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June 28, 2007
There seems to be some slight disagreement about what information the Federal Open Market Committee meant to convey with today's post-meeting statement. MarketWatch, for example, had no problem covering a lot of territory with its collection of expert opinion:
The statement was "mildly hawkish," said Bill Sullivan, chief economist at JVB Financial. "They don't want investors to get complacent about the inflation outlook even though we've had some good data recently."
The Fed softened its tone about inflation, said Tony Crescenzi, chief bond market strategist for Miller Tabak & Co., who cautioned against overanalyzing the statement, "which continues to paint a picture of monetary policy that is likely to be little changed in the months ahead."
Kevin Logan, senior market economist at Dresdner Kleinwort, disagreed. He said the Fed "haven't backed off at all" on its inflation worry.
The "softened tone" interpretation got a little support at The Wall Street Journal's Real Time Economics blog:
ING economist Rob Carnell said the FOMC, in acknowledging improvement in core inflation, took “a slight step in the direction of a neutral bias to policy...
But most of the votes were lining up in the "hawkish" camp: At FX Daily:
This language is more hawkish than the May statement, where the Fed simply said that “economic growth has slowed.” In terms of inflation, the Fed isn’t convinced that the battle has been won. Instead, they expect inflation to remain a problem.
... at Bloomberg ...
"The Fed is signaling it wants it proven first that inflation is down and will stay down,'' said Gerald Lucas, senior investment strategist in New York at Deutsche Bank AG, one of the 21 primary U.S. government securities dealers that trade with the Fed. "Inflation and the perception that the Fed will remain on hold is what the market is reacting to''...
"The market is pricing in a higher probability, though it's still very small, that the next Fed move is a tightening,'' said Scot Johnson, who manages $2.1 billion of government bonds in Houston at AIM Capital Management Inc. Inflation is still ``not low enough that everybody's happy.'
... and at Forbes.com...
"The statement suggests that the Fed has a ways to go in containing inflation," [Drew Matus, economist at Lehman Brothers] told Forbes.com. "But they acknowledge progress. The Fed is no closer to raising or cutting rates. They will be on hold for some time, and that is what we should continue to expect."
There were, in fact, warnings about reading too much of anything into the changes in the Committee's language. Again from The Wall Street Journal:
... Drew Matus notes that the FOMC removed the word “elevated” from its latest description of inflation. The fact that the year-over-year inflation rate is likely to be unchanged from the readings before the May meeting “suggests that the removal of the word had less to do with a change in the FOMC’s view on the inflation outlook and more to do with removing a word that was garnering unwanted attention.”
The net change in the Fed’s position is “trivial” given the view of moderating growth and the risk that inflation won’t moderate, said Ian Shepherdson, chief U.S. economist at High Frequency Economics.
And elsewhwere at the WSJ's Real Time Economics, there is the suggestion that the language is ambiguous because the Committee is feeling -- uh, ambiguous:
With core inflation at 2% in April and perhaps about to go lower, Thursday’s policy statement by the Fed dropped its reference to inflation as “somewhat elevated.” Some analysts saw this as acknowledgement of an inflation target somewhere around 2%.
More likely, the Fed simply punted on the question...
Dropping the reference to “elevated” without replacing it with anything may have been necessary to satisfy those who don’t buy into the 1% to 2% comfort zone without arousing objections from those who do.
If you are feeling puzzled, you can always look forward to July 19 -- and the release of the meeting minutes.
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June 26, 2007
What's That Unpleasant Sound?
The United States faces a severe credit crunch as mounting losses on risky forms of debt catch up with the banks and force them to curb lending and call in existing loans, according to a report by Lombard Street Research.
The group said the fast-moving crisis at two Bear Stearns hedge funds had exposed the underlying rot in the US sub-prime mortgage market, and the vast nexus of collateralised debt obligations known as CDOs.
"Excess liquidity in the global system will be slashed," it said. "Banks' capital is about to be decimated, which will require calling in a swathe of loans. This is going to aggravate the US hard landing."...
Lombard Street’s warning comes as fresh data from the US National Association of Realtors shows that the glut of unsold homes reached a record of 8.9 months supply in May. Sales of existing homes slid to an annual rate of 5.99m.
The median price fell for the 10th month in a row to $223,700, down almost 14pc from its peak in April 2006. This is the steepest drop since the 1930s.
The Mortgage Lender Implode-Meter that tracks the US housing markets claims that 86 major lenders have gone bankrupt or shut their doors since the crash began.
The latest are Aegis Lending, Oak Street Mortgage and The Mortgage Warehouse.
It is worth noting that those are specifically mortgage-lending corporations not commercial banks, so I am not clear on the basis of this claim:
Lombard Street said the Bear Stearns fiasco was the tip of the iceberg. The greatest risk lies in the “toxic tranches” of lower grade securities held by the banks.
Much-trumpeted claims that banks had shifted off the riskiest credit exposure on to the asset markets was “largely a fiction”, said [Charles Dumas, the group's global strategist].
In fact, the article contains more assertions than facts. But I think it is agreed that if there is going to be a really big spillover effect from ongoing housing woes, this is where we'll find it.
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June 25, 2007
Would Subtracting Housing Make Inflation All Better?
I really did not need another must-read blog added to my list, but the Wall Street Journal's Real Time Economics feature has left me no choice. In last Friday's edition, Greg Ip detected some pebbles coming from the direction of glass houses:
The Federal Reserve has come under fire increasingly for focusing on “core” inflation rather than headline inflation. Excluding food and energy made sense, critics said, when those two were volatile but trendless. In recent years, however, they’ve mostly headed up, and thus core inflation has consistently lagged headline inflation.
This week’s issue of The Economist joins the criticism of core inflation, saying “Bond investors are living in a world where nobody eats or drives.” It notes Bank of England governor Mervyn King earlier this month said “measures of ‘core inflation’ that strip out certain prices can be highly misleading.” The bank’s chief economist Charles Bean leveled the same criticism last year in the heart of Fed territory, the annual symposium at Jackson Hole...
Yet when the Fed hears these criticisms from the British, it may wonder if the pot is calling the kettle black. The Bank of England targets a price index that excludes almost all housing costs, notably mortgage payments. And in the U.K. overall inflation, at 4.3% in May, is notably higher than the 2.5% inflation rate as measured by the index targeted by the Bank of England. The European Central Bank also excludes owner-occupied housing from the price index it targets, though that represents more than 10% of total consumption. Given housing’s sizable contribution to U.S. inflation last year, the Fed might have preferred the British target.
Or maybe not. Though the inflation rate measured by the CPI less its shelter component might have provided some comfort, the overall story remains pretty much the same:
I personally prefer to look at inflation over the "medium-term," say three to five years. Any help there? Nope.
What if that picture had turned out better? You might have said "so what", and I would have been with you. As far as I can tell -- and as I have said here many times before -- the predominant view among those of us who spend a lot of our lives thinking about such things is that core measures are useful insofar as they help us get a clearer real-time picture of where the overall inflation trend is headed. The Economist's jibe that "Bond investors are living in a world where nobody eats or drives" willfully ignores the real reason that core inflation is discussed in the first place.
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June 21, 2007
Dark Matter By Any Other Name
... The United States miracle of the 1990s was that our productivity began growing faster than that of other countries, even though we were the richest to start with...
To explain the experience in the United States, one would have to believe that Americans have some better way of translating the new technology into productivity than other countries. And that is precisely what [London School of Economics] Professor [John] Van Reenen’s research suggests.
His paper “Americans Do I.T. Better: U.S. Multinationals and the Productivity Miracle,” (with Nick Bloom of Stanford University and Raffaella Sadun of the London School of Economics) looked at the experience of companies in Britain that were taken over by multinational companies with headquarters in other countries. They wanted to know if there was any evidence that the American genius with information technology transfers to locations outside the United States. If American companies turn computers into productivity better than anyone else, can businesses in Britain do the same when they are taken over by Americans?
And in the huge service sectors — financial services, retail trade, wholesale trade — they found compelling evidence of exactly that. American takeovers caused a tremendous productivity advantage over a non-American alternative.
When Americans take over a business in Britain, the business becomes significantly better at translating technology spending into productivity than a comparable business taken over by someone else. It is as if the invisible hand of the American marketplace were somehow passing along a secret handshake to these firms.
Sound familiar? If you can't quite put your finger on it, here's a refresher from Ricardo Hausmann and Federico Sturzenegger:
There is a large difference between our view of the US as a net creditor with assets of about 600 billion US dollars and BEA’s view of the US as a net debtor with total net debt of 2.5 trillion. We call the difference between these two equally arbitrary estimates dark matter, because it corresponds to assets that we know exist, since they generate revenue but cannot be seen (or, better said, cannot be properly measured)...
At least three factors account for the accumulation of dark matter. The first refers to foreign direct investment (FDI). Consider a simple example. Imagine the construction of EuroDisney at the cost of 100 million (the numbers are imaginary). Imagine also, for the sake of the argument that these resources were borrowed abroad at, say, a 5% rate of return. Once EuroDisney is in operation it yields 20 cents on the dollar. The investment generates a net income flow of 15 cents on the dollar but the BEA would say that the net foreign assets position would be equal to zero. We would say that EuroDisney in reality is not worth 100 million (what BEA would value it) but four times that (the capitalized value at our 5% rate of the 20 million per year that it earns). BEA is missing this and therefore grossly understates net assets. Why can EuroDisney earn such a return? Because the investment comes with a substantial amount of know-how, brand recognition, expertise, research and development and also with our good friends Mickey and Donald. This know-how is a source of dark matter. It explains why the US can earn more on its assets than it pays on its liabilities and why foreigners cannot do the same. We would say that the US exported 300 million in dark matter and is making a 5 percent return on it. The point is that in the accounting of FDI, the know-how than makes investments particularly productive is poorly accounted for.
That story might only go so far, as the Federal Reserve Bank of New York's Matthew Higgins, Thomas Klitgaard, and Cedric Tille claim...
... we review the argument that the United States holds large amounts of intangible assets not captured in the data—assets that would bring the true U.S. net investment position close to balance. We argue that intangible capital, while a relevant dimension of economic analysis, is unlikely to be substantial enough to alter the U.S. net liability position.
... but it's apparently more than a fairy tale.
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Tracked on Jun 22, 2007 12:46:50 AM
June 20, 2007
Apples To Apples
Today at Angry Bear, my friend pgl is doing some back-of-the-envelope econometrics:
From 1980QIV to 1992QIV, average annual real GDP growth = 3.0%.
From 1992QIV to 2000QIV, average annual real GDP growth = 3.6%.
From 2000QIV to 2006QIV, average annual real GDP growth = 2.6%.
Notice something? During the low tax eras (Reagan-Bush41 and Bush43), we witnessed lower growth rates. During the Clinton Administration – which began with its fiscally responsible policies with a tax rate increase – we saw strong growth. Maybe part of the explanation has to do with the impact on national savings from fiscal irresponsibility justified by phony free lunch promises.
I have a bit of a problem with the evidence here. To get the gist of my objection, take the following quiz:
Which one of these time periods did not include a recession?
a. 1980QIV to 1992QIV
b. 1992QIV to 2000QIV
c. 2000QIV to 2006QIV
If you answered b, you win the gold star. And if you knew that, are you really surprised that the period from 1992 through 2000 had higher average growth than the other two periods, which did include recessions? Suppose we instead make the comparisons including only the expansion years of the Reagan-Bush41 and Bush43 administrations? Here's what you get:
From 1983 to 1989, average annual real GDP growth = 4.3%.
From 1992 to 2000, average annual real GDP growth = 3.7%.
From 2002 to 2006, average annual real GDP growth = 2.9%.
You could just as well look at those numbers and conclude that potential GDP growth -- measured cycle to cycle -- is declining through time. And if you accept pgl's characterization of irresponsible policy, followed by responsible policy, followed by irresponsble policy, you might then conclude that policy has very little to do with that trend.
Perhaps you would want to argue that I shouldn't exclude recessions because the absence of a downturn in the 1992-2000 period is itself evidence of the superior growth effects of the fiscally responsible policies of the Clinton administration? Let me try to talk you out of that with a few more questions:
1. Do you really want to blame the Reagan fiscal policies for the 1980-82 recessions -- which are almost universally attributed to the Volcker Fed's fight against double digit inflation inherited from the policies of the 1970s?
2. Do you really want to characterize Bush41 as a tax cutter? And would you maintain that position knowing that Clinton's major piece of fiscal policy -- the Omnibus Reconciliation Act of 1993 --was pretty much of copy of the Omnibus Reconciliation Act of 1990, the legislation in which President Bush the Elder famously broke his "no new taxes" pledge?
3. Do you really want to finger the Bush43 tax cuts for the 2001 recession which began a scant two months into the administration and was over even before the tax cuts took effect?
Look -- It might very well be that "fiscal responsibility," as pgl defines it, is a central ingredient of pro-growth policy. But those GDP comparisons don't make the point.
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June 19, 2007
Housing, Wherein We Learn Not Much
What can you say about this month's housing news? Calculated Risk suggests:
[Today's Census Bureau New Residential Construction] report shows builders are still starting too many projects, and that residential construction employment is still too high.
The Skeptical Speculator seconds the emotion...
As I've said before, the housing market will take a while to recover, especially with the prevailing trend in interest rates.
... and Barry Ritholtz makes it unanimous:
... despite the hopes of the bottom-callers, there is still a ways to go.
Inside the number: The lowest builder confidence since 1991. NAHB President Brian Catalde:
"Builders continue to report serious impacts of tighter lending standards on current home sales as well as cancellations, and they continue to trim prices... to work down sizeable inventory positions."
Flyin in the face of Fed speak: "Home sales most likely will erode somewhat further in the months ahead and improvements in housing starts probably will not be recorded until early next year.
As a result, we expect housing to exert a drag on economic growth during the balance of 2007."
Changes in house prices could have a bigger effect on consumption than the traditional “wealth effect” suggests, Ben Bernanke said on Friday in comments that offer some insight into how the Federal Reserve may think about the continuing problems in the US housing market.
The Federal Reserve chairman told a conference hosted by the Atlanta Fed that, in addition to making homeowners richer or poorer, changes in house prices might influence the cost and availability of credit to consumers.
Ideas that Ben Bernanke pioneered years before becoming Federal Reserve Chairman could prove important in evaluating how financial stress, such as the subprime mortgage mess, affects the economy.
... Although Mr. Bernanke doesn’t say so specifically, the record level of consumer leverage today means a change in asset prices (such as homes or stocks) can produce a much larger change in consumers’ net worth, and as a result their ability to borrow and spend. “If the financial accelerator hypothesis is correct, changes in home values may affect household borrowing and spending by somewhat more than suggested by the conventional wealth effect,” that is, the tendency of a changes in asset prices to make consumers feel more or less wealthy, and thus spend differently. That is because “changes in homeowners’ net worth also affect their … costs of credit.”
It is clear that some are willing to assert that this scenario is more than hypothetical. Again from Calculated Risk:
From the LA Times: Report from UCLA team skirts the R-word
"We suspect that the weakness in the housing market is finally spilling over into consumption spending," wrote senior economist David Shulman in the quarterly forecast being released today. "Retail sales appeared to stall in April and automobile sales have become decidedly weak.
"This is not a recession, but it is certainly close," Shulman said.
To tell you the truth, I'm not quite sure what Dr. Shulman finds so convincing. Under the category of spilling over, I think Greg Ip offers the right entry:
As yet, there has been little spillover from these developments into consumer spending or the economy overall.
As for a conclusion, I'll sign on with The Capital Spectator:
For mere mortals, the only reaction is wait, wait for more data. Yes, we've been waiting now for months and still we've no clarity. Grin and bear it.
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June 15, 2007
Comfort In Core?
If you had even a glance at today's report on consumer-price inflation in May, it would have been hard to miss the pretty significant dichotomy between the growth in overall prices and the inflation rate measured by so-called core measures. And if you did miss it, you can fill yourself in at The Street Light, at The Prudent Investor, at The Capital Spectator, and at the Big Picture. For some, like my friend (and Brandeis professor) Steve Cecchetti, the core report feels like victory:
I wish that the Boston Red Sox were doing as well in maintaining their lead in the American League's Eastern Division as the Federal Reserve's Open Market Committee is at keeping inflation under control. The former have been slipping badly, losing six of their last ten games at the same time that the dreaded Yankees have won nine of ten. By contrast, this morning's Bureau of Labor Statistics release confirms that the latter is right on track to bring inflation down to levels that make us all comfortable.
Today's numbers do show a rather large increase in the all-items CPI for the month of May: 8.4 percent at an annual rate (a.r.). But this hefty rise is primarily a result of yet another large gasoline price increase. Energy prices overall rose 5.4 percent for the month; that's 88 percent at an annual rate.
Core measures of inflation, designed to remove short-term volatility, increased by much less. The traditional core, the CPI excluding food and energy. rose 1.8 percent (a.r.), while the Median CPI computed by the Federal Reserve Bank of Cleveland increased an extremely modest 1.0 (a.r.). And the 16 percent trimmed mean, increasingly my favorite inflation indicator, is up only 2.3 percent. Looking over the past 12 months, we see that headline inflation of 2.7 percent, while various core measures registered between 2.2 and 3.1 percent.
The Nattering Naybob, on the other hand, is none too impressed with Steve's attitude:
This on the heels of a CPI proving stagflation is ragin in double digits with the 2nd largest monthly increase in 16 years.
Where do they hand out these PHD's??? (Piled High and Deep)....
That's a little harsh, especially when there are plenty of good reasons to champion core inflation as a guide to monetary policy. Still, I'm unwilling to argue that the critics of core, nattering and otherwise, are completely off base. Earlier this week, Cleveland Fed president Sandra Pianalto had this to say:
... inflationary risk can occur when large and persistent relative price shocks temporarily ripple through the inflation data. The obvious example is energy prices, although we see such changes in commodity prices more generally. These price pressures are temporary and so do not represent changes in the inflation trend. Still, a central bank cannot ignore them if it hopes to maintain credibility for delivering low and stable inflation.
Since 2005, the three- to five-year moving average of U.S.inflation has hovered around 3 percent. This is above where I would like to see the trend settle in the longer run. The reality of rising oil and commodity prices is evident, and my Federal Reserve colleagues and I have been clear that we believe the impact of these influences will dissipate over time. But until our beliefs are validated by the data, there is a risk that the public's trust could erode and inflation expectations could move higher.
Unfortunately, the data is definitely not validating:
And if "the public's trust" were to erode? Well, that would be bad.
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» Fed Watch: Fed Not Ready to Declare Victory on Inflation from Economist's View
Tim Duy says the Fed is not quite ready to give up its inflationary bias: Fed Not Ready to Declare Victory on Inflation, by Tim Duy: Fed officials like to remind us that inflation remains above their comfort level, but [Read More]
Tracked on Jun 18, 2007 1:35:24 AM
June 13, 2007
Still The Place To Run
Just when you think you have it figured out. From Bloomberg:
Treasurys rallied Wednesday, after recent sell-offs in bond prices sent the benchmark yield to a five-year high, attracting money from investors amid speculation the economy will continue to grow at moderate levels.
The buying spree occurred despite news of a jump in May retail sales, higher- than-expected import prices and a Federal Reserve Beige Book survey of regional economies that depicted an economy with tame inflation and moderate growth.
One explanation for the sudden reversal in the Treasury-yield trend is that there is no explanation required: On a day-to-day basis asset prices rise and asset prices fall. Unless you are one of the relatively few who makes his or her fortune vacuuming up the arbitrage pennies, it really is of no consequence. Still, it's fun (if not particularly productive) to speculate. One line of argument might be that the strong retail sales were really not quite as strong as they seem. From the Wall Street Journal Online:
We do not advise looking at either the very weak April or the robust May result alone, as neither is an accurate representation of underlying consumer spending… While May saw a bounce, the two months together don’t paint a particularly ebullient picture, particularly when looked at excluding large, price-related gains in gasoline purchases. –Joshua Shapiro, MFR, Inc.
But if you don't like that one, the Bloomberg article has plenty more:
"There are lots of rumors out there" to explain the unexpected rally, said
T.J. Marta, fixed income strategist at RBC Capital Markets. "Our rumor is that there was a huge purchase of 30-year notes by an Asian buyer."
After the purchase "a sheep-like mentality" set in, inspiring more buyers to return to the market, Marta said...
Kim Rupert, fixed-income strategist at Action Economics, attributed the day's gains to "an oversold condition."
"We've come a long way in a short time," she said.
Renewed concerns about the deteriorating subprime mortgage market may have spurred some safe-haven buying. BusinessWeek online Wednesday reported that a 10-month-old Bear Stearns Companies Inc. (BSC) hedge fund is down 23% for the year largely due to subprime problems.
That last one is the one that catches my eye, as it reflects a point that seems to prove itself over and over again: When the players get nervous, it's still to the U.S. Treasury market they run.
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June 12, 2007
Putting The Money Back In Monetary Policy?
The Wall Street Journal's Joellen Perry reports (page A8 in the print edition) on the latest debate within the European Central Bank:
With euro-zone interest rates near a six-year high, European Central Bank policy makers are clashing over the role of the swollen supply of money in pushing up prices.
That rare break in the bank's public facade of unity suggests policy makers are divided about how high to push interest rates in the 13-nation currency bloc, and it could rekindle a global debate on the merits of monitoring money supply...
Years of low interest rates have fueled a global liquidity glut that has inflation-wary central bankers world-wide paying attention to money-supply data. The ECB, as the only major central bank to give money-supply growth an official role in its decision-making, has led the charge. But other policy makers, including at the Bank of England and Sweden's Riksbank, have also cited strong money-supply growth as a reason for recent interest-rate rises.
Actually, Claus Vistesen was thinking about this last week, while I was in Frankfurt attending a joint conference on Monetary Strategy: Old issues and new challenges, jointly sponsored by the Deutsche Bundesbank and the Federal Reserve Bank of Cleveland. The question of whether or not central bankers ought pay attention to money, and talk about it when they do, did come up. Gunter Beck and Volcker Wieland, both from the Goethe University Frankfurt (and the latter formerly of the Federal Reserve Board), offered up a theoretical argument for why the money-guys in the ECB might be on to something:
... we develop a justification for including money in the interest rate rule by allowing for imperfect knowledge regarding unobservables such as potential output and equilibrium interest rates. We formulate a novel characterization of ECB-style monetary cross-checking and show that it can generate substantial stabilization benefits in the event of persistent policy misperceptions regarding potential output.
... We assume that the central bank checks regularly whether a filtered money growth series adjusted for output and velocity trends averages around the inflation target. If the central bank obtains successive signals of a sustained deviation of inflation from target it adjusts interest rates accordingly.
Our simulations indicate that persistent policy misperceptions regarding potential output induce a policy bias that translates into persistent deviations of inflation and money growth from target. In this case, our “two-pillar” policy rule may effectively overturn the policy bias. Cross-checking relies on filtered series of actual money and output growth without requiring estimates of potential output. Indirectly, however, it helps the central bank to learn the proper level of interest rates.
Some of the conference participants noted that there are lots of alternative (and established) statistical techniques for forecasting in the face of uncertainties about concepts such as potential output and the equilibrium real interest rate, but another of the conference papers -- from the Bundesbank's Martin Scharnagl and Christian Schumacher -- suggested that Beck and Wieland may just be on to something when they say the ECB money-guys may just be on to something:
This paper addresses the relative importance of monetary indicators for forecasting inflation in the euro area. The analysis is carried out in a Bayesian framework that explicitly considers model uncertainty with potentially many explanatory variables...
The empirical results show that money is an integral part of the forecasting model... The key finding of the paper is is that the majority of models include both monetary and non-monetary indicators.
To paraphrase, when it comes to short-run forecasts, the kitchen sink works best. But the result that got my attention was Scharnagl and Schumacher's finding that, in their experiments, the trend in the money supply is the only factor that appears useful in forecasting inflation once you get out beyond about 6 quarters.
That may surprise you, but it probably shouldn't. The Scharnagl and Schumacher study is on the technical side, but some years ago economists George McCandless and Warren Weber offered up some evidence which was pretty easy to grasp:
That's a graph of the relationship between average money growth (measured by M2) and average inflation for a large cross-section of countries, over the period from 1960 through 1990. If you are an old hand on this topic, you probably remember that it was around 1990 that both the ECB and the Federal Reserve lost confidence in the money measures they were tracking. The ECB responded by moving from a narrow measure of money to the very broad M3 concept. The Federal Reserve responded by more-or-less abandoning monetary measures all together.
OK, let's take a look at the McCandless and Weber picture post-1990:
Hmm. The Wall Street Journal article correctly notes that there is still a great deal of skepticism about the usefulness of monetary measures in formulating monetary policy:
The U.S. Federal Reserve is among the doubters. Fed Chairman Ben Bernanke said in November that a "heavy reliance" on money-supply data as a predictor of U.S. inflation was "unwise."
I don't think either the Beck-Wieland or Scharnagl-Schumacher work contradicts that skepticism about "heavy reliance." But maybe money deserves just a little more love on this side of the Atlantic than it currently gets?
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» Transparency and the ECB from Economist's View
Francesco Giavazzi argues that monetary policy in Europe could be greatly improved with increased transparency at the European Central Bank: Sarkozy and the ECB: Right intuition, wrong target, by Francesco Giavazzi, VoxEU: During his electoral campaign... [Read More]
Tracked on Jun 18, 2007 4:27:30 PM
June 11, 2007
One Savings Glut That Carries On
China's monthly trade surplus soared 73% in May from a year earlier, a state news agency reported Monday, amid U.S. pressure on Beijing for action on its yawning trade gap and the possibility of sanctions.
Exports exceeded imports by $22.5 billion, the Xinhua News Agency said, citing data from China's customs agency. That figure, close to the all-time record high monthly surplus of $23.8 billion reported in October, came despite repeated Chinese pledges to take steps to narrow the gap by boosting imports and rein in fevered export growth. The report gave no details of imports or exports.
The U.S. government has been pressing Beijing for action, especially steps to raise the value of the Chinese currency. Critics say the yuan is kept undervalued, giving Chinese exporters an unfair advantage and adding to the country's growing trade gap.
Apparently, the U.S. Senate is about to officially jump into the yuan-peg fray. From Bloomberg:
The U.S. Senate will introduce a bill this week to pressure China to strengthen its currency, the Financial Times said today, citing unidentified people close to the situation.
The market, on the other hand, suggests that maybe things aren't so straightforward:
The gap may increase pressure on China to let the yuan appreciate to reduce tensions with trading partners and cool the world's fastest-growing major economy. The currency today had its biggest decline in 10 months and has reversed gains made in May when Chinese and U.S. officials met for trade talks in Washington...
The yuan declined 0.2 percent to 7.6691 against the U.S. dollar at 4 p.m. in Shanghai today, the biggest one-day fall since Aug. 15.
The currency has strengthened 7.9 percent since China scrapped a 10-year peg to the dollar and revalued the currency in July 2005. The 0.74 percent monthly gain in May was the biggest since the end of the fixed exchange rate.
I'm not sure what the story is there, but Nobel Prize winner Robert Mundell warned this weekend that too much pressure on the Chinese may not imply an appreciating yuan. From the Wall Street Journal (page A9 in the weekend print edition):
... in the unlikely event that the yuan were suddenly made fully convertible, Mr. Mundell predicts that the value of the currency would fall, not rise. Many Chinese savers would want the security of keeping at least some portion of their wealth in foreign currency and would convert quickly, worried that the government might slam the door shut. This might become a self-fulfilling prophecy. In the U.K. in 1947, the Bank of England saw its reserves evaporate in a matter of weeks, and reinstated capital controls. The movement to full convertibility is fraught with danger and must be approached cautiously.
Meanwhile, yet another Nobel Prize winner, Michael Spence, suggests there is something much deeper in play than mere currency policy. From China Daily:
China has been in a high growth mode since it started economic reforms in the late 70s. Its almost three decades of high growth is the longest among the 11 high-growth economies in the world and part of "a recent, post-World War II phenomenon". And the Chinese economy will sustain its fast growth for at least two more decades...
The high levels of savings and investments both in the public and private sectors, resource mobility and rapid urbanization are the important characteristics of China's high growth, says Spence, who is also the chairman of the independent Commission on Growth and Development. The commission was set up last year to focus on growth and poverty reduction in developing countries. China's saving rate of between 35 to 45 percent is among the highest despite the relatively low level of income of its people. Resource mobility has generated new productive employment to absorb surplus labor in a country where 15-20 million people move from the rural areas to the cities every year.
The most important feature of sustained high growth is that it leverages the demand and resources of the global economy, says Spence. All cases of sustained high growth in the post-War period have integrated into the global economy because exports act as a major high-growth driver.
Enumerating the reasons why the Chinese economy will sustain its high growth rate for another two decades, he says: "There are basically two reasons. One is that there is still a lot of surplus labor in agriculture. The engine for high growth is still there. The second is that the Chinese economy has diversified very rapidly. It's quite flexible and entrepreneurial."
Spence clearly believes that the Western complaints of too low a value for the Chinese currency and too high a surplus in its trade balances will self-correct, with a little help from government policy:
The only way to stop China's high growth would be to shut the economy off from the rest of the world. "It's just not going to happen." Even 20 years later, China will continue to grow because its currency will appreciate, helping raise the income level and increase the wealth of the people...
... To balance the huge trade deficit, Spence hopes China would boost domestic consumption and bring down the saving rate.
He acknowledges, though, that the relatively high-income younger generation is spending more despite the fact that East Asians traditionally are good at saving. A solution to the trade imbalance could also be found by increasing social security and the pension system, making them available to everybody, improving the medical coverage in the rural areas and making education at all levels affordable.
Meanwhile, the move to liberalize domestic financial markets in China took another step forward this weekend. From Reuters, via China Daily:
China Export-Import Bank (EximBank) is set to issue 2 billion yuan (US$261 million) in yuan-denominated bonds in Hong Kong this month, making it the first Chinese lender to do so, sources told Reuters on Monday.
Exim Bank is to sell the 3-year bonds only to institutional investors, an investment banking source said, adding that the bank would decide on the yield later.
Never boring, is it?
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