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November 29, 2006
And So It Begins?
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.
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November 27, 2006
More Signs That A Recession Is Not Around The Corner
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.
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November 26, 2006
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.
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.
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.
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.
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November 24, 2006
Europe Rethinks Kyoto
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.
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.
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November 22, 2006
Inequality: Not Just Made In The USA
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.
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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.
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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.
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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.
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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.
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...
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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:
Rare is the period without a record. Perhaps if we adjust for inflation?
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:
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.
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