears to be contradictory to the achievement of price stability.  I'm surprised because such sentiment seems to imply that the FOMC places significant weight on the behavior of monetary statistics in the first place!

Let's go back in time, to the July 1993 Monetary Policy Report to the Congress.   Here is what Chairman Greenspan had to say in his testimony:

... at least for the time being, M2 has been downgraded as a reliable indicator of financial conditions in the economy, and no single variable has yet been identified to take its place.

By July 2000, this footnote appeared in the written report:

At its June meeting, the FOMC did not establish ranges for growth of money and debt in 2000 and 2001. The legal requirement to establish and to announce such ranges had expired, and owing to uncertainties about the behavior of the velocities of debt and money, these ranges for many years have not provided useful benchmarks for the conduct of monetary policy. Nevertheless, the FOMC believes that the behavior of money and credit will continue to have value for gauging economic and financial conditions, and this report discusses recent developments in money and credit in some detail

"Velocity" represents the number of times the stock of money turns over in support of spending, and it is the key piece of information policymakers need to to connect monetary measures to objectives.  (You can read a bit more about the theory here.)  In short, if you can't predict velocity, you really cannot predict how changes in the money supply will impact the rate of inflation.

With that thought in mind, the following picture of M2 velocity helps to explain why monetary statistics have been "downgraded " in monetary policy deliberations:

 

M2_velocity

The lines represent the trends in velocity -- and the changes in those trends -- identified by formal statistical tests.  If you are interested in the formal details of these calculations, you can look them up in a paper by John Calrson, Ben Craig, and Jeff Schwartz that describes the methodology.  But you can also just believe your own lyin' eyes, which will tell you, I think, that velocity has not been very predictable over the past decade-and-a-half.

I would have shown you a picture of M3 velocity instead of M2 velocity, but for one problem.  One way to think about velocity is that it represents the part of money demand that is sensitive to changes in interest rates.  Estimating trends requires some estimate of the return on the monetary measure (so it can be compared to the return on nonmonetary assets -- giving us an idea of the "opportunity cost" of holding money). To the best of my knowledge, no regular estimate of the return to M3 is even available.  That alone speaks volumes.

So here's my last word on the subject.  If you have a sense that M3 is providing any information at all related to the objectives of monetary policy, you know something I don't know.

For all of you in the States -- or whose hearts are in the States -- Happy Thanksgiving.

November 24, 2005 | Permalink

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EXPECTATIONS SHIFT WATCH!

AS IN GROUNDHOG DAY WE ALWAYS WATCH FOR THE FIRST OF THE "HERD" TO PUBLICLY SHIFT THEIR FORECASTS..

WHERE ONE GOES SO DO ALL EVENTUALLY WE'VE FOUND....

THIS IS OUR FIRST OFFICIAL SITING OF A MAJOR PLAYER HERE CITIBANK/SOLLY.. COMING FORTH WITH THE ANSWER TO THE CONUNDRUM..

THE FED WILL START EASING BY MID 2006!!!
TOUGH TO KEEP THE OLD TEN YEAR NOTE DOWN IN PRICE WHEN YOUR PRIOR IS THAT THE FED WILL BE EASING SOON?

The Federal Reserve will raise its benchmark interest rate
to 4.5 percent in the first quarter from 4.0 percent now,
Citigroup said yesterday in a note to clients. The U.S. central
bank will bring the figure down to 4.25 percent by year-end,
matching the 10-year yield, it said

Posted by: stan jonas | November 24, 2005 at 11:33 AM

I will try the other approach and find out why M3 is so important for the ECB. It is the only figure that gets honored by the ECB with a regular monthly press release. Also of note is that Trichet and his chief economist Issing have been saying for months that M3 growth is a major concern to them and gives reason to think about hiking rates. When European central bankers talk about ample liquidity they always refer to M3.

Posted by: The Prudent Investor | November 24, 2005 at 01:25 PM

The ECB routinely accommodates overshoots of its "reference" rate for monetary growth, suggesting that it is only paying lip service to monetary aggregates.

Posted by: Stephen Kirchner | November 24, 2005 at 05:38 PM

"I will try the other approach and find out why M3 is so important for the ECB."

Yep, well if you come up with any meaningful answers, please let me know.

God, and the ECB both "move in mysterious ways" as far as I am concerned.

I won't say anything about Otmar Issing, since I've promised to be polite all this week.

Posted by: Edward Hugh | November 25, 2005 at 06:33 AM

"In short, if you can't predict velocity, you really cannot predict how changes in the money supply will impact the rate of inflation."

Yep, that's right. But somehow I keep hearing the argument that inflation is, always and everywhere, a monetary phenomenon.

For those who somehow find they can't treat this as gospel, here's an interesting article by Belgian economist Paul de Grauwe, published in the Scaninavian Journal of Economics, and entitled appropriately enough:

"Is inflation always and everywhere a monetary phenomenon?"

http://www.econ.kuleuven.be/ew/academic/intecon/Degrauwe/PDG-papers/Recently_published_articles/DeGrauwe_Polan_SJE_2005.pdf

This issue has more than passing importance in the light of recent economic evidence from Germany and Japan, which suggests that "deflation" and "absence of inflation" is *not* always and everywhere a monetary phenomenon.


Now here's an extract from the paper:


"In this paper, we return to this issue using a sample of countries spanning the whole world over a period of 30 years. The key question we analyse concerns the link between inflation and the growth rate of money and how it depends on whether countries experience low or high rates of inflation.

Our results have some implications for the question regarding the use of the money stock as an intermediate target in monetary policy. As is well known, the European Central Bank continues to assign a prominent role to the growth rate of the money stock in its monetary policy strategy. The ECB bases this strategy on the view that ‘‘inflation is always and everywhere a monetary phenomenon’’. This may be true for high-inflation countries. Our results, however, indicate that there is no evidence for this statement in relatively low-inflation environments, which happen to be a characteristic of the EMU countries. In these environments, money growth is not a useful signal of inflationary conditions, because it is dominated by ‘‘noise’’ originating from velocity shocks. It also follows that the use of the money stock as a guide for steering policies towards price stability is not likely to be useful for countries with a history of low inflation."

Posted by: Edward Hugh | November 25, 2005 at 06:49 AM

In the same vein, here's some more grist to the mill from Paul de Grauwe in yesterdays Financial Times and talking about ECB President Trichet's volte face last week on interest rates:

"It is difficult to understand such a turnaround. One can only guess what underlies this “volte face” that put the financial markets on the wrong foot. Here is my explanation, which I cannot prove but which seems to make sense. There is a hard core of “hawks” in the governing council who cherish a monetarist agenda. This agenda has two items. One is to bring the rate of inflation back below 2 per cent, the only target the ECB has declared to be salutary and consistent with price stability. The second is to curtail the “excessive” growth of the money stock, M3, which has now reached an annual rate of 8 per cent (but this was also the case two weeks ago when the ECB declared that this was not sufficient to raise the interest rate). The hawks somehow managed to have the upper hand in the governing council and to make the president their spokesman when he came out declaring that a rate increase now had become necessary. This statement also makes a rate increase almost inevitable next month"

"The argument that a rate increase is necessary because the acceleration of M3 growth signals a higher future inflation is equally weak. In 2002-2003 the yearly growth rate of M3 was about 8 per cent during two consecutive years. Monetarists, reminiscent of Milton Friedman’s notorious predictions, forecast that this would inevitably lead to an upsurge of inflation two years later. It has not happened. Inflation moved in a flat band between 2 and 2.5 per cent. This will not surprise other central bankers who abandoned monetary targeting long ago after finding out that, in a low inflation environment, money numbers are very bad predictors of future inflation."

Posted by: Edward Hugh | November 25, 2005 at 06:56 AM

There seems to be a growing disconnect between what people are told the rate of inflation is, and what they experience in their own lives - and not just for energy. Healthcare, tuition, and many other service categories have been rising sharply, while at the same time the cost of imported goods remains stable or declines (how many DVD players do you really need?).

And then there's housing.

Congresswoman Carolyn B. Maloney put it best when asking the following question of Alan Greenspan before the Joint Economic Committee meeting on November 3rd:

"The question that my constituents ask me, I'm going to ask you, 'If the economy is so good and inflation is so well behaved, and there's price stability, then why does everything cost so much more when you go to buy something?"

Not just energy, "everything" (exclusive of DVD players, probably).

Over the last ten years inflation as measured by CPI-U has been in the 2-3 percent range, whereas money supply growth has been in the 5-10 percent range, with the fastest growth coming from the M3-M2 component, the reporting of which is being terminated.

The sense that I get is that the rise in prices felt by consumers is higher than what is being reported in government inflation statistics, and that past and future M3 growth is the uncomfortable confirmation of this.

P.S. (The name of my blog works equally well in the present and past tense).

Posted by: Tim | November 25, 2005 at 11:09 AM

First we define down cpi by a full point (Greenspan hyped Boskin recommendations), then we stop tracking our broadest money stock because it, in Wm. Polley's words, "has very little to do with monetary policy. But, the Fed's H.6 release indicates non-m2 M3 growth is mostly in large denomination deposits & eurodollars, not in repos. Isn't that monetary? It makes sense that a Fed that believes r.e. asset appreciation is NOT inflationary wouldn't want to track the "new money" created by asset appreciation. But, why aren't Economists questioning the Fed's decision?
Dave Altig, who knows the Fed, says the "Board" made the decision & he doesn't know all the factors that went into it. My experience is when staff's excluded from decisions, there's a good chance politics are involved.
For thousands of years inflation was addressed as the changing value of real assets over time. Now, the Fed (& Fed talking heads interpret inflation as "an increased quantity of money" and tell us the increase in cost of goods is responsive to the changed money supply. The confusion comes because the Fed (post Bretton Woods) rightly refuses to restrict its options by rigidly defining what "money" is. So, the question remains, if our broadest money stock is now deemed "NOT" money, what is money? And, why did the Fed descard M3 without first providing a "new" measure? The legitimacy of this question is validated by the agressive attacks on questioners of this Fed action. My response: 1. Repos are only a very small part of non-m2 m3 growth, too small to use as justification for abandonment. 2. Large denomination deposits are not attributable to "financial market innovation" & historically don't they better track inflation than m2? 3. Correlating current m2 to pre-Boskin cpi (+1%) would make a stronger argument for its recent relevancy over m3. 4. Ad hominem dismissals of "conspiracy theorists" is hardly a reasoned response worthy of honest brokers, the role I'd expect of Academic Economists.
Where does the pro-Fed spin from "independents" stop & when will Academic Economists recognize their societal
responsibilities? What's the value of tenure if it doesn't encourage argument independent of political consideration?
Below is a link to a blog by David Chapman maybe someone would respond to when time allows. I'm not familiar with him (probably a businessman) but I think he presents some strong points.
http://www.freemarketnews.com/Analysis/40/2982/2005-11-23.asp?wid=40&nid=2982

Posted by: bailey | November 26, 2005 at 09:17 AM

11/25/05 Prudent Bear's Doug Noland adds insight into M3 debate:
"A Quickie on “Money”:
“Money” connotes quite different things to different people. Some would argue that gold – a store of value over the ages that is nobody’s liability – is money in its purest form. Others have a more traditional (narrow) focus on currency and banking system reserves (“money stock”), and would generally analyze “money” primarily in terms of its role in consummating transactions. Many still view the money supply as something under the Federal Reserve’s control, holding “Fed pumping” responsible when the monetary aggregates expand rapidly. It is common for pundits to focus on what they believe “money” should be rather than the distinguishing characteristics of the creation, intermediation, risk profile, function and various effects of today’s extraordinary inflation of myriad financial claims.

And while most will view it as unconventional, I believe my “money” analytical framework is consistent with the thinking of some of the leading monetary economists of the past. Consistent with Ludwig von Mises’ “fiduciary media” approach, monetary analysis must be quite broad in scope and focused on the “economic functionality” of new financial claims. Allyn Abbott Young was keen to appreciate the “preciousness” attribute of money throughout history. It is the perceived preciousness (“moneyness”) of specific types of contemporary financial claims that leave them highly susceptible to over-issuance. Traditionally, when it came to financial claims expansion it was government issued currency and central bank created reserves that generally enjoyed the type of persistent (“store of value”) demand conducive to protracted Credit inflations. These days, the defining feature of contemporary Wall Street finance is the amalgamation of financial sector intermediation, the proliferation of credit insurance, financial guarantees, derivatives, implied and explicit GSE and government guarantees, and myriad sophisticated risk-sharing structures that have created to this point unlimited capacity to issue perceived “precious” financial claims. It is the Inherent and Dubious Nature of The Moneyness of Credit that Supply Creates its Own Demand.

I will loosely define contemporary “money” as financial claims perceived to be a highly safe and liquid store of nominal value. Simple enough, one would think, although it is a definition quite problematic for most. The catch is “perceived.” You can’t model perceptions, so my definition would be unacceptable to most academics, econometricians and trained economists (including Fed economists that measure and monitor money growth). Nonetheless, it is my view that the type of financial claims that demonstrates the “economic functionality” of “money” can vary greatly depending on evolving marketplace perceptions with respect to safety, liquidity, and the capacity to maintain nominal value.

And, importantly, I strongly argue that over the life of an inflationary boom the marketplace will come to perceive characteristics of “moneyness” in an expanding array of financial claims, and that this expanding universe of readily accepted instruments plays a defining role in perpetuating the boom. This is particularly the case when it comes to asset Bubbles and the underlying claims backed by inflated collateral values (i.e. after a protracted real estate boom, ABS and MBS today enjoy perceived moneyness qualities). Almost by definition, the final precarious boom-time speculative blow-off is financed through the frenetic expansion of dubious, yet momentarily treasured, financial claims.

With the above as background, I will attempt to clarify my view that we are at no analytical loss with the upcoming relegation of M3 to the government data scrapheap. First of all, M3 is today definitely not reflective of marketplace perceptions with respect to “moneyness.” With each boom year, the spectrum of perceived safe and liquid instruments expands. This year will see record ABS and commercial paper issuance, with the combined growth of these two categories of financial claims likely in the range of total M3 growth. M3 captures little of this imposing monetary expansion.

The monetary aggregates (“M’s”) were constructed for a bygone monetary era largely dictated by banking sector liabilities, intermediation and payment clearing. The expansion of deposits and other bank liabilities (“repos,” euro deposits, etc.) would sufficiently capture total system Credit growth, with the M’s generally correlating well with nominal economic output and indicative of general financial conditions. However, several fundamental developments have profoundly altered the monetary landscape and the capacity for the M’s to reflect relevant economic and market developments. The rise to prominence of non-bank lending mechanisms has profoundly changed the nature of financial sector liability creation and intermediation.

Market-based securities issuance is now a major aspect of monetary expansion, and the M’s are undoubtedly ill-equipped for such an environment. The unprecedented expansion of GSE obligations (debt and MBS) created several Trillion dollars of perceived safe financial sector liabilities. The enormous growth of Wall Street intermediation has spurred both a boom in securities issuance and incredible growth in (individual and institutional) account balances held throughout the (international) broker/dealer community. Technological advancement has also played a key role in expanding “moneyness.” For example, the Internet now allows households and institutions to directly purchase Treasury bills and myriad securities online, when much of these funds would have in the past been held in bank or money fund deposits (and included in the M’s). I also believe our massive Current Account Deficits and the corresponding ballooning of foreign central bank dollar holdings have impacted the relevancy of the M’s. Every day now, a couple billion dollars of Credit growth immediately flows to overseas institutions, where much of it is recycled back to financial claims (Treasuries, agencies, MBS, and ABS) not included in the monetary aggregates. If these funds were instead held domestically as savings, it is quite likely that a large percentage would be held in instruments included in the M’s.

It is also worth noting that the M’s can at times prove especially flawed indicators of Credit expansion. In periods marked by a significant augmentation of Marketplace Risk Embracement, disintermediation out of low-yielding bank and money fund deposits into riskier instruments may meaningfully distort the M’s (recall 2003’s 4th quarter). Not only would stagnant monetary aggregate growth fail to reflect system Credit expansion, it would give decidedly erroneous signals with respect to system liquidity. And I know this is unconventional thinking, but I have come to completely disassociate the M’s from system liquidity. I would argue that system liquidity is today determined by the capacity of the broader financial system (including Wall Street, hedge funds, the “repo market”, foreign bank and global central bank dollar holdings) to expand, almost irrespective of the M’s.

In summary, the M’s no longer reflect either system Credit growth or system liquidity, and are prone to give erroneous signals at critical junctures (when Marketplace Risk Embracement is modulating). I have watched repeatedly over the past few years as analysts have pounced on any slowdown in the M’s as an indicator of waning Credit growth and liquidity. This year, it was the stagnation of MZM that captured analysts’ attention, notwithstanding that this development was largely related to continued disintermediation from the money fund complex and the shift to higher-yielding term deposits; Credit growth remained on record pace, and the Bubble economy carried on. Moreover, M3 is clearly not capturing the historic expansion in the securities-financing repurchase agreement (“repo”) marketplace. While primary dealer “repo” positions have expanded $975 billion over the past two years, the M3 component bank net “repo” liability position has increased $27 billion. And while some “repo” positions are being captured in Money Funds holdings, there are enormous perceived “money” assets held in the ballooning securities financing arena outside the purview of the M’s.

If the Fed endeavored to shroud the extent of current monetary inflation, I suggest they stick with publishing M3. And it is inconceivable at this point to expect the Fed – or the economic community – to embrace a broad-based measure of monetary instruments that would include Wall Street marketable securities and “repos.” Anyway, contemporary “money” is a moving target that changes at the whim of marketplace perceptions. And while I question the premise that the Fed has much to gain by eliminating M3, this nonetheless misses the much more salient point: The Fed has lost control of our nation’s “money” and Credit creation processes. The Greenspan/Bernanke Fed can now only administer feeble attempts to remove accommodation, hoping that over time baby-steps makes some headway but without ever attempting to impede, interrupt or discipline Wall Street Monetary Processes." Link:
http://www.prudentbear.com/creditbubblebulletin.asp

Posted by: bailey | November 26, 2005 at 11:45 AM

The prudent bear analysis is very good. Over time, interest in money supply waxes and wanes.
Right now M 3 is not of much value. But who knows what will happen in a few years. It may become important again, but how will we know if it is not published?

Posted by: spencer | November 26, 2005 at 04:54 PM

Linking money supply increases to currency debauching and asset bubble inflation is as easy as identifying a foot print made by a Bruno Magli. The printing presses will double our current money supply by 2010.

http://naybob.blogspot.com/2005/11/asleep-at-wheel-part-i.html

Posted by: The Nattering Naybob | December 01, 2005 at 09:10 PM

I shifted 25% of my assets to gold (then at $350) when I saw the M3 supply figures going through the rough. Come on David, you do not belong to the Fed anymore.

Posted by: Raphael | January 21, 2006 at 07:26 PM

While primary dealer “repo” positions have expanded $975 billion over the past two years, the M3 component bank net “repo” liability position has increased $27 billion. And while some “repo” positions are being captured in Money Funds holdings, there are enormous perceived “money” assets held in the ballooning securities financing arena outside the purview of the M’s. http://www.elinkslondon.com/links-of-london-bracelets.html

Posted by: pandora beads | July 18, 2010 at 10:48 PM

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November 23, 2005


The Bank of England On Hold

Yesterday we received the minutes from the last meeting of the Federal Reserve's monetary policy committee.  Today the news is the minutes from the Bank of England's November meeting.  Some details, from the London Times Online:

The Bank of England’s Monetary Policy Committee was so unanimous in its view not to change interest rates at its meeting earlier this month, that they did not even discuss the matter, according to the meeting minutes published this morning.

The MPC meeting on November 9-10, which had access to the economic forecasts within the central bank’s quarterly Inflation Report at the time of the meeting, said the risks around the central projections were evenly balanced, but that the uncertainty around the near-term profile for inflation was more than usual.

Against that backdrop, the Committee agreed to maintain the repo rate at 4.50 per cent," the MPC said.

But the unanimity does not mean the MPC is being decisive, according to analyst Howard Archer, of Global Insight. "The 9-0 vote and general tone of the minutes confirm that the Monetary Policy Committee is firmly in 'wait and see mode' at the moment," Mr Archer said.

Here's the outlook in the words of the MPC, from Bloomberg :

Policy makers reached their decision in light of new projections published on Nov. 16 that showed inflation would hit its target of 2 percent within two years and economic growth in Europe's second-biggest economy would gradually recover. Governor Mervyn King said in a press conference that given the inflation projection it was "perfectly reasonable'' to keep the benchmark rate on hold.''...

"There were signs that output growth in the second half of the year would be a little stronger than in the first half,'' the minutes said. "There was also considerable uncertainty about the impact of higher energy prices on inflation both in the recent past and the immediate future.''

What's the message?

"The message is that interest rates are on hold for now,'' Adam Chester, chief economist at HBOS Treasury Services plc in London said in a telephone interview. "Genuinely, they have very little idea about growth and inflation next year. There are risks to both sides.'...

Some investors are speculating the central bank will pare its benchmark rate again since it lowered its projections for inflation and growth over the next two years.       

The implied rate on the interest-rate futures for June was 2 basis points higher at 4.51 percent as of 10:04 a.m. in London, which compares with 4.56 percent on Nov. 16.

BBC News interprets things this way:

The minutes indicate rates are now set to stay unchanged into the New Year.

Experts are split on whether rates will rise or fall in 2006. The last change was August's cut to 4.5% from 4.75%.

Some economists predict rates will be lowered again next year to aid the under-pressure manufacturing sector and lift retail sales, while others point to a rise to prevent any inflationary pressures.

In related news, the Times Online reports that "confidence is back" in the UK housing market:

British homeowners were handed some more good news this morning when the latest housing market survey from Rightmove, the property website, suggested that house prices have now risen for two months in a row.

In an echo of recent bullish surveys by mortgage lenders such as the Halifax, Rightmove said house prices rose by 0.8 per cent in the four weeks to November 12 - building on a 0.5 per cent rise during the previous month...

"This is not a return to a boom market, but the arrival of the long-awaited soft landing. It is also a reflection of the unseasonably high sales reported by estate agents during the summer months working through to completion," Rightmove said...

Perhaps the uncertainty will lift sooner than later.

November 23, 2005 in Europe | Permalink

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Tracked on Nov 25, 2005 8:13:39 AM

Comments

"Perhaps the uncertainty will lift sooner than later".

Yep, but the thing about uncertainty is that we don't know which way it will lift :).

Be careful with the housing data, the jury is most definitely still out.

btw, shouldn't you re-christen this the "central banking blog"?

Posted by: Edward Hugh | November 25, 2005 at 06:58 AM

Att Bank Of England.
I very much appreciate if you can
even lower those long term mortgages rates as my five hundred
and forty nine properties are up for renewal on those high term mortgages taken out over the last decade.When I renew them I try
to renew them at very long term
so my bank expense will drop dramatically starting int the year
2006.As mr.Alan Greenspan stated
over and over again.Those long term
rates are a conundrum.But not for
me.For me they are very sweet and
delicious.If You wish to you may relay
this message to Mr.Alan Greenspan,Fed chief of the U>S>..
Please tell him his conundrum is so sweet,it is better then those
$8.00 watermelons I purchase all
summer at my summer retreat in
californis

Signed by Mr.harry jackson

Posted by: Mr.Brian van fenster | November 29, 2005 at 01:59 PM

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November 22, 2005


Germany's Economic Blueprint

It's official:

Angela Merkel was sworn in Tuesday as Germany's first female chancellor, heading a bipartisan government that's seeking to turn around Europe's leading economy.

Merkel assumes office after a tumultuous post-election period, forcing her center-right Christian Democratic Union-led alliance to turn to Gerhard Schroeder's center-left Social Democrats to form a ruling coalition, and ceding key government posts in the process. The September election resulted in a stalemate.

Merkel, Germany's eighth head of state since World War II, will be working with opposition members including Peter Steinbruck, who will be finance minister, and Franz-Walter Steinmeier, who will be foreign minister...

The parties agreed on several strategies to boost the German economy, which has suffered from unemployment of over 11% and virtually non-existent domestic consumption.

Here is a rundown of that strategy, from the London TimesOnline:

POLICIES TO RESTORE GERMANY

BUDGET: Bring budget deficit into line with EU’s 3 per cent of GDP cap by 2007; said to require a minimum of €35 billion in cuts and new revenue

TAX: VAT to rise 3 percentage points, to 19 per cent, in 2007; reduction in tax incentives/exemptions from Jan 2006, such as scrapping tax breaks on new home purchases

ECONOMY: €25 billion to be invested in research and infrastructure. Small and medium-sized companies boosted by tax breaks and simpler rules on writing down value of plant and equipment against tax

ENERGY: Continue gradual decommissioning of nuclear power stations by 2020. Aim to generate 12.5 per cent of total electricity output from renewable sources by 2010, 20 per cent by 2020

LABOUR: Job protection measures to be reduced; probationary period for new recruits extended to 24 months from present six. Long-term jobless benefits in eastern Germany to be raised to western level

PENSIONS: Retirement age to rise to 67 from 2012 to 2035. Benefits to be frozen for four years, contributions to rise 0.4 percentage points, to 19.9 per cent of salary, from 2007

The headline from the TimesOnline article about says it all:

Now for the really difficult bit

UPDATE: Maybe even more difficult than everyone had hoped.  Edward Hugh points to a Financial Times report on weakening consumer spending plans in the eurozone, which he characterizes as "sobering news."


November 22, 2005 in Europe | Permalink

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Comments

This reminds me of the Churchillian phrase "this is not the end, but simply the begining of the end". Of the reform process I mean. The FT pointed out that this is likely to be the most fiscally conservative government in recent German history, which contextualises a bit their worries about what might be going on over at the ECB.

Posted by: Edward Hugh | November 23, 2005 at 01:24 AM

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The End To Measured Pace?

The minutes of the November 1 meeting of the Federal Open Market Committee are now public record, and they contained this tidbit about the future of the measured pace formulation:

In their ongoing discussion of the Committee's communication strategy, participants expressed a variety of perspectives about how the policy statement issued at the end of FOMC meetings might evolve over time. Several aspects of the statement language would have to be changed before long, particularly those related to the characterization of and outlook for policy. Possible future changes in the sentence on the balance of risks to the Committee's objectives were also discussed. Participants noted that any forward-looking elements of the statement should clearly be conditioned on the outlook for inflation and economic growth. For this meeting, members concurred that the current statement structure could be retained, as it accurately conveyed their near-term economic and policy outlook.

Looking toward a change in language is certainly understandable in light of this (from Bloomberg):

Federal Reserve policy makers discussed the need "before long'' to change their outlook for the benchmark U.S. interest rate, with some worried about the risk of raising it too much, minutes of their Nov. 1 meeting showed.

Some members of the rate-setting Federal Open Market Committee "cautioned that risks of going too far with the tightening process'' may eventually emerge. The report was released today in Washington.         

That prompted this, from Reuters:

"If the Fed is going on hold, it's a big positive," said Mark Bronzo, managing director of Gartmore Separate Accounts LLC.

The Nov. 1 minutes showed that some members of the Federal Open Market Committee "cautioned that risks of going too far with the tightening process could also eventually emerge."

Not so fast though:

After the closing bell, Jeffrey Lacker, the president of the Federal Reserve Bank of Richmond, said it was too soon to declare the U.S. central bank's campaign of interest-rate increases was over. He also said inflation remained a risk amid solid growth, echoing concerns revealed in the Fed's minutes.

"It looks like we're weathering the energy shocks pretty well, but it is too soon to declare us out of the woods," Lacker said.

Nonetheless, the equity markets liked what they read. From MarketWatch:

Stocks closed sharply higher Tuesday, with Dow component Intel Corp. advancing more than 3%, after new Federal Open Market Committee meeting minutes showed some members are worried about excessive rate tightening...

What caught the market's attention is a comment that some FOMC members believe the Fed should be alert to the fact that they may raise rates too aggressively at some point in the future and that this might affect economic growth," said Michael Sheldon, chief market strategist at Spencer Clarke.

"This comment is the first time FOMC members have provided any hint that they may be moving closer to the end of the current rate tightening cycle," he added.

The bond market was pleased too. From CNNMoney:

Treasury bonds turned higher Tuesday as investors eyed the minutes from the last Fed meeting, which revealed that central bankers were still worried about a possible pickup in inflation but were also eyeing a slowdown in their rate-hiking campaign.

The currency watchers, though, had a little different reaction. From DailyFX:

The dollar is rolling over and as always, it is the Fed’s fault. The market was already reeling from the hawkish comments from ECB officials over the past few days and today, the sell-off in the dollar deepened when some Federal Reserve members warned against going too far with rates during their November 1st meeting.

I guess you just can't please everyone.

UPDATE: Stock Trading Update says "The Fed Blinks," and thinks this is why market participants are "wearing their rally hats."  Barry Ritholtz agreesEdward Hugh complains that the Financial Times can't quite get the story straight.

November 22, 2005 in Federal Reserve and Monetary Policy | Permalink

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Tracked on Nov 27, 2005 6:54:09 PM

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http://naybob.blogspot.com/2005/11/market-soapbox-112205.html

Dave,

Here's what the talking heads ignored:

"The outlook continued to be for core inflation to pick up modestly over coming quarters owing to the lagged effects of higher energy prices... Manufacturing capacity utilization dropped substantially in September... underlying economic slack was likely quite limited."

In other words, the fed expects core inflation to pick up near term and even though capacity utilization dropped, the underlying slack (i.e. the output gap or difference in what we can produce vs. what we are producing) is quite limited or narrow.

Limited slack means that if there is a further increase in demand, price inflation will ensue. This could trigger more rate increases at higher levels (i.e. 50 basis point, rather than the measured 25 bps) and this would necessitate the removal of the term "measured".

The Nattering Naybob

Posted by: The Nattering Naybob | November 22, 2005 at 10:24 PM

Well, well, well. What are the odds now on a brief pause at the next meeting, and a moore definitive revision of the wording before continuing to tighten.

This all depedns on how you read the tea leaves, but if you think that this was done explicitly to open possibilities later (to increase your options portfolio), ie you need to read this backwards, well.......

Posted by: Edward Hugh | November 23, 2005 at 02:49 AM

Well, I take some comfort in the fact that Bloomberg just picked up a tune I've been playing: you need to prepare the ground for Bernanke. I still expect one pause before 1 February 2006:

"Federal Reserve policy makers, by signaling they will soon alter their outlook for interest rates for the first time in 18 months, may help maximize Ben Bernanke's options on how much further to go in raising rates."

"Bernanke awaits Senate approval to succeed Alan Greenspan as Fed chairman. Bernanke would take office Feb. 1, the day after traders expect the central bank to boost the benchmark rate to 4.5 percent, which would be the 14th consecutive quarter-point increase."

"``The assumption is, they'll have to change it to give Bernanke a clean slate,'' said Diane Swonk, chief economist at Mesirow Financial Inc. in Chicago."

The puase can't be Bernanke's first decision (or his second one), that would give all the wrong signals. That would be a job for the ECB, and the Fed isn't the ECB (I hope).

Basically Bernanke is going to be tested, and it doesn't matter whether inflation is a real problem or not, to establish credibility he has to be seen to be tough. This is what happens when you get into the realm of credibility and expectations.

Posted by: Edward Hugh | November 23, 2005 at 02:59 AM

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