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November 29, 2006

And So It Begins?

From the Financial Times:

Last week was significant in that the dollar breached an important barrier, according to traders. Since May, it had been relatively stable within a euro trading range of $1.25-$1.30. Its fall outside this range left investors wondering whether that was simply due to a lack of liquidity around the Thanksgiving holiday or the start of a more sustained slide in the US currency...

An even bigger concern is growing talk of global central banks diversifying their foreign exchange reserves away from the US currency. One factor supporting the dollar has been huge purchases by foreign central banks. Since 2001, global currency reserves have soared from $2,000bn to $4,700bn according to the IMF, with two-thirds of the world's stockpiles held by six countries: China, Japan, Taiwan, South Korea, Russia and Singapore.

Anxieties over reserve diversification have been around for at least six months, with central banks in Russia, Switzerland, Italy and the United Arab Emirates announcing plans to cut the proportion of dollars held in their reserves. A shift by central banks away from dollars would remove a key source of financing for the US deficit...

Fan Gang, director of China's National Economic Research Institute and a member of China's monetary policy committee, saw things differently. He said the real problem the world faced was an overvalued dollar, not only against the renminbi but against all the leading currencies.

His comments come at a time when speculation is increasing that China, which is thought to hold 70 per cent of its foreign currency stockpile in dollars, is considering a fundamental change in its reserve allocation. These concerns were highlighted on Friday when Wu Xiaoling, deputy governor of the People's Bank of China, said Asian foreign exchange reserves were at risk from the dollar's fall.

And there is this (hyperlink added):

... Market expectations, monitored by the Federal Reserve Bank of Cleveland, show that investors think there is a 30 per cent chance of a cut in US rates in March.

Just as it seems interest rates in the US may have peaked, they are being increased by the European Central Bank, the Bank of England and the Bank of Japan. The ECB is expected to raise its main rate from 3.25 per cent to 3.5 per cent at its December 7 meeting. The big question is whether Jean-Claude Trichet, ECB president, will signal further increases in 2007.

Here's something to think about.  If the move away from the dollar is for real -- with the presumably inevitable result that current account deficits will not continue to support domestic spending in the United States -- the result will almost certainly be higher U.S. interest rates.  Here's a position, which I endorse, about what that might mean for monetary policy:

We believe that changes in the federal funds rate should be considered on the basis of where economic forces are taking market interest rates, a perspective stemming from several presumptions about the way our economy works. First, “a balance between the quantity of money demanded and the amount the central bank supplies” requires the federal funds rate to adjust roughly in alignment with changes in real—that is, inflation-adjusted—returns to capital.

In other words, if long-term real interest rates rise, monetary policy becomes more expansionary even if the federal funds rate doesn't change.  (This is roughly behind the idea of associating "easy" monetary policy with a steep yield curve, and "tight" policy with a flat yield curve.) That is worth keeping in mind as you read stories like this one:

In another volatile day on the currency markets, the dollar recovered some poise against the euro on Wednesday after an unexpectedly large upward revision to US growth 2.2 per cent in third quarter against an estimated 1.6 per cent and consensus forecasts of a 1.8 per cent rise...

Speaking in New York overnight, Mr Bernanke struck a hawkish tone on US interest rates, saying that inflation in the US remained “uncomfortably high”.

Analysts said that, while it might be something of a surprise that the dollar had failed to derive support from Mr Bernanke’s remarks, he might be in danger of “crying wolf” over US inflationary pressures.

You know, sometimes the wolf is really there.

November 29, 2006 in Exchange Rates and the Dollar, Fed Funds Futures, Federal Reserve and Monetary Policy | Permalink

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Hi Dave,

The reason the USD is going down, and didn't respond to Greenspan, oops, i mean Bernanke (!), is the ongoing adjustment in the US property market. This process has only just begun, not in terms of starts, but in terms of housing competions, which are still near highs. Hence, employment in construction is still high, though with starts down, it has flattened out.

This means that the employment effect is coming in 2007. How big will it be? Who knows (I think bad, but i've been wrong many times before!).

But, what we do know is that, ahead of this process, and with the USD near all time lows, a bad outcome could leave the USD without a rudder and send it tumbling. That's a risk that justifies reducing exposure, or as we do it in hedgefund land, selling the USD.

We also know one other thing. The FED will likely take their time to ease. This process should be a good deal slower than after the stock market crash in 2000. That effect was fast and furious, and the FED a bit slow. Unlike today, the U-rate bottomed in April, the month after stocks turned down. And, the first negative emp report was in June that year. Emp growth has slowed, but it is still positive this time.

So, the longer the process takes, the greater the potential for a nastier eventual outcome. The higher rates stay, the bigger the eventual pressure on housing.

That's why, when Bernanke suggests he is still worried about inflation, the USD didn't bounce. A rate hike, or delay in cuts (as I expect), eventually makes the property adjustment worse not better. And, the downside risks to the USD that much higher.

I hope this helps give a glimpse of how some from the speculative side of the FX arena looks at this issue.

regards,
Andres

Posted by: andres | November 29, 2006 at 04:15 PM

I personally disagree with Andres, although I'm no expert in the arena. It looks to me as if cost-push inflation is coming in the next few months, with rising wages and little to no increase in productivity. If this occurs with no intervention from the FED to raise interest rates, the USD will slip and, given enough time, foreign bodies will begin to sell their USD, furthering any economic woes the US would have at that point. Of course, I could be entirely wrong on that.

~Cyrus

Posted by: Cyrus | November 29, 2006 at 05:46 PM

I agree, the wolf is out there; AG let him out of his cage and he's running loose on Wall ST. Those with kids & grandkids should be very concerned, he eats his young.

Posted by: bailey | November 29, 2006 at 06:31 PM

hahaha, i agree with both of you! Cyrus, it is possible wage inflation will lead to more price inflation.

but, in this case, the outlook for property, and assets in general canget very ugly. higher rates will impinge on property demand at a time of high supply; higher inflation will challenge asset values which are premised on low inflation and low rates. Yikes!

Your case makes the USD look worse, not better.

that's why selling it seems the really good trade, rather than taking a strong view on the outlook for interest rates!

woof woof

Posted by: andres | November 29, 2006 at 08:49 PM

"We believe that changes in the federal funds rate should be considered on the basis of where economic forces are taking market interest rates, a perspective stemming from several presumptions about the way our economy works. First, “a balance between the quantity of money demanded and the amount the central bank supplies” requires the federal funds rate to adjust roughly in alignment with changes in real—that is, inflation-adjusted—returns to capital."

i can clap to this.

it does make some sense to use a moving average or rate of change of the long term yield to at least be a part of the calculation that determines monetary policy.

the bond market is large enough that price/yield manipulation would be difficult to achieve; but something tells me the goldman sachs/hedge funds of the world would still try in order to get access to cheaper capital/liquidity.

but still, i think it's an interesting suggestion...

Posted by: m3 | November 29, 2006 at 11:10 PM

Just look at those Texas janitors getting a 50% (f-i-f-t-y) [That's FIVE, ZERO] pay hike after only a month of bargaining and you know wage inflation is more than andres, Ben and GOD-knows-WHO say it is.
Rates will have to rise to contain this tsunami of inflationary wages and we will just have to face the consequences for the housing market. Those dummies who bought ARMs and sub-primes can go back to camping. Cry me a river, this is about keeping the buck from becoming buckshot.
Interesting amount of foreign relations being conducted by US diplomats at the moment --did Condi take a vacation or what? Most notably Bernanke and Paulson off soon to China on a trade mission, or was that a currency mission? a banking mission? Something.

Posted by: calmo | November 29, 2006 at 11:20 PM

Always remember to check the revisions in any of the horribly skewed financial releases.

Wage compensation has been revised - Compensation up 1.4%, not 7.4%

http://tinyurl.com/y2ha28

This maybe another reason the dollar is on its downward spiral. I have a feeling when the revisions for GDP come out, another downward "surprise" will be lurking.

This is not to say that there shouldn't be liquidity/inflation worries, but to enhance them as Bernanke lowers rates soon and does more one day 22 billion dollar coupon passes.

With vendor financing via China and petrodollars looking like bad ROI as the US consumer fades, I expect a greater dollar loss.

Posted by: Alan Greenspend | November 30, 2006 at 08:58 AM

It sure looks like BB's been played like Charlie Brown since the day he signed on. More & more he's looking like a nice guy on a field full of Lucys, unable to apply reason in a world run by rules he doesn't "get".
First, he gets sucker-punched by a dufus cnbc reporter. Then, he takes someone's advice to forget he's always been a straight-shooter, that we all want him to talk gibberish. Then, for some unknown reason he approves an all but toothless credit guidance to his Banks AFTER they publicly confess to absurdly loose lending practices. And now, it's the BEA's turn to pull the football away with a casual oops.
BEA's under Commerce, it's mission is “to foster, promote, and develop the foreign and domestic commerce” of the United States." THEIR job is to help business do more business. Even I know Commerce is just as political as the RNC. So, why is our FED Head "trusting" them, unchecked, to present a credible representation of anything?
On housing, BB has commented that price increases were "driven by fundamentals". He hasn't asked Congress or used his pulpit to call for greater regulatory control over our financial sector, post Glass-Steagall.
He hasn't even cautioned markets not to overread his professed belief that a lot of economic ills can be cured with printing presses. Obviously, the markets are betting big time that Ben will "work" with them.
In a statement last March on the challenges hedge funds present, BB argued that market discipline can work but counterparty risk management is concerning. Concerning? What's the growth rate of credit derivatives? Is anyone reassured because BB's going to China with Hank?
Dave's wonderful Cleveland Fed link ended with a great closing line: "Credibility is the currency of central banks." We ALL trust in the FED to identify and act on the REAL threats to our longterm economic wellbeing. If the scope is now outside FED mandate, we trust it to argue for new regulatory controls. My simple question for BB is, if we can't trust the FED to act for our LONGTERM economic viability, what are our prospects? Personally, I take no solice that BB's going to China with Hank. It's the Administration's & Congress' profligate policies & practices that got us here & it's folly to think there's a win in this for the FED. I just wish BB would learn, the Lucys in his world NEVER change.

Posted by: bailey | November 30, 2006 at 11:31 AM

Well the U.S.A. has a problem: it needs to maintain offshore confidence in the USD so foreign investors will keep providing the cash to fund the U.S. Federal Government Deficit. In this environment the U.S. can't really afford to ease, even if the U.S. economy is going down the toilet. The external constraint is too great.

It's a very fine tight rope to walk and sooner or later they are gonna trip over.

Posted by: Paris_Ib | November 30, 2006 at 01:34 PM

Bailey asks a question of BB: "if we can't trust the FED to act for our LONGTERM economic viability, what are our prospects?"

My question is similar, but twisted to read: "How can we (why should we?) trust the FED to act for our LONGTERM economic viability?" This I ask because the FED keeps coming up with (and being proud of) documents like the one Dave linked us to above that ask us pretty much to "trust them." After all they "are" the experts, no?

We'll I don't trust physicians, engineers, economists or pretty much any of the too-arrogant professional classes. What I want to know from them is what they intend to do when faced with difficult choices (policy and other) and then be able to make my choices accordingly.

What I read from the afformentioned paper http://www.clevelandfed.org/Annual01/essay.pdf was that "central banks ultimately can deliver more economic growth by abandoning preoccupaiton with output gaps (and the like) in favor of a price-stability rhetoric and a policy orientation that meets this objective with the least interference to the natural, dynamic forces of the econmy."

Good luck when the FED seems incapable of even admitting to asset inflation, let alone admitting any complicity in such. I'm probably in a distinct minority, but I trust the ECB more than I do the FED. Or maybe I just don't know enough about the ECB to not trust their rhetoric or policy either.

Posted by: Dave Iverson | November 30, 2006 at 05:30 PM

The notion that higher long rates mean more accommodative monetary policy is counter-intuitive. That doesn't mean it isn't true, but it needs more than a suggestion to be pursuasive.

Posted by: kharris | December 01, 2006 at 09:56 AM

I can't help but keep harping that we'd ALL be a LOT better off today had Congress listened to Katharine Abraham instead of AG. Here's a Dean Baker post that makes the point better than I'm capable of doing.
http://www.prospect.org/deanbaker/2006/09/the_consumer_price_index_and_l.html
But, on to today. I appeal to the BB because this Administration, Congress AND current Democratic leadership have ALL convinced me the FED's the only thing between us & a disastrous economic meltdown. Recognizing we're a LONG way from FED transparency, I'd love to hear BB read Dave's linked Cleveland Fed piece verbatum to our financial center moguls. In fact, I'd love to hear BB speak to our long-term prospects, any time, any way he chooses.
I can't fathom a way out of the financial hole we've dug for ourselves except to take our medicine & get back to work. A great first step would be for BB to start explaining to the markets why they've made a terrible bet that he's as short-sighted as they are.

Posted by: bailey | December 01, 2006 at 11:38 AM

The dollar has fallen over the past couple of weeks because foreign central banks and monetary authorities have changed their behaviour. Instead of passively rebalancing their reserve portfolios, like they did all summer, they have indeed stepped up their net sales of dollars against G10 currencies substantially.

This is an annual phenomenon and is unlikely to spell the death of the dollar, as this type of activity generally moderates in the new year.

The notion that the US government will be up the creek if foreign central banks don't want so many dollars is likely to be flawed.

If the dollar is finally allowed to adjust against Asian and oil-exporting reserve accruers, then the current account deficit will shrink and there is unlikely to be the need to attract as much foreign capital to the US.

This has yet to happen, however. Several Asian central banks (notably the MAS in Singapore)intervened very heavily last week.

This, of course, begs the question: if these guys don't like the dollar, then why do they buy so many?

Posted by: Macro Man | December 02, 2006 at 11:27 AM

Yes it does beg the question. And I'm sure they are asking themselves the very same thing. In fact the recent (weak) performance of the USD suggests that the Central Banks are not coming up with a very good answer. Why do we like USDs? No idea. So perhaps they stop buying. In fact the Central Banks of the world don't even have to sell current USD denominated holdings to see the USD in serious trouble. That is: in even more trouble.

The Asian crisis and the building up of FX reserves by Foreign Banks which followed promoted the view that the U.S. will always have access to large capital inflows, no matter how bad economic and foreign policy leadership. Now we are testing the validity of that view. Which was based on intellectual laziness and arrogance more than anything else. The U.S. is not immune to the laws of economics and their is no natural reason why the USD should have International Reserve Currency Status. The impact of that change of scenario could be quite dramatic.

And all you have to do is just wait and see.....

Posted by: Paris ib | December 05, 2006 at 08:19 AM

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November 27, 2006

More Signs That A Recession Is Not Around The Corner

From USAToday:

College graduates are experiencing the best job market in four years as a stronger economy leads more employers to ramp up hiring.

Employers expect to hire 17.4% more new college graduates in 2006 and 2007 than in 2005 and 2006, according to a new survey by the Bethlehem, Pa.-based National Association of Colleges and Employers (NACE).

Signing bonuses range from $1,000 to $10,000, with the average at $3,568. And employers reported plans to boost their starting salary offers by 4.6% over last year, nearly a full percentage point higher than increases for the classes of 2006 and 2005.

Tomorrow will bring another set of housing statistics, and I know of no reason to think those statistics will put smiles on too many faces.  But if the cards are all about to fall the wrong way, you would be hard pressed to tell it from the labor market.

November 27, 2006 in Labor Markets | Permalink

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does anyone believe these increased starting wages & bonuses will offset the HUGE student loan debt these kids are starting off with?

Posted by: bailey | November 27, 2006 at 08:24 PM

You hire college graduates when you cant afford to hire someone experienced.

Posted by: Adrasteia | November 27, 2006 at 08:38 PM

they were saying the same thing when i graduated.

(i graduated in 2000)

Posted by: m3 | November 27, 2006 at 09:24 PM

you are assuming that they have debt. i saw a story today that said the university of illinois has less lower income kids than it had ten years ago.

the enrollment has shifted to upper middle class and wealthy.

two things i can think of. first, enrollment standards are much higher than they used to be, and the kids from better schools have the test scores to get in.

second, while the cost of college has gone up, the cost of education at state schools is still relatively reasonable when compared to private colleges.

I mean, it's 16K a year for an in-state kid to go to U of I. I assume its about the same in other states. That is a good deal even if you borrow 100% and get paid the average when you get out.

Posted by: jeff | November 27, 2006 at 09:56 PM

they were saying the same thing when i graduated. (2000)

Me too - 1981.

Posted by: dryfly | November 27, 2006 at 10:42 PM

m3 and dryfly -- That is interesting if true. However, I do not know who the "they" are that you referring to. I'm going to try to get hold of the old NACE data, but the fact that they emphasize the "three years in a row" increase does suggest that they do not always have such a rosy outlook. Just before the recessions would be different story, perhaps, so it is worth looking into how badly this information lags the cycle.

Posted by: Dave Altig | November 28, 2006 at 07:16 AM

David,

Isn't using the labor market as an indicator for future GDP growth (strength of the economy) problematic in that labor market indicators are a lagging indicator?

Just a query of mine.

Thanks

Matt

Posted by: Matt festa | November 28, 2006 at 07:54 AM

Dave, A 3/27/05 USA Today article (link below) quotes a U.S. Education Dep't. study saying I should tip my hat to you this a.m. & I do.
While "Undergraduate students borrowed, on average, $19,300 from all sources, up from $12,100 a decade earlier"
"The median college loan payment for a recent graduate amounted to 6.9% of monthly salary, up only slightly from 6.7% in 1994."
(I also heard some nonsensical murmurings from deep within my cranium about "bias", but I immediately dismissed that as channel static!)

http://www.usatoday.com/news/education/2005-03-27-grad-debt_x.htm

Posted by: bailey | November 28, 2006 at 09:56 AM

Labor and hiring is a lagging indicator. The decline in asset prices (housing) is a prognosticator.

Posted by: Ryan | November 28, 2006 at 03:08 PM

Good comment and use of data.

But, employment is a lagging indicator so be careful.

A better indicator might be S&P 500 earnings growth. Every recession but one -- the 1981 recession -- was preceeded by S&P EPS growth slowing to single digit rates and earnings or profits growth generally leads employment growth..

Posted by: spencer | November 28, 2006 at 04:38 PM

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November 26, 2006

Ideological Faceoff

From The New York Times:

FOR years, the Clinton wing of the Democratic Party, exercising a lock on the party’s economic policies, argued that the economy could achieve sustained growth only if markets were allowed to operate unfettered and globally...

This approach coincided with a period of economic prosperity, low unemployment and falling deficits. Over time, this combination — called Rubinomics after the Clinton administration’s Treasury secretary, Robert E. Rubin — became the Democratic establishment’s accepted model for the future.

Not anymore. With the Democrats having won a majority in Congress, and disquiet over globalization growing, a party faction that has been powerless — the economic populists — is emerging and strongly promoting an alternative to Rubinomics.

... They want to rethink America’s role in the global economy. They would intervene in markets and regulate them much more than the Rubinites would. For a start, they would declare a moratorium on new trade agreements until clauses were included that would, for example, restrict layoffs and protect incomes.

Oh, Lord.

The split is not over the damage from globalization. Mr. Rubin and his followers increasingly say that globalization has not brought job security or rising incomes to millions of Americans. The “share of the pie may even be shrinking” for vast segments of the middle class, Mr. Rubin’s successor as Treasury secretary under President Clinton, Lawrence H. Summers, recently wrote in an op-ed in The Financial Times. And the populists certainly agree.

But the Rubin camp argues that regulating trade, or imposing other market restrictions, would be self-defeating.

That seems right to me.  What's the counter?

The economic populists argue that the trade agreements themselves are the problem. They cite several studies showing that more jobs shifted to Mexico as a result of Nafta than were created in the United States to serve the Mexican market.

Hmm.  Doesn't that argue by way of attacking with a point the other side already conceded?  Perhaps we should focus on the actual claims made by those who argue globalization is a force for good?

And then there is this:

As the two groups face off, Lawrence Mishel, president of the Economic Policy Institute, contends that the populists are pushing much harder than the Rubinites for government-subsidized universal health care. They also favor expanding Social Security to offset the decline in pension coverage in the private sector.

Expanding Social Security?  Maybe "the people" weren't as upset about growth in entitlements (via Medicare's prescription drug benefit, for example) as we were led to believe?

Is there any room for agreement here.  Sure:

Apart from such differences, there are nevertheless crucial issues on which the groups agree. Both would sponsor legislation that reduced college tuition, mainly through tax credits or lower interest rates on student loans...

OK. I'm not sure access is the problem with our educational system, but at least that focuses on a real issue.

Both would expand the earned-income tax credit to subsidize the working poor.

Nice.

Both would have the government negotiate lower drug prices for Medicare’s prescription drug plan.

Uh-oh.  Price controls by any other name...

And despite their relentless criticisms of President Bush’s tax cuts, neither the populists nor the Rubinite regulars would try to roll them back now, risking a veto that the Democrats lack the votes to override.

That's interesting.

Here, I guess, is the bottom line:

The populists argue that the national income has flowed disproportionately into corporate coffers and the nation’s wealthiest households, and that the imbalance has grown worse in recent years. They want to rethink America’s role in the global economy. They would intervene in markets and regulate them much more than the Rubinites would. For a start, they would declare a moratorium on new trade agreements until clauses were included that would, for example, restrict layoffs and protect incomes.

I have a prediction: I won't lose much sleep thinking about which side in this debate I support.

November 26, 2006 in Economic Growth and Development, Federal Debt and Deficits, Labor Markets, This, That, and the Other, Trade | Permalink

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I'm losing more sleep over the fact that there actually appears to be a debate in the first place.

I was under the impression that we had just finished performing a very thorough half century empirical evaluation of these theories.

Posted by: Adrasteia | November 26, 2006 at 06:29 PM

Medicare already dictates reimbursement rates to providers - so we already have plenty of price controls in health care.

Posted by: Morris Davis | November 26, 2006 at 11:29 PM

What *is* it about this "debate"?

Is it this moderation:

"They want to rethink America’s role in the global economy. They would intervene in markets and regulate them much more than the Rubinites would."
--a moderated view that presumes the global market is free and unfettered with the introduction (and not intrusiveness) of transnational companies? Is it a view that presumes the government is the intervening and regulating agent rather than the co-venturing arm of the transnationals?

Do we need to have double the number of illegal immigrants to see this matter more clearly?

The populists...whiners...scumbag socialists if they aren't ideological terrorists!

Do we need to have another ramp up in the decay (half life?) of equitable distribution of wealth?

Apparently we do.

Posted by: calmo | November 27, 2006 at 01:51 PM

"For a start, they would declare a moratorium on new trade agreements until clauses were included that would, for example, restrict layoffs and protect incomes." Do you mean "would" or "could"? Isn't this just opinion at this point?

Posted by: bailey | November 27, 2006 at 02:10 PM

It's interesting the hand-wringing over the possible policies of the new Democrat-controlled congress. It's almost as if the previous beloved Republicans were free-trade zealots. Bush and his buddies in Congress promoted free trade in steel, right? And softwood lumber. And textiles. Internet gambling. Agricultural products. They got a deal worked out in Doha, didn't they? Must have been the Democrats that somehow blocked all that free-trade manouevering.

And, as I saw someone say elsewhere on the web, how come it's price controls if the govt negotiates drug prices with manufacturers, but just good practice to get fleet discounts for their vehicles? Or are we suggesting there are price controls on cars now?

Posted by: foo | November 27, 2006 at 04:54 PM

bailey -- Although I didn't include it in my post, the Times article does include a quote from my new Senator who answers the question as "would." No speculation there, although that is, of course, just one opinion. (However, as far as I can tell Sherrod Brown is one of the darlings of the "new thinking" crowd.)

foo -- Fair point. If the intervention of the government is more like collective bargaining with monopolists, then the regulations could improve efficiency. But I'm a skeptic on that matter.

Also, as I ahve said in previous comments, I don't think it is very useful to use arguments like "yeah, but the guys before us were bad too." That may be a fair way for history to judge, but for now I'm for thinking about whether the future will bring good policies or not so good policies.

Posted by: Dave Altig | November 28, 2006 at 07:24 AM

foo -

the drugs purchased by the government is a large percentage of total drugs purchased. the same can't be said of cars.

Posted by: cb | November 28, 2006 at 01:52 PM

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November 24, 2006

Europe Rethinks Kyoto

Then:

The United States believes, however, that the Kyoto Protocol is fundamentally flawed, and is not the correct vehicle with which to produce real environmental solutions.

The Kyoto Protocol does not provide the long-term solution the world seeks to the problem of global warming. The goals of the Kyoto Protocol were established not by science, but by political negotiation, and are therefore arbitrary and ineffective in nature. In addition, many countries of the world are completely exempted from the Protocol, such as China and India, who are two of the top five emitters of greenhouse gasses in the world. Further, the Protocol could have potentially significant repercussions for the global economy.

Now:

Europe is damaging its competitiveness by moving faster than the rest of the world to tackle climate change, the European Union’s industry commissioner has warned.

In a letter seen by the Financial Times, Günter Verheugen says: “We have to recognise that ... our environmental leadership could significantly undermine the international competitiveness of part of Europe’s energy-intensive industries and worsen global environmental performance by redirecting production to parts of the world with lower environmental standards.”

His comments are understood to be aimed in particular at the economic threat from China, India and other Asian nations.

Provide your own punchline.

November 24, 2006 in Economic Growth and Development, Europe, This, That, and the Other | Permalink

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No one country or region can solve this serious problem alone, and as Europe is discovering, by acting alone they put themselves at a competitive disadvantage.

As far as Kyoto is concerned, it was just a first step. I spoke with my college chemistry professor two years ago (Nobel laureate Sherwood Rowland) about the difficulties in getting the international community to act on limiting chlorofluorocarbon emissions to protect the ozone layer. Many people think the Montreal Protocol (1987) solved the problem, but in reality it was just a weak first step. There have been five significant revisions since then.

Think of Kyoto as Montreal. There should have been modifications every couple of years to improve the agreement and bring all nations into the fold.

In the end, this may be seen as George W. Bush's greatest failure (I know the list of his failures is long).

Best Wishes.

Posted by: CalculatedRisk | November 24, 2006 at 01:31 PM

Kyoto is not George Bush's greatest failure, but one of his greatest successes. The entire premise of Kyoto, as told to me by a high environmental official from an Oceanic country, was that Europe saw a way to get a "leg up" on U.S. industry.

The entire protocol was designed to help Europe gain market share, or force the U.S. to "buy" credits from "lesser-developed" countries.

In the end, Kyoto is more likely to cause environmental harm than good, as China and India, countries with poor environmental regulations, are exempt.

Posted by: D. Brender | February 06, 2007 at 12:02 PM

I thank you for your comment.

Posted by: Rosie | April 24, 2007 at 04:00 PM

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November 22, 2006

Inequality: Not Just Made In The USA

From the Financial Times:

China’s poor grew poorer at a time when the country was growing substantially wealthier, an analysis by World Bank economists has found.

The real income of the poorest 10 per cent of China’s 1.3bn people fell by 2.4 per cent in the two years to 2003, the analysis showed, a period when the economy was growing by nearly 10 per cent a year. Over the same period, the income of China’s richest 10 per cent rose by more than 16 per cent...

China, which had relatively even income distribution in 1980 when it embarked on market reforms, is now “less equal” than the US and Russia, using the Gini co-efficient, a standard measure of income disparities.

The Wall Street Journal has more (on page A4 of today's print edition):

The reason for the income decline at the bottom isn't clear. The World Bank hasn't completed its analysis and its conclusions haven't been published. Even so, the data call into question an economic model that economists have held up as an example for other developing nations.

"This finding is very important. If true, it sheds doubt on the argument that a rising tide lifts all boats," said Bert Hofman, the World Bank's chief economist in China...

Many observers place part of the blame on the way China dismantled its social-welfare system as it phased out state control of the economy -- without building up much to replace it. Health care has become a point of particular concern, as costs shoot up without any widespread system of medical insurance to cover them.

Here is an important piece of information:

The World Bank's Mr. Hofman says the bank's analysis shows the majority of China's poorest 10% appear to be only temporarily poor, thrown down by some setback like sudden illness, the loss of a job or the confiscation of land. That suggests that a basic social safety net, like medical insurance or unemployment benefits, could help move them back out of poverty. Only about 20% to 30% of the poorest appear to be long-term poor, and even they have some savings.

... the survey compares snapshots of the lowest tier of Chinese society at two different points, rather than tracking the same of group of households over time. So, it doesn't necessarily mean that the people who were in the poorest 10% of society in 2001 were all 2.5% worse off in 2003.

Temporary bouts of economic hardship are clearly a much different thing than persistent poverty traps.  And if, in fact, poverty is predominantly transitory, we should perhaps be more circumspect about declaring that a rising tide fails to raise all boats.  Rising inequality -- here and elsewhere -- may be very well be a problem.  But policymakers would be well advised to understand what problem it is, before the surgery begins.

November 22, 2006 in Asia, Inequality | Permalink

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nice little summary of the wall street journal
there definately has something to be done about the poor chinese

Posted by: Otto | November 22, 2006 at 06:52 AM

Well, I guess the World Bank chief economist ought to read up on Kuznets. Also, there must be some kind of reason (and not just BW2) why China wants to make welfare a priority in coming years.

Posted by: 4degreesnorth | November 23, 2006 at 05:47 AM

I wonder if there is a correlation between educational achievement and poverty in China. The linkage in the United States is clear.

Posted by: jeff | November 24, 2006 at 10:08 AM

One place to look may be labor market rigidity. Not the kind we tend to think of in G10 countries. Labor mobility is limited in China by a social/legal system that is arranged to maintain stability. Those who are from the countryside have very limited right to work elsewhere. (Those from anywhere have a limited right to work elsewhere.) One consequence is that they can be paid less and treated worse in industrialized areas than those from the industrial region. That makes insecure, non-local workers preferable to factory managers. Those with employment rights have a harder time getting work, while those who get work have limited bargaining power. Locals from industrialized areas become transients if they go in search of work beyond their own region, adding to downward pressure on low-skilled factory wages. This system also puts pressure on incomes in farm areas, because it discourages farm workers from moving to industrial areas.

I would also point out what looks like over-eagerness on the part of our host to warn against jumping to conclusions when the conclusion is that classical assumptions don't work. Evidence shows up questioning a rising tide lifting all boats? Oh, we must wait before acting. Hint that one's priors are confirm don't seem to require equal caution. Doesn't objectivity imply equal scepticism in both directions?

Posted by: kharris | November 24, 2006 at 11:27 AM

kharris -- Sorry if I was unclear. I don't dispute the evidence that growth alone does not seem to have reliable effects on poverty numbers. But I am not convinced that we really know how to think about poverty statistics when we see it, nor do I think all proverty is created equal. We know for example that the labor force particpation rates of young people have fell sharply in the last recession, and have not recovered. That is likely to increase poverty numbers, but is it something to worry about? I'm not so sure -- you have to tell me why the participation rate fell. If it is because of delayed entry into the labor market to build human capital, then I am not worried at all.

I'm not saying that is the answer, least not for all of the incidence of poverty we observe. But neither am I willing to accept knee-jerk reactions to poverty numbers that offered without any thought about what the numbers really reflect.

Posted by: Dave Altig | November 28, 2006 at 07:32 AM

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November 21, 2006

Do These Numbers Add Up?

Today's Wall Street Journal has a long, and interesting, article (page A1 of the print edition) on where the Democrat-controlled Congress might take economic policy if they have their druthers. On the let's-pay-for-things side of the ledger:

The Senate Finance Committee, with the blessing of both parties' leaders, is circulating a list of ways to shrink the "tax gap" between taxes owed and taxes actually paid. Most are aimed at upper-income taxpayers, such as requiring stock brokers to report not only the price a client got for shares, but also the original purchase price paid.

Boosting taxes on upper-income Americans would reduce disparities and provide revenues for other attacks on inequality. Raising the top two tax rates, now 33% and 35%, by a single percentage point would yield $90 billion over five years, the Congressional Budget Office estimates.

Another favorite Democratic target is the lower tax rate -- a maximum of 15% -- on capital gains and dividends.

But then there is this list, which includes expanded tax breaks for low-income workers...

Enlarging the earned-income tax credit, viewed by many economists as a smart alternative to a higher minimum wage, is an option likely to figure in Democratic tax deliberations. The credit offers up to $4,536 to a family with two or more children to offset payroll taxes that the working poor pay. And it offers a cash bonus if the credit exceeds taxes paid, rewarding low-wage workers without raising employers' costs...

... expanded social insurance for displaced workers...

One direct response to workers' anxiety is expanded government programs to cushion the fall of those who lose jobs in today's rapidly changing economy...

Lori Kletzer of the University of California at Santa Cruz and Howard Rosen of the Peterson Institute for International Economics in Washington, for instance, would offer eligible dislocated workers up to half the difference between weekly earnings at their old and new jobs, up to $10,000 a year. This isn't cheap: They put the price tag at between $2.6 billion and $4.3 billion a year, financed through general tax revenues or an expanded payroll tax.

... larger expenditures on education...

Democrats are focused on doing more to help Americans pay for college, especially important since the typical college grad earns 45% more than the typical high-school grad. Ms. Pelosi's platform calls for making up to $12,000 a year in college tuition tax-deductible -- or the equivalent in a $3,000 tax credit -- as well as cutting interest rates on student loans and increasing the maximum Pell Grant for low-income students to $5,100 from $4,050.

A coalition that spans the political spectrum is pushing more government support of Pre-K education. The case: Low-income children are behind when they arrive at kindergarten and never catch up; spending more on them sooner would have a big payoff.

... and incentives to induce more private saving

... such as replacing current tax breaks for retirement savings with universal 401(k) accounts into which the government would match family savings -- a 2-to-1 match for low-income families, 1-to-1 for middle income families and perhaps 0.5-to-1 for high-income families.

... an idea suggested by Clinton economic adviser Gene Sperling, described in an online companion article.

These are all responses to very legitimate concerns -- how do we encourage more saving, how do we ensure opportunities to develop the skills that so clearly separate the haves from the have-nots, how should we view society's responsibilities to people who are harmed by economic change through no fault of their own?  And though the ideas above may or may not be the best approaches to dealing with these questions, they are certainly worthy of discussion.

But how should that discussion proceed? An awful lot of people seem to feel that just reversing past tax cuts will somehow lead us to the promised land, but the arithmetic looks pretty shaky to me.  That's why I think this is a good place to start:

New House Speaker Nancy Pelosi has vowed to restore a 1990s rule requiring new spending to be offset by spending cuts or tax increases...

First, a means to institutionalize priority setting.  Then, on the specifics of those priorities, we can talk.

November 21, 2006 in Federal Debt and Deficits, Saving, Capital, and Investment, Taxes, This, That, and the Other | Permalink

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Paygo? That thing that George W. Bush decided to dismantle so he could claim he was cutting taxes as he also raised spending. No, the Dems promises likely don't add up but then we would never hold the Bush Administration to such a standard when we have Fuzzy Math.

Posted by: pgl | November 21, 2006 at 08:58 AM

"Institutionalize priority setting"? That's a mouthful I wish I'd heard about 6 years ago! I would hope encouraging "more savings" is a "legitimate concern", but I haven't seen any evidence to suggest it. In SoCal, I'm STILL receiving 2-3 credit card offers weekly with enticements of 0% interest for 15 months on xfers & purchases. Potential home buyers here are still beseiged with no-doc, no $$ down financing offers, stores are still offering no interest on purchases until 2008. Have you checked what interest rates Banks are offering?
So, here's my rhetorical question of the day:
How does the FED decide 5.25% Fed Funds rate is near that midpoint where it encourages neither spending nor saving? We're not a manufacturing economy anymore and most distributors long ago switched to just-in-time inventory management. (Many of these now use Wall St., not their local bank, to fund their overhead. My guess is, the FED is VERY slow to change, that it's one thing to push for the HUGE changes repealing Glass-Steagall brought, but it still prefers to conduct its oversight in the same old way that worked poorly in the past.
I'm as tired of banging the "accountibility" drum as you are of politically charged rhetorical argument, but I think in times of Administration AND Congressional irresponsibility, the FED at the least should at the least use it's pulpit to call for responsibile legislation & fiscal budgeting. Yet, it doesn't. It's clear AG HUGELY damaged our long-term economic prospects, BUT he's gone. Where is BB's plan to institute & bring regulatory controls of our financial sector into the 21st century? If the FED doesn't want sole responsibility for independent oversight of our economy it serves no public benefit. Encouraging the FED to lead "would be a GREAT beginning".

Posted by: bailey | November 21, 2006 at 10:58 AM

pgl and bailey, my friends -- C'mon. There are new kids in town. Don't you think its time to stop harping on the past? Time to start thinking about the new agenda, not the purported failures of policymakers who are no longer relevant.

Posted by: Dave Altig | November 22, 2006 at 05:49 AM

Thanks Dave, It's great to start the morning with a smile!

Posted by: bailey | November 22, 2006 at 07:56 AM

I do not believe this

Posted by: fornetti | August 31, 2008 at 10:11 PM

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November 20, 2006

Worrying About Inflation

What worries you most:  That the immediate future will bring slower than desired growth or higher than desired inflation?  If you answered "inflation", you are not alone.  Here's what the world's finance ministers and central bankers had to say after putting their heads together this past weekend:

G-20 members noted that the world economy continues to expand at a solid pace, with growth above its long-term average for the fourth consecutive year. The outlook remains positive. Global economic growth is expected to slow slightly from the rapid pace of the past few years... Above average growth in the global economy has seen spare capacity decline which, combined with buoyant energy and mineral prices, has increased the risks to inflation.

Maintaining strong world growth and containing inflation will require ongoing adjustments to monetary and fiscal policies while ensuring appropriate exchange rate flexibility and structural reform.

And then there is this, from Bloomberg:

Accelerating wage growth around the world is making central bankers less willing to cut interest rates than some investors expect. The concern: The increasing labor costs may trigger a renewed rise in inflation even as energy prices abate.

"Wages are creeping up,'' former Federal Reserve Chairman Paul Volcker told the Concord Coalition, a fiscal-policy watchdog group, in New York Nov. 14. When it comes to inflation, Volcker said, "we're a little bit on the edge.''

In the U.S., unit labor costs rose last quarter at the fastest pace in almost 25 years. Germany's largest steelmakers, ThyssenKrupp AG and Salzgitter AG, are giving workers their biggest pay raise in more than 10 years. New Zealand wages increased at a record pace in the third quarter.

There's more to come. The International Monetary Fund expects unit labor costs at manufacturers in advanced economies to chalk up their biggest increase in six years in 2007...

ECB President Jean-Claude Trichet told reporters today central banks shouldn't be "complacent'' about inflation risks...

"The main risk to the inflation outlook in the medium term surrounds the behavior of pay growth,'' Bank of England Governor Mervyn King told reporters in London Nov. 15.

The article does note that there is controversy about how well labor costs predict inflation, but the general message is pretty clear:  If you ask the world's policymakers what is making them itchy at the moment, the answer is the prospect of too high inflation, not too little economic growth.

November 20, 2006 in Federal Reserve and Monetary Policy, Housing, Inflation, Labor Markets | Permalink

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In the US anyway, labor costs may be increasing due to inflation rather than the other way around. With the hottest sectors cooling this "inflation" seems unlikely to last.

Posted by: Lord | November 20, 2006 at 02:40 PM

After three years of raging inflation in housing, commodities, executive pay, equities, and corporate profit margins, economists are now concerned that we really have inflation as worker wages are beginning the long road to catching up. This is a profession in need of a makeover.

That central bankers are finally mumbling aloud about something the general poulation has been aware of for years is amazing. A true case of it ain't real till the fat lady says it's real.

What is truly amazing is the amount of counterfeit currency these clowns have dumped (and continue to dump)on the world while feigning surprise that inflationary expectations have become rooted. Some say Milton Friedman passed away from age related issues. Others think it may have been something else..........

Posted by: zinc | November 22, 2006 at 05:44 AM

I would worry more about transparency in the measure of inflation :). More here:

http://www.eurotrib.com/story/2006/11/20/143350/23

Posted by: Laurent GUERBY | November 24, 2006 at 02:13 PM

I guess there is some controversy concerning wages and their relation to productivity as well, how quaint.

Posted by: self | November 25, 2006 at 04:08 PM

Investing in Forclosures..
One approach is to purchase a foreclosure that is under-priced and selling it immediately at a higher value. One way to sell homes for a higher value is to take back a mortgage. For example, let's say a house worth $100,000 is sold at a foreclosure to an investor for $50,000. The investor may put down 10 percent and assume or create a new mortgage for $45,000. The investor then advertises the property at a discount, say $80,000, offering 100-percent seller financing (remember, we're figuring that like houses are worth $100,000). The owner hopes to create a sense of urgency by under-pricing the house and pulling in buyers. If successful, the investor takes a promissory note from the new purchaser for $80,000. He has now created a $35,000 note for himself (The difference between the $80,000 sale price and the original $45,000 mortgage). The new buyer makes payments to the investor for an $80,000 loan and the investor makes payments on the original loan for $45,000. In real numbers, here's what it would look like. If the original loan is for $45,000 at 8 percent over 30 years, the principal and interest is $366.88. When the second buyer takes a note for $80,000, the investor may charge a bit higher interest since he's offering 100 percent financing (which is normal in the mortgage world). Let's say he offers an $80,000 loan, 9.5 percent over 30 years. The monthly payment is $672.68, creating a positive cash flow of about $306 per month. If the borrower stays in the house for 30 years, the investor will make $88,295 in interest and $30,000 in capital gains after he's paid his own interest on the first note for a total return of $118,295. Not a bad return on a $5,000 down-payment.

Keep in mind that not all mortgages allow an owner to "wrap" a second mortgage onto original loan. Most loans today contain a "due-on-sale" clause, meaning if the property is sold, the first trust must be paid off immediately. Wraparound financing is popular when investors purchase foreclosed Veterans Affairs (VA) properties as the VA allows wrap-around loans in such cases.

Posted by: Wally Smith | December 12, 2006 at 01:06 PM

A third approach is to purchase a foreclosure that is under-priced and selling it immediately at a higher value. One way to sell homes for a higher value is to take back a mortgage. For example, let's say a house worth $100,000 is sold at a foreclosure to an investor for $50,000. The investor may put down 10 percent and assume or create a new mortgage for $45,000. The investor then advertises the property at a discount, say $80,000, offering 100-percent seller financing (remember, we're figuring that like houses are worth $100,000). The owner hopes to create a sense of urgency by under-pricing the house and pulling in buyers. If successful, the investor takes a promissory note from the new purchaser for $80,000. He has now created a $35,000 note for himself (The difference between the $80,000 sale price and the original $45,000 mortgage). The new buyer makes payments to the investor for an $80,000 loan and the investor makes payments on the original loan for $45,000. In real numbers, here's what it would look like. If the original loan is for $45,000 at 8 percent over 30 years, the principal and interest is $366.88. When the second buyer takes a note for $80,000, the investor may charge a bit higher interest since he's offering 100 percent financing (which is normal in the mortgage world). Let's say he offers an $80,000 loan, 9.5 percent over 30 years. The monthly payment is $672.68, creating a positive cash flow of about $306 per month. If the borrower stays in the house for 30 years, the investor will make $88,295 in interest and $30,000 in capital gains after he's paid his own interest on the first note for a total return of $118,295. Not a bad return on a $5,000 down-payment.

Keep in mind that not all mortgages allow an owner to "wrap" a second mortgage onto original loan. Most loans today contain a "due-on-sale" clause, meaning if the property is sold, the first trust must be paid off immediately. Wraparound financing is popular when investors purchase foreclosed Veterans Affairs (VA) properties as the VA allows wrap-around loans in such cases.

Posted by: Wally Smith | December 12, 2006 at 01:07 PM

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November 19, 2006

Is Monetarism Dead?

Courtesy of Mark Thoma, I am sent to the Scientific American blog, where JR Minkel ruminates on the contributions of Milton Friedman, asking the question "Is economics a science?".  Minkel offers up the question in the spirit of open debate, so fair enough.  I did, however, find this passage somewhat puzzling:

Well, Friedman's most famous prediction was a pretty good one: he foresaw the possibility that high unemployment could accompany high inflation, a phenomenon better known as stagflation. That foretelling earned him the Nobel Memorial Prize, although Friedman's monetary theory is currently out of favor.

A similar sentiment is expressed by the eminent historian Niall Ferguson, in an article titled "Friedman is dead, monetarism is dead, but what about inflation?"

It wasn't just that Friedman rehabilitated the quantity theory of money. It was his emphasis on people's expectations that was the key; for that was what translated monetary expansion into higher prices (with positive effects on employment and incomes lasting only as long as it took people to wise up)...

... it will be for monetarism — the principle that inflation could be defeated only by targeting the growth of the money supply and thereby changing expectations — that Friedman will be best remembered.

Why then has this, his most important idea, ceased to be honoured, even in the breach? Friedman outlived Keynes by half a century. But the same cannot be said for their respective theories. Keynesianism survived its inventor for at least three decades. Monetarism, by contrast, predeceased Milton Friedman by nearly two.

The claim that "Friedman's monetary theory is currently out of favor" is, I think, wildly overstated -- at best.  Pick up virtually any textbook in monetary or macroeconomics and what you will find is a presentation that it is fully steeped in Professor Friedman's justly famous "The Quantity Theory of Money: A Restatement."  In simple terms, the quantity theory says something like this:  Inflation results from an excess of money growth over the amount of money that people want (expressed in terms of money's purchasing power over goods and services). If you have taken a course in macroeconomics, or money and banking, that is probably what you learned, and it was bequeathed to you by Milton Friedman. 

So why the belief Friedman's views have fallen into disrepute?  I think it is a result of two things that, in the end, have little to do with whether Friedman's version of the quantity theory remains the dominant intellectual tradition among macroeconomists. 

First, there is the association of Friedman's oft-cited constant money growth rule with the broader quantity-theoretic logic.  Part of the rationale for the constant money growth rule had to do with specific assumptions that Friedman invoked regarding money demand -- the assumption, specifically, that changes in money demand not associated with income growth tend to be relatively slow and predictable.  Part of it had to do with his judgment that the control needed to successfully "fine tune" the economy far exceeds the capacity of mortal men and women.  These elements are not, however, essential to the quantity theory itself. Not accepting Friedman's views on these matters is very much different than rejecting the general quantity theory framework or its core implication that inflation is, in the end, a monetary phenomenon.

Second, there is the fact that monetary aggregates are themselves little used in the practical implementation of monetary policy.  An exception, of course, is the European Central Bank, which still claims fealty to the notion that growth in monetary aggregates is a legitimate guide to policy choices.  But, as William Keegan reports in the Guardian Unlimited, even that pillar of monetary policy may be "tottering":

The two elements became known as the 'two pillars' of the ECB's approach - an approach which seems to give too much influence to changes in the money supply (the 'second pillar'), which most economists now believe to be unreliable guides to the kind of short-term changes in the economy that concern central banks when they take their decisions about rates.

Sensitive to such criticisms, the ECB held a conference in Frankfurt 10 days ago, and its subject was 'The role of money: money and monetary policy in the 21st century'. Guests included a glittering array of central bankers, including Ben Bernanke, Alan Greenspan's successor as chairman of the US Federal Reserve, many distinguished academic economists, and a few journalists such as myself.

Bernanke and most of the academics gave short shrift to the importance of the 'second pillar', with varying degrees of politeness. Trichet delivered a spirited defence of the ECB's approach, as did Otmar Issing, the embodiment of the second pillar, who recently retired from being the highly influential chief economist of the ECB.

The tone of the conference was so one sided - that is, against the message of the hosts - that a conspiracy theory developed about this being the last stand of the monetarist-inclined ECB, and that they had invited hostile academics to give them an excuse to get off the hook, rather in the way that organisations employ management consultants to advise them to make changes they wish to make anyway.

Central banks these days do tend to conduct monetary policy with reference to interest rates rather than monetary growth.  But choosing a target for an overnight bank lending rate -- like the federal funds rate -- is implicitly about choosing a path for money growth.  Once an interest path is chosen, money growth follows automatically, and is in that sense invisible (or, mathematically, redundant).  That does not, however, mean that the insights of the quantity theory are obsolete.  That central bank practice has evolved toward a focus on a price (the short-term interest rate) rather than a quantity (money growth) says more about our confidence in the measurement of money than it does about our confidence in the theory that inflation has its roots in money growth (a theme that is expanded on, at length, in an essay in Federal Reserve Bank of Cleveland's 2001 annual report.)

It is true that recent influential ideas about inflation and central banking have incorporated the existence of "cashless" economies, which would indeed move us outside of the reach of the quantity theory.  But those ideas contemplate the control of inflation in a hypothetical world (asking, for example, whether rules that work well in a monetary economy might work equally well in a non-monetary economy).  That alone does not invalidate quantity-theoretic reasoning.  What is more, justifying some aspects of central bank behavior -- the desire to avoid sharp movements in interest rates, for example -- seems to require the existence of money, and in an entirely conventional way.  Which is to say, in more or less the fashion handed down by Milton Friedman. 

Up to the very end -- hat tip, again, to Mark Thoma -- Professor Friedman was explaining why money matters.  How appropriate.  Although many these days would be less enthusisatic than he about emphasizing a particular measure of money, his ideas about money are as vital to the core of monetary policy reasoning as they ever were. 

The king is dead. Long live his kingdom.      

November 19, 2006 in Federal Reserve and Monetary Policy, Interest Rates, This, That, and the Other | Permalink

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Of course, money matters. To say otherwise is an extreme proposition. Of course to say only money matters would also be extreme. I doubt any serious economist would say the latter - but check out those "tributes" to Milton Friedman over at the National Review. It's sort of like the old adage - with friends like these, who needs enemies.

Posted by: pgl | November 19, 2006 at 09:15 AM

Pgl tries to trivialize Friedman's view by arguing that it would be extreme to argue that money matters not at all and extreme to argue that only money matters. What Friedman actually said in 1970 is "Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output... A steady rate of monetary growth at a moderate level can provide a framework under which a country can have little inflation and much growth. It will not produce perfect stability; it will not produce heaven on earth; but it can make an important contribution to a stable economic society."

Notice that he did made a specific claim. "Money matters" is the shorthand that many have used to characterize his view. To riff off a second hand quote in order to give another tedious jab at NRO is pretty lame.

Posted by: Rich Berger | November 19, 2006 at 01:42 PM

Rich - it is a fair point that Milton Friedman did argue that monetary restraint could stop inflation, which again few deny. The debate then - as is now - how much lost output would this require. The new classical view of Tom Sargent and Bob Locas (something I noted that Friedman did not endorse 100%) was there was no need for a recession to disinflate. As I noted when the National Review referred to Thatcher's recession in their strange tribute, I don't blame Friedman for this.

But Sargent's unpleasant monetarist arithmetic stands for the propostion that reckless fiscal policy can undo attempts at monetary restraint. The Reagan - Volcker tug of war was an early indication of this. Argentina around the turn of the century was a dramatic representation of how bad fiscal policy can undo tight money.

Posted by: pgl | November 19, 2006 at 04:41 PM

Further, to what extent is current central bank behaviour driven by the effects of tightening on aggregate demand, not on the money supply as such?

Posted by: Alex | November 20, 2006 at 12:04 PM

Debating Moneterism is wading into treacherous waters, but Bernanke argued in his tribute to Friedman back in 03 that you can Reconcile the Sargent/Lucas and Fiedman views by throwing in expectations.

Since the public knows the budget deficit must be financed via increased money supply, inflation rises. It looks like this has a lot to do with Central Bank credibility, the level of the deficit, etc.

Thanks

Matt

Posted by: Matt festa | November 21, 2006 at 09:28 AM

Japan offers the best vindication of the quantity theory. Japan brought interest rates to almost zero, but failed to stimulate its economy. However, money growth was weak.

Then they went to "quantitative easing," increasing money supply more rapidly even though interest rates couldn't fall any more. That brought their economy around.

The Fed is using interest rates as a tool, but they are thinking monetarist thoughts, not Keynesian thoughts. The use of interest rates is about challenges caused by the widespread use of sweep accounts rather than any fundamental problems with the quantity theory.

Posted by: Bill Conerly | November 21, 2006 at 02:56 PM

It seems to me that the Fed's current stance is diametrically opposite from Friedman's: fine-tune the interest rate to keep the economy at trend growth, and no inflation should result.

The implicit assumption is above-trend real growth causes inflation, not excess money. Of course, the corrolary is this: below trend growth is incompatible with inflation, and it therefore should be fought with lower rates, regardless of money growth.

This single idea will be the cause of much dislocation in the economy in the years to come.

Posted by: michael pearson | November 23, 2006 at 06:43 AM

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November 16, 2006

Is Inflation Waning?

That's the question Mike Bryan asks -- and attempts to answer -- in a brand new post on the research page of the Federal Reserve Bank of Cleveland website:

The CPI excluding food and energy rose a restrained 1.2 percent last month—well under analysts’ expectations. This may be a good sign that inflation is finally coming down. But another measure, the Cleveland Fed’s Median CPI, which trims away all but the price increase in the center of the CPI’s monthly price-change distribution, showed that October’s inflation rate remained high, at 3.7 percent (annualized.)...

This month’s core CPI reading is being heavily influenced by a recent softness in goods prices, and not just energy goods. Retail goods prices excluding energy fell more than 3 percent (annualized) in October, with adult apparel, jewelry, and new cars and trucks all showing substantial price declines during the month.

In fact, the auto industry stats seem to be influencing quite a few of the macroeconomic stats lately -- from retail sales on the plus side...

U.S. retail sales fell less than expected in October on a rise in auto sales, but fell more than anticipated when vehicles were excluded as gasoline sales continued to slide, a Commerce Department report showed on Tuesday.

... to industrial production on the minus side:

Industrial production in the U.S. rose last month, propelled by a rebound in utilities and gains at computer and electronics manufacturers...

Manufacturing production, which accounts for about four- fifths of total output, fell 0.2 percent for a second month in October, reflecting a slump in auto output. Excluding autos, factory production rose 0.1 percent, after a 0.1 percent September decline.

Returning to the price outlook, Mike offers a word of caution:

... experience suggests that the behavior of [retail] goods prices is also among the most volatile in the index, and therefore may not be a very reliable indicator of where the inflation trend is headed...

... very few items in the consumer’s market basket showed price increases in the medium 1 to 3 percent range. And the share of the market basket that was posting either no change or a decline in prices was identical to the share of the market basket that showed relatively large price increases (at 46 percent).

You can see a picture of that distribution in the full post linked above, but here is Mike's bottom line:

Is the inflation trend waning? Well, the answer to that question would seem to rest on whether you believe that the core goods prices or the core service prices are providing the better indicator of future inflation trends. While we may still be optimistic that it is the former, historical experience suggests it has more often been the latter.

Those who ignore history...

November 16, 2006 in Data Releases, Inflation | Permalink

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well, walmart the nation's largest retailer cut prices to stimulate business. you have to figure their competition did the same. oil is in a bear market.

however, grain prices are through the roof. land that cost 1800 an acre a few months ago is now 3000-3500.

the economy is still sloshing in cash. i would err on the side of caution and sop up some more cash with another .25 increase.

Posted by: jeff | November 16, 2006 at 07:36 PM

What does the cost of money show in terms of market evaluation of inflation?

Posted by: TCO | November 18, 2006 at 02:31 PM

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November 15, 2006

Another Thing That Annoys Me

I will officially start the holiday celebrations next Thursday, and I promise to post only nice friendly comments during the season of good cheer.  But we're not there yet, so I just have to take exception to this item from Forbes, describing the October and end of fiscal-year 2006 deficit report issued by the Treasury on Monday:

The government posted a budget deficit of 49.3 bln usd in October, compared with expectations of a 49 bln usd deficit and the 47.4 bln usd deficit in October last year.

Receipts totaled a record high 167.7 bln usd, while outlays totaled 217 bln usd, also a record.

I added the emphasis, because that is what I came to complain about. To wit, is that "record" stuff at all meaningful?  Don't think so.  Here's a picture of annual nominal receipts and outlays, since 1970:

   

Receiptsoutlays_nominal 

   

Rare is the period without a record.  Perhaps if we adjust for inflation?

   

Receiptsoutlays_real

   

You see a bit more in the way of non-records there -- around the times of recessions, in particular -- but the standard story is ever upward and to the right.  Not surprising, since that is also the story of income growth.

The informative statistic, of course, is not the dollar size of outlays and receipts, but their magnitudes relative to the size the economy, or GDP:

   

Receiptsoutlays_gdp

   

No records there, though I will forgive you if you choose to fret about that gap between the green line and the red line.

See?  The good cheer has started already.

November 15, 2006 in Federal Debt and Deficits | Permalink

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David,

Of greater concern is the 18.6% increase in interest payments on the national debt.

It would not be in our trading partners best interests to let our interest rates go any higher.

And me thinks they won't regardless of what the Fed does.

Posted by: The Nattering Naybob | November 15, 2006 at 01:13 PM

Gotta love it! A couple of possible quibbles, however. I would replace the nominal interest expense figure with a real interest expense figure, which might show real surpluses for some of the 1970's. Milton Friedman had a wonderful Newsweek (or was it Business Week) oped in 1980 on this point. I might also suggest - as Mankiw alluded to in his much maligned post - that we report the primary deficit. But then Nattering Naybob would rightfully argue that we can't just ignore interest payments.

Posted by: pgl | November 15, 2006 at 01:36 PM

I want to add a REAL annoyance! It drives me nuts that the FED's signaled the equity markets it will not shut down credit expansion but it will ease to prevent a housing induced recession. This is ABSOLUTELY THE WORST POSSIBLE MESSAGE for the FED to be sending at this time! Isn't anyone at the FED concerned about the growing risk Hedge Funds present & promote? Is there NO point when credit expansion becomes a concern for the FED? What is he doing, channeling Alan Greenspan?

Posted by: bailey | November 15, 2006 at 03:57 PM

bailey -- I'll assume those are rhetorical questions.

Posted by: Dave Altig | November 16, 2006 at 03:05 AM

Dave, Where have you been for the last 10 years? Didn't we learn way back during Clinton's impeachment that ALL questions are "rhetorical" and all answers selfserving?

Posted by: bailey | November 16, 2006 at 12:11 PM

I love that last graph.

Posted by: Chris M. | November 18, 2006 at 06:45 PM

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