macroblog

About


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

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


« January 2011 | Main | March 2011 »

February 24, 2011


Global inflation and the Fed: One more time

George Melloan is unhappy with U.S. monetary policy, and he repeats what has become by some a criticism of Federal Reserve policy:

"In accounts of the political unrest sweeping through the Middle East, one factor, inflation, deserves more attention…

"Probably few of the protesters in the streets connect their economic travail to Washington. But central bankers do. They complain, most recently at last week's G-20 meeting in Paris, that the U.S. is exporting inflation…

"About the only one failing to acknowledge a problem seems to be the man most responsible, Federal Reserve Chairman Ben Bernanke. In a recent question-and-answer session at the National Press Club in Washington, the chairman said it was 'unfair' to accuse the Fed of exporting inflation. Other nations, he said, have the same tools the Fed has for controlling inflation.

"Well, not quite."

I would simply repeat my argument from our previous macroblog post, but I don't really have to. Mr. Melloan makes the point for me [with my emphasis added in italics]:

"Consider, for example, that much of world trade, particularly in basic commodities like food grains and oil, is denominated in U.S. dollars. When the Fed floods the world with dollars, the dollar price of commodities goes up, and this affects market prices generally, particularly in poor countries that are heavily import-dependent. Export-dependent nations like China try to maintain exchange-rate stability by inflating their own currencies to buy up dollars."

If the United States unwisely floods the world with dollars, driving down the international value of the dollar, countries with flexible exchange rates would see the value of their currencies rise—making food grains and oils denominated in dollars more affordable, not less. The only way inflation gets exported to these other countries is if they attempt to maintain the values of their currencies below the levels that markets would otherwise take them. That inflation is purely homegrown.

That point is also exactly the one I made last time with respect to Chinese inflation:

"To keep the nominal exchange rate from rising, the People's Bank of China in effect prints yuan and buys dollars. Though this has limited impact on any real fundamentals, it is the source material for inflation."

I did, however, leave one unfinished piece of business in the previous blog post:

"Of course, the astute and skeptical among you might ask, if the money-to-inflation nexus is relevant to China, why not the United States? A fair question, one that I will take on another day."

Well, it's another day, so here we go. In China, increases in the monetary base—the stuff that the central bank directly creates—translate pretty directly into broader measures of money held (and spent) by the public, as illustrated by the relative stability of the so-called M1 and M2 multipliers:



Admittedly, the collapse in the M2 multiplier in the United States—which has, for practical purposes neutralized the inflationary impact of the increase in the Fed's balance sheet—may not last forever. If it reverses, I for one will read this again.


Photo of Dave Altig By Dave Altig
Senior vice president and research director at the Atlanta Fed


February 24, 2011 in Federal Reserve and Monetary Policy, Inflation, Monetary Policy | Permalink

TrackBack

TrackBack URL for this entry:
http://www.typepad.com/services/trackback/6a00d8341c834f53ef014e864b72b0970d

Listed below are links to blogs that reference Global inflation and the Fed: One more time:

Comments

After reading your very interesting piece, I shall be grateful if you can throw some light on the following:

First, the relevence of monetary base (M1 and M2) to gauge price inflation, because as Michael Woodford, et al, have shown, electronic money, credit, repos, shadow-banking, makes it difficult to make the connection between money supply and inflation (unlike in 1960's).

Second, possible differences between the determinants of monetary base between US and China.

Posted by: thehouse | February 25, 2011 at 02:53 PM

Oops. The collapse of M2. "... has neutralized the inflationary impact of the increase in the Fed's balance sheet." Rather, the collapse of M2 illustrates that the tail thought it was the dog.

Elizabeth Duke, for one, is rethinking the non-impact of expanding the monetary base. It turns out, as Kydland and Prescott showed so many years ago, money growth PRECEDES the expansion of the monetary base.

But my point is that the Fed is not "flooding the economies," it is giving cheap money to the financial sector. Far from acting as a passive multiplier, these folks are levering up and carrying their trade to emerging market investments and commodity futures. Paul Krugman aside, and the recent signs of weakness in the emerging market bubbles aside, it is clear that the Fed is indeed exporting higher prices.

Posted by: demandside | February 27, 2011 at 06:35 PM

Besides the year over year increase in gasoline prices of 65 cents, and the obvious double digit increases in food that the Fed chooses to ignore, there is now a parabolic price move occurring in MIT's billion price survey. The three month inflation rate annualized of the MIT index is a hot 6 percent.

enter USA:
http://bpp.mit.edu/daily-price-indexes/

Inflation has already raised its ugly head in America even without the currency adjustments you speak of. If those dollar peggers actually did revalue, the US would have double digit inflation in a heartbeat. I say we are close already. Better be careful what you wish for.

Posted by: Russ Winter | February 28, 2011 at 10:47 PM

I can't help but get a sense that Ben will be one of many unemployed shortly. I know there's talk about QE3 but with the inflation monster starting to nip and the politicians looking for a scapegoat... well. I won't be surprised.

Posted by: Hal (GT) | March 01, 2011 at 03:38 PM

Your comment, "The only way inflation gets exported to these other countries is if they attempt to maintain the values of their currencies below the levels that markets would otherwise take them. That inflation is purely homegrown." raises a couple questions I hope you would answer.

1. How can anyone that works at the Fed seriously talk about the true market value of another country’s currency? - The very idea of the Fed accusing another country of currency manipulation makes me laugh. Perhaps the Fed should sweep their own porch before attempting to sweep the porch of another.

2. If you and Bernanke believe that China should let the markets dictate the value of their currency, why don't you have the same problem with the Fed dictating interest rates, instead of the market determining them? LOL, it brings me such humor.

3. If China decides to let their currency fluctuate to the dollar, what happens to the value of the U.S. debt they hold? Hmmm....

4. If your belief is truly that markets should determine the value of a currency (interest rates), would you support the idea of having competing currencies here in America?

5. Lastly, please explain the difference between China printing yuans and buying dollars; and the Fed printing dollars and buying recently issued Treasuries from Primary Dealers, and other fantastic assets like MBS, CDO, CMO, etc.... etc….?

I look forward to anyone that might actually respond to these non-CNBC digestible questions.

William

Posted by: William | March 01, 2011 at 05:29 PM

I'm not so sure that they haven't been restructuring with the moves that they've been doing.

Posted by: Shena | March 02, 2011 at 12:48 AM

Really great blog and great post. Going to read your other posts...

Posted by: slot makinaları | March 02, 2011 at 05:05 AM

William,

You seem to be focused on the irony of the Fed lecturing anyone.

If you want to answer your own questions you should be thinking about the consequences of China's policies on China.

Chinese currency policy is not some exogenous force like the weather. They are making decisions for their own reasons and now they are facing the predictable consequences of those choices.

Their scope of action is constrained just as US monetary policy is and in fact now in 2011 it may be even more so because they are caught by BOTH the fundamentals and their own rhetoric This fact actually increases the leverage of the US in the near term to do manipulate expectations because the risk of sudden adjustments by the Chinese counter parties is lower and the chance of constructive gradual moves is greater.

Posted by: Michael Carroll | March 21, 2011 at 03:19 PM

Post a comment

Comments are moderated and will not appear until the moderator has approved them.

If you have a TypeKey or TypePad account, please Sign in

February 18, 2011


China’s inflation dilemma

As the G20 meets and debates issues of inflation and global imbalances, China's central bank is again on the move. From Reuters:

"China on Friday raised required reserves to a record 19.5 percent, adding to an increasingly aggressive effort by Beijing to stamp out stubbornly high inflation.

"Over the past four months, China has also raised interest rates three times and ordered banks to issue fewer loans in an attempt to make sure it can meet a 2011 inflation target of 4 percent."

Though rising food prices are indicted in a good many discussions of emerging market inflation these days, it is not just food, the article notes:

"Soaring food costs have driven Chinese inflation, rising 10.3 percent in the year to January and accounting for nearly three-quarters of the jump in overall prices.

"But pressures have been broadening. Non-food inflation, long subdued, rose at its fastest pace in more than a decade in January."

The Reuters piece, in my opinion, also hits on the key issue:

"Excess cash in the economy, stemming from China's trade surplus, is a root cause of fast-rising prices, prompting the central bank to use reserve requirements to lock up a bigger share of deposits and thereby slow money growth."

That issue gets most of the story, leaving out only the implicit key link—the pegging of the yuan to the dollar. The Economist this week offers up an interesting comparison between a measure of the real (or inflation-adjusted) yuan-dollar exchange rate and the nominal exchange rate:

021811

The real exchange rate—which, in effect, measures the value in trade of Chinese goods and services for U.S. goods and services—is rising and has been more or less continuously for some time. It is not so apparent that the real exchange rate is being systematically manipulated or controlled, and in fact there is good reason to claim that it is not (or at least not via monetary policy). Real exchange rates are about the demand and supply of real resources—things that are not over time controlled by manipulating the money supply. That reality is suggested by evidence cited in the Economist article:

"Conventional wisdom says that a stronger yuan would reduce China's current-account surplus. Yet the empirical support for this is weak. In a paper published in 2009, Menzie Chinn of the University of Wisconsin and Shang-Jin Wei of Columbia University examined more than 170 countries over the period 1971-2005, and found little evidence that countries with flexible exchange rates reduced their current-account imbalances more quickly than countries with more rigid regimes."

But if printing money does not buy you control over real stuff, it is very definitely a factor in controlling the nominal exchange rate—a measure of the value in trade of currency for currency. And there, I believe, is the crux of the problem. To keep the nominal exchange rate from rising, the People's Bank of China in effect prints yuan and buys dollars. Though this has limited impact on any real fundamentals, it is the source material for inflation. In fact, if a monetarist heart beats within you, the picture of the recent Chinese inflation experience will surely warm it:


As Chairman Bernanke said in recent congressional testimony:

"The renminbi is undervalued. … It would be both in our interest and in the Chinese interest for them to raise the value of their currency. And it would help them with their inflation problem."

Today he put forward a similar sentiment, though not mentioning China by name.

Of course, the astute and skeptical among you might ask, if the money-to-inflation nexus is relevant to China, why not the United States? A fair question, one that I will take on another day.


Photo of Dave Altig By Dave Altig
Senior vice president and research director at the Atlanta Fed


February 18, 2011 in Inflation, Monetary Policy, Trade Deficit | Permalink

TrackBack

TrackBack URL for this entry:
http://www.typepad.com/services/trackback/6a00d8341c834f53ef014e5f4ee312970c

Listed below are links to blogs that reference China’s inflation dilemma:

Comments

I am surprised that Bernanke said that inflation in Emrging Market, Middle East and Africa are from the wrong policies in those countries but actually Bernanke is the major reason of the food crises around the world inclduing America; howeverr, US inflation data is hidden by shelter slowdown. I think all political and economic crises from food and commodities hike can be solved if Bernanke admits the guilty of the upheaval around the world. I think food price hike will affect US at the end and we could see people blame the wrong monettary policy. I will see.

Posted by: Young Economist | February 19, 2011 at 07:32 AM

"The renminbi is undervalued. … It would be both in our interest and in the Chinese interest for them to raise the value of their currency."

The first sentence is irrefutable. The second is highly questionable. If China were to halt currency interventions, it may seriously reduce its growth. A "rebalancing" is inevitable, but it would be more painful under conditions of global AD deficiency.

Research arguing that currency interventions by China do not materially improve its exports and current account are akin to what is called "the doctrine of immaculate transer." I have even seen Menzie make statements that the yuan may not be undervalued.

I think a much better picture is obtained by comparing China's current situation with Japan before it relinquished capital controls.

Posted by: don | February 23, 2011 at 01:53 PM

Great article dave,

Imported food price is higher could be attributed to the depreciation of the USD. But if measure it in another currency you could have different results. China's inflation problem is the opposite of the US, where a currency that is kept artificially weak is driving higher food prices.

Similarly it is interesting to note that if you measure the oil price in another currency, it has not risen as much. For example the Oil price in Yen is still cost at equivalent to $65 per barrel.

Intrinsic Value: Current Oil Price Adjusted for Exchange Rates

Posted by: Intrinsic Value | March 06, 2011 at 01:34 AM

Post a comment

Comments are moderated and will not appear until the moderator has approved them.

If you have a TypeKey or TypePad account, please Sign in

February 11, 2011


The inflation disconnect

Reuters's Brad Dorfman and Mark Feisenthal pick up the theme of our last macroblog post:

"Inflation in the United States? The Fed might not see it, but company executives, especially those who sell to consumers, say if it is not here yet, it is on its way.…

" 'There definitely seems to be a disconnect with the Fed's commentary and the experience of the common man,' said Lawrence Creatura, a portfolio manager with Federated Investors."

Messrs. Dorfman and Felsenthal offer this as one possible source of the disconnect:

"So why the disconnect between consumers and executives and the Fed?

"It is because the Fed's top officials, including Bernanke, look at the economy through a prism that compares how fast the economy would grow if firing on all cylinders versus its pace when sputtering.

"Seen that way, there is a wide gap between the current state of the economy and its potential, as measured by the job market."

So it appears they are saying: The Fed thinks inflation can't occur in theory, and therefore it fiddles while the inflation embers burn.

I, as I often remind you, do not speak on behalf of "the Fed's top officials." But I can tell you that this is simply not the source of the advice we are offering here on behalf of the staff of the Atlanta Fed. First, there are the data, duly noted in the Dorfman-Felsenthal article:

"In congressional testimony on Wednesday, Federal Reserve Chairman Ben Bernanke said 'overall inflation is still quite low and longer-term inflation expectations have remained stable.'…

"Also, the Fed likes to see inflation in the range of 2 percent or a bit below. Until recently, inflation had fallen to the point where policymakers worried about the risk of an outright downward deflationary spiral.

"The Fed's preferred measure of inflation, the personal consumption expenditures index, rose a modest 1.2 percent in the 12 months to December, the most recent data shows. Core inflation, which strips out food and energy costs and which the Fed believes is a better indicator of where inflation is heading, has been near five-decade lows."

Yes, I know the headline CPI took a big jump in December. That's what an annualized increase of 145 percent in motor fuel and 62 percent increase in fuel oil will tend to do. But nearly half of prices in the CPI grew at a rate of 1.5 percent or less. Sixty-eight percent grew by 2.1 percent or less.

We recognize that the data are, by definition, yesterday's news, and extrapolating to the future is imperfect (to say the least). For exactly that reason, we do rely—heavily, in fact—on those "consumers and executives" with whom we are purportedly disconnected. In the two weeks prior to every Federal Open Market Committee (FOMC) meeting, we meet face to face with the 44 business leaders (consumers and executives, all) that make up the boards of directors of our main office and the five branches of the Sixth Federal Reserve District. In these meetings we lay out our view of the data, how we are interpreting the information, and what we think it means for the course of the economy going forward. And then we ask them where and how we are getting it wrong.

Advice-seeking is not confined to those 44 directors, however. Our branch system is the basis of what we call our Regional Economic Information Network, or REIN. Through REIN, between each and every FOMC meeting we reach out to literally hundreds of contacts throughout Alabama, Georgia, Florida, Louisiana, Mississippi, and Tennessee. The goal of these interactions is exactly the same as with our directors: Ask real people, making real decisions, about the real circumstances as they see them. And they we ask them what they see coming, share our views on that question, and try to reconcile the two when they differ.

Every Federal Reserve Bank has its own procedures for bringing anecdotal and real-time color and nuance to the data. But we are all doing it one way or another. The picture of a Federal Reserve as disconnected from the on-the-ground realities is simply false.

And what have we been hearing? Yes, certainly highly visible prices and costs have been rising. Yes, some businesses have been able to pass these costs through to customers. Yes, there is some concern about whether price pressures might become more widespread.

But have they yet? Does it seem, as people contemplate market circumstances and their own pricing plans, that widespread price increases are imminent, or even highly probable? The consistent answer we have been getting is no.

We will continue to ask. We are doing it as I write. Jon Hilsenrath and Luca Di Leo note the Chairman's words in a recent Wall Street Journal article:

" 'We do not now have a problem,' Mr. Bernanke said amid repeated questions about inflation from lawmakers during an appearance before the House Budget Committee on Wednesday.

"…lawmakers pressed him on when and how he will begin tightening policy. 'I do want to repeat that we are extremely vigilant,' he said. 'We will be very careful to make sure that we don't wait too long.' "


Photo of Dave Altig By Dave Altig
Senior vice president and research director at the Atlanta Fed

February 11, 2011 in Inflation, Monetary Policy | Permalink

TrackBack

TrackBack URL for this entry:
http://www.typepad.com/services/trackback/6a00d8341c834f53ef0147e2844ffd970b

Listed below are links to blogs that reference The inflation disconnect:

Comments

Hi guys just a word from the trenches I can understand the need to use models to try to predict whats happening and I appreciate the comments about wanting to get real information from real people about whats happening. Economics is some what of a hobby for me I subscribe to your blog and to the blogs of at least 4 economists .That said I walk around my local grocery store with my calculator and compare adds from 3 different stores and when cucumbers cost $1.00 one week and $1.2 the next thats a 20 % price increase no matter how you slice it , I am also noticing that I am paying the same price for an item that now comes in a smaller package 13% reduction in package size on one item this week . Things like this are happening regularly we are on the low end of the totem pole as are many of our friends and our wages that have been stagnating for years are reaching the point where they can not deal with these increases .Food and fuel are 2 of our major expenses and the pricing volatility is only headed in 1 direction and thats up. These 2 items are having a profound impact on already strained budgets and stripping them out and calling inflation low may work in some circles but not others. Thought you would want to know
Thanks

Posted by: Barry | February 11, 2011 at 04:49 PM

If businessmen, consumers, and the common man all expect inflation, why is the TIPS spread only a couple percent on the 10 year?

Wouldn't you expect it to widen?

Is there another measure of the market's inflation expectation that is as specific and as measurable?

Posted by: Max Rockbin | February 11, 2011 at 06:04 PM

Food inflation is almost totally correlated to the weather. Just had a rough crop in Mexico, where we get a lot of veges from in the winter.

Food prices are headed up.

Posted by: Jeff | February 13, 2011 at 07:06 PM

I think the point that Barry brings up is that consumers don't see prices going up 2 percent a year, but in discontinuous jumps, which can seem more dramatic. Food is volatile because of weather and season. Energy is too, to some extent, but those markets are also subject to manipulation by political and financial players. Commodity markets can be driven by fear of international events, as much as by rational factors. And there hasn't been wage inflation, so people's budgets are squeezed. If food and energy cost more, then less is spent on other less essential goods, keeping prices down overall. All the money the Fed is "easing" into existence isn't ending up in _our_ pockets, that's for sure.

Posted by: Moopheus | February 14, 2011 at 01:15 PM

I've recently noticed an uptick in the data from MIT's realtime inflation data collection
(bpp.mit.edu). I've also personally noticed some change in food packaging (smaller frozen pizzas at same price, etc.).

Is the Fed seeing this too? Is bpp misleading?

Posted by: Raybender | February 15, 2011 at 05:52 PM

The Fed considers inflation to be moderated.. yet Wal-Mart is being priced out of the market as consumers trade down to Dollar General. This was stated just the other day on their investor call with the result of a 1.8% drop in same-store sales. Data from many regions show prices paid by merchants increasing at a 20% annualized rate yet prices they are able to charge increasing at only 2%.

Price ramps in input costs can only go one of two places - it can either hit margins or it can be passed through to consumers. When the consumer is broke and has no job, any attempt to pass it through simply results in lower sales.

How is the housing ATM good while on the upside - you'll pay attention to it by dropping the interest rate to pump sales - but you throw up your hands and assert that the bubble crashing is absolutely impossible to be comprehended or tracked on the downside? Look, the debt taken on through a HELOC remains on the books of real people paying real money... yet the monthly servicing of that debt is counted as "savings."

Here's how all this ties together with this post: Try recalculating CPI using median (or Case-Shiller mean) house prices instead of OER.. I dare you!

Posted by: Unsympathetic | February 23, 2011 at 04:20 PM

Post a comment

Comments are moderated and will not appear until the moderator has approved them.

If you have a TypeKey or TypePad account, please Sign in

February 08, 2011


Inflation confusion

As opinion about rising food prices and the consequences thereof divides between "the Fed did it" and "the fundamentals did it" camps, I am reminded of the tricky nature of the semantics of any discussion about "inflation."

In case you need convincing of that yourself, take a look at the results of the most recent Pew News IQ Quiz. Of 13 multiple-choice questions on the quiz, the question that received the fewest correct answers was whether the national inflation rate reported by the government (as of November 2010, when the poll was taken) was closer to 1 percent, 5 percent, 10 percent, or 20 percent. Only 14 percent of the 1001 adults surveyed knew that the answer was 1 percent; more people knew David Cameron is the prime minister of the United Kingdom.

That response does not indicate a general lack of knowledge about economic issues. Seventy-seven percent of respondents knew the deficit is larger now than in 1990s, 64 percent know that the United States runs a trade deficit, and 53 percent are aware that the current unemployment rate is closer to 10 percent than 5 percent or 15 percent. What I think the failure to identify the reported inflation rate probably represents is slippage between the definition of inflation that the average person has in mind and the definition that economists and central bankers are so intently focused upon.

That distinction was the topic of a speech given by Atlanta Fed president Dennis Lockhart earlier today, in which he said:

"In the most recent FOMC statement, following the January meeting, the committee acknowledged the rise of commodity prices, but stated that ‘measures of underlying inflation have been trending downward.'

"Yet inflation anxiety is rising. There seems to be a disconnect between what the Fed is saying and what people are experiencing when they fill up their gas tanks or read about rising food prices around the world.… Are the Fed and the public on different planets?

"Certainly not. But I do think in the swirl of official statements and public discourse we may be talking about different things. To my way of thinking, the term ‘inflation' is misused in describing rising prices in narrow expenditure categories (for example, food inflation). Nonetheless, recent price news has encroached on the public consciousness with the effect that any price rise of an important consumption item is often taken as signaling inflation."

The key distinction is the one between the ideas of "the purchasing power of money" and "the cost of living." Again, quoting President Lockhart:

"Let's review what inflation is and is not. Inflation affects all prices. Inflation is not the rise of individual prices or the rise of categories of prices.

"I want to contrast inflation to the cost of living. In casual language, we often interpret a rise in the cost of living as inflation. They are not the same thing. Cost-of-living increases are a result of increases in individual prices relative to other prices and especially relative to income. These relative price movements reflect supply and demand conditions and idiosyncratic influences in the various markets for goods and services. If some component of a household's cost-of-living basket goes up in price, the higher cost of living is not ipso facto inflation."

When food prices rise or oil prices rise, people are right to feel in some sense worse off, because they are. And if you are tempted to call that "inflation," I understand. But for policy purposes, the distinction between cost of living increases and inflation as a deterioration in the generalized purchasing power of money is critical. President Lockhart explains:

"In principle, the central bank could respond to the impact of rising costs in particular markets, but only by exerting downward pressure on the dollar price of all goods and services. Monetary policy is a blunt instrument without the capacity to systematically influence prices in targeted markets. Because monetary policy affects the value of the dollar across the board, the targeted item would still be expensive relative to income and relative to everything else.

"…The Fed, like every other central bank, is powerless to prevent fluctuations in the cost of living and increases of individual prices. We do not produce oil. Nor do we grow food. Or provide healthcare. We cannot prevent the next oil shock, or drought, or a strike somewhere—events that cause prices of certain goods to rise and change your cost of living.

"So monetary policy is not about preventing relative price adjustments dictated by market forces. It is about controlling the broad direction and pace of change of all prices across the economy.

"If monetary policy cannot reliably control the cost of living, what is the point? The point is bringing some certainty to planning and long term decision making of individuals and institutions. This is my third basic point. The benefit of price stability—low and stable long-term inflation—is that it reduces the risk associated with longer-term decision-making and avoids the drag on the economy that uncertainty creates."

There are those, of course, who argue that current policy is, in fact, a source of long-term uncertainty. I will save my commentary on that assertion for a follow-up post.


Photo of Dave Altig By Dave Altig
Senior vice president and research director at the Atlanta Fed

February 8, 2011 in Inflation, Monetary Policy | Permalink

TrackBack

TrackBack URL for this entry:
http://www.typepad.com/services/trackback/6a00d8341c834f53ef0147e26cd9ee970b

Listed below are links to blogs that reference Inflation confusion:

Comments

Question about oil. Oil products underpin our entire economy. Even if you don't buy oil products directly, you will be impacted by increased oil prices via increased transportation costs for the majority of products you do buy and via increased costs for oil-based products, such as plastics.

If increased oil prices feed into the vast majority of other markets, causing a broad-based increase in prices, is that inflation? Or is "inflation" only a monetary phenomenon?

Posted by: Ned Baker | February 08, 2011 at 06:43 PM

Do I dare say the President seems confused about terminology, though generally on target.

The CPI is a "cost of living index" by construction(Boskin, 1996). However Lockhardt is right all that monetary policy can/should do is manage to the average price change, the CPI, or the COL, and not individual components, or relative prices.

Capitalism, unlike centrally planned economies, depends on price signals and changes thereof, to operate. So yes, hopefully relative prices fluctuate (and if dramatic imbalances, like those brought about by the housing crisis, fluctuate dramatically!). We face that situation now. Overall CPI is muted because housing inflation is very muted, while food inflation(a small part if CPI) is robust.

Posted by: Brynjo | February 08, 2011 at 09:37 PM

""I want to contrast inflation to the cost of living. In casual language, we often interpret a rise in the cost of living as inflation. They are not the same thing. Cost-of-living increases are a result of increases in individual prices relative to other prices and especially relative to income. These relative price movements reflect supply and demand conditions and idiosyncratic influences in the various markets for goods and services. If some component of a household's cost-of-living basket goes up in price, the higher cost of living is not ipso facto inflation."

This paragraph is not clear at all. I think I've worked out what he means, which is that increases in the 'cost of living' might actually simply be 'decreases in the standard of living' (ie negative growth), and not simply price inflation (ie a fall in the value of money). Is that right?

Posted by: Matthew | February 09, 2011 at 01:46 AM

to recap, the problem most of the population has with seeing what inflation is is that they spend far too much of their money on food and energy...they should be spending more on entertainment and electronics and new cars...

Posted by: rjs | February 09, 2011 at 04:04 AM

Lockhart says:

"Monetary policy is a blunt instrument without the capacity to systematically influence prices in targeted markets. "

But is there any other principle to current Fed policy other than attempting to stabilize housing prices? If housing prices drop further, the US banking system fails. The Fed has made it very clear that there are asset prices than it cannot allow to fall. Does anyone deny this?

An honest Lockhart would say that he doesn't care how much other prices rise as long as housing doesn't fall any more.

Posted by: tinbox | February 09, 2011 at 11:23 AM

The distinction between "inflation" and "cost of living" is real only in the terminology of economists and central bankers in order to justify a theory about why monetary policy should control economic growth (though the president of the Atlanta Fed acknowledges that monetary policy is a blunt instrument).

The distinction is essentially between volatile prices of commodities and less-volatile prices of manufactured goods. This perspective must assume that any long-term trends in the former will be reflected in the latter. The conclusion is that inflation must be kept in check, if necessary limiting production by limiting credit. Hence, increasing unemployment.

If pursued consistently, it will stringently limit wage growth. In theory, though not in practice, wages will rise only if workers are more productive. This hasn't happened. So the puzzle of increasingly inequality will be given to a separate department to study, as an anomaly to an otherwise sound theory. And policy will continue the same, viewing wage increases as a main cause of "inflation" which, rightly understood, has nothing to do with the fact that paychecks do not keep up with the cost of living.

Posted by: jcb | February 09, 2011 at 03:15 PM

There are many that are linking QE2 with inflation. That is incorrect. Virtually all of the price inflation in commodities can be traced to a few things.
1. Really bad weather. Wiped out wheat, cotton, cocoa, coffee crops world wide

2. Corn linked to oil via ethanol. 40% of corn crop goes to ethanol.

3. Countries are hoarding commodities for fear that their citizens will revolt. Saudi Arabia is a perfect example

4. Many emerging economies are still expanding, and are utilizing commodities to feed a growing middle class, and to build infrastructure.

Want to see commodity prices( at least food and fibre) drop-pray for real good growing seasons world wide.

Posted by: Jeff | February 09, 2011 at 08:17 PM

Interesting article. Even though I do appreciate the distinction between cost of living and inflation, I believe that this difference is extremely academic.

Because of the correlation between the fed expanding the monetary base, the devaluation of the dollar, and the increase in the price of oil, Cost of Living going up, and inflation going up are in real terms the same thing.

Even though there are extreme circumstances that have occurred recently that have brought about an upsurge in commodity prices that are not linked to the monetary base, to exclude the link completely is too general.

Check out my recent article on the upsurge in prices and the devaluation of the dollar.

Here is the address:

www.thecashflowisking.com

Posted by: Hunter Thompson | February 22, 2011 at 05:13 PM

Post a comment

Comments are moderated and will not appear until the moderator has approved them.

If you have a TypeKey or TypePad account, please Sign in

February 02, 2011


John Taylor and Fed reform: Is change required?

Update: Professor Taylor responds.

Update: Nicolas Groshenny over at voxeu.org discusses his December 2010 working paper, in which he performs a counterfactual analysis that lets the federal funds rate follow a Taylor rule: "[The] results are in line with Bernanke's (2010) testimony. They suggest that the deviations from the Taylor rule between 2002 and 2006 reduced the risk of deflation and high unemployment materially, and were thereby consistent with the pursuit of the dual mandate."

____________________

In a Wall Street Journal article this past Friday, Stanford economist John Taylor articulated a two-track plan to restore growth. The first track pertains to fiscal policy, but what always attracts our attention here at macroblog are Professor Taylor's comments on monetary policy, the essential second track in his formulation for economic restoration. Here are the highlights (emphasis mine):

"… the Fed should lay out a plan for reducing its extraordinarily large balance sheet. To achieve a more predictable rules-based policy going forward, the Fed's objectives should be clarified…

"Recently the multiple objectives [for both price stability and maximum employment] have been used as a rationale for interventionist policies, such as QE2, an approach that Fed officials avoided in the 1980s and '90s. Such interventions can have the unintended consequence of increasing unemployment—as illustrated by the decisions to hold interest rates very low in 2003–2005, which may have caused a bubble and led to the high unemployment today.

"It would be better for economic growth and job creation if the Fed's objective was simply 'long-run price stability within a clear framework of economic stability'

"The Fed should also be required to report in writing and in hearings its strategy for monetary policy… the renewed requirement should focus on the strategy for setting interest rates. The Fed should establish its own strategy and report it to Congress."

I bolded portions of those passages because I have some thoughts on them. These are not new thoughts, but I believe they are worth noting again:

1.  Though all plans are subject to revision and refinement, the Federal Open Market Committee (FOMC) has laid out "a plan for reducing its extraordinarily large balance sheet" and did so some time ago. From the minutes of the January 26–27, 2010, meeting of the FOMC:
   
2. "Staff also briefed policymakers about tools and strategies for an eventual withdrawal of policy accommodation and summarized linkages between these tools and strategies and alternative frameworks for implementing monetary policy in the longer run. The tools for moving to a less accommodative policy stance encompassed (1) raising the interest rate paid on excess reserve balances (the IOER rate); (2) executing term reverse repurchase agreements with the primary dealers; (3) executing term RRPs with a broader range of counterparties; (4) using a term deposit facility (TDF) to absorb excess reserves; (5) redeeming maturing and prepaid securities held by the Federal Reserve without reinvesting the proceeds; and (6) selling securities held by the Federal Reserve before they mature. All but the first of these tools would shrink the supply of reserve balances; the last two would also shrink the Federal Reserve's balance sheet."

The minutes go on to explain the options for deploying those tools, actions, and plans (that have since been completed) for ensuring that the tools are operational and agreement by FOMC participants that "raising the IOER rate and the target for the federal funds rate would be a key element of a move to less accommodative monetary policy."

3.  Large-scale asset purchases (termed QE2 by some) are in my opinion clearly in line with the Fed's price stability objective. I have made this point before, but through the summer of last year up to the point when the possibility of more accommodation was signaled by Fed Chairman Ben Bernanke in late August, there was a clear downward tilt to market inflation expectations and a discernable shift upward in the perceived probability of deflation:




Stabilizing inflation expectations is at the core of any central bank's price stability objective. As these charts clearly illustrate, the concern that expectations were becoming unanachored was real, and the policy, I believe, has been successful in addressing that problem.

Whether the Fed's so-called dual objectives complicate policy going forward remains, of course, to be seen. But from where I sit, the dual objective/mandate question is a red herring in the discussion of whether QE2 was warranted or not.

4.  The notion that the Fed has not established its own consistent strategy in terms of interest rate policy is not supported by the facts. Here's the Taylor critique, succinctly:
   
 

"Economists cite the Taylor rule—which says that the Fed's target interest rate should be one-and-a-half times the inflation rate, plus one-half times the shortfall of GDP from potential plus one—as evidence that this approach worked…

"Unfortunately, leading up to and during the recent crisis, the Fed deviated from this framework. It held interest rates too low for too long from 2002 to 2005, and after the crisis began to flare up in 2007 it engaged in massive discretionary credit operations.

"So the answer to the question ['What should the Fed do next?'] is simple: Get back to the rule-based policy that was working before the crisis."

An important issue with this critique, noted by Chairman Bernanke in a speech delivered about this time last year, is that, at least up to the point where the federal funds rate hit its effective lower bound, the FOMC did behave in a consistent rule-based fashion—just not precisely the one preferred by Professor Taylor:


In the chart above, the blue line is a simple version of the Taylor rule, which prescribes that the central bank react to contemporaneous inflation and GDP. But, as Chairman Bernanke explained:

"… because monetary policy works with a lag, effective monetary policy must take into account the forecast values of the goal variables, rather than the current values."

The green line in the chart above depicts a "forecast-based Taylor rule," and as can be clearly seen, it is quite a good indicator of the funds rate policy actually chosen—and chosen in a consistent rule-like manner—by the FOMC.

That consistency is certainly no virtue if the implicit rule is flawed. But that brings me to my final point.


5.  The theme that runs through many a critique of current and past Fed decisions arises from the assertion repeated in this most recent Taylor piece that "decisions to hold interest rates very low in 2003–2005… may have caused a bubble and led to the high unemployment today." The evidence presented to date on this count is, in my opinion, tenuous at best. For some perspective, I refer you to Tim Duy, who provides others' rebuttals, as well as his own. Also, here's some more perspective, from the Financial Crisis Inquiry Commission Report, which is relevant as well:
   
 

"Low interest rates, widely available capital, and international investors seeking to put their money in real estate assets in the United States were prerequisites for the creation of a credit bubble. Those conditions created increased risks, which should have been recognized by market participants, policy makers, and regulators. However, it is the Commission's conclusion that excess liquidity did not need to cause a crisis. It was the failures outlined above—including the failure to effectively rein in excesses in the mortgage and financial markets—that were the principal causes of this crisis. Indeed, the availability of well-priced capital—both foreign and domestic—is an opportunity for economic expansion and growth if encouraged to flow in productive directions."


There is no absolution for policymakers in that conclusion. But, I believe there is a warning about carefully separating the baby from the bath water when evaluating past, present, and future monetary policy actions.


Photo of Dave Altig By Dave Altig
Senior vice president and research director at the Atlanta Fed

February 2, 2011 in Federal Reserve and Monetary Policy | Permalink

TrackBack

TrackBack URL for this entry:
http://www.typepad.com/services/trackback/6a00d8341c834f53ef0148c844cc70970c

Listed below are links to blogs that reference John Taylor and Fed reform: Is change required?:

Comments

How do 'market participants recognize increased risks' when government-guarantees against any risk are widely accepted as implicit, when government legislators throttle any public caution of mounting risk by accusing the honest concern being expressed of being "racist," or where capital flows are engineered by government action to aggregate toward some privileged elite in the name of some worthy social goals instead of for some optimal economic investment established by the open market?

Posted by: Don Kirk, a Duoist | February 02, 2011 at 07:21 PM

"… because monetary policy works with a lag, effective monetary policy must take into account the forecast values of the goal variables, rather than the current values."

"At the same time, because economic forecasting is far from a precise science, we have no choice but to regard all our forecasts as provisional and subject to revision as the facts demand. Thus, policy must be flexible and ready to adjust to changes in economic projections." - Bernanke

Monetary lags are not "long & variable". They are "precise". The money supply can never be managed by any attempt to control the cost of credit.

Greenspan never tightened monetary policy despite raising the FFR on 17 separate occasions over 41 consecutive months.

When Bernanke took over, he initiated a tight monetary policy continuing with it despite Bear Sterns collapse, never “easing” until Lehman Brothers declared bankruptcy.

I.e. Bernanke tightened for 29 consecutive months driving the economy into a depression.

Yeah, real reform is needed.

Posted by: flow5 | February 03, 2011 at 09:22 AM

Reform? Fire all the economists at the FED. Every one of them. None of them can forecast.

Posted by: flow5 | February 05, 2011 at 08:46 PM

worried the Fed will be so behind the curve that no matter if they use policy machinations to recall all the monetary stimulus, it will be very late.

Ironically, I think the Fed is being blamed for the current spate of food and fibre inflation when in fact they are not guilty. Weather and crop destruction last year had more to do with inflation than the recent QE2. Fed policy never acts that fast.

the other facet ignored in this whole debate is Government fiscal or regulatory policy which is out of the purvey of the Fed. Who contributed to the build up in real estate values more? The Fed and easy money or Fannie and Freddie backstopping the entire subprime mortgage market?

Who contributes to the higher price of oil more? The Fed? Or the government ban on drilling and exploration along with turning 40% of the corn crop into ethanol?

Applaud David and Taylor for taking up the debate.

Posted by: Jeff | February 06, 2011 at 03:02 PM

Quantitive easing is just a nicer sounding term for economic recklessness. The Fed is debasing the dollar for the lack of better ideas. The day will come when the piper will need to be paid. Being a reserve currency helps keep the dollar strong. Want to buy oil , you need to buy dollars first. When and if countries who supply commodities start dropping this requirement , the dollar will move into freefall

Posted by: Michael | February 07, 2011 at 04:51 PM


"Fannie and Freddie play a central role in our housing finance system and must continue to do so in their current form as shareholde­r-owned companies. Their role in the housing market is particular­ly important as we work through the current housing correction­. The GSEs now touch 70 percent of new mortgages and represent the only functionin­g secondary mortgage market. The GSEs are central to the availabili­ty of housing finance, which will determine the pace at which we emerge from this housing correction­. ...

OFHEO has reaffirmed that both GSEs remain adequately capitalize­d. At the same time, recent developmen­ts convinced policymake­rs and the GSEs that steps are needed to respond to market concerns and increase confidence by providing assurances of access to liquidity and capital on a temporary basis if necessary.­"

Posted by: home buyer | February 22, 2011 at 10:15 AM

Post a comment

Comments are moderated and will not appear until the moderator has approved them.

If you have a TypeKey or TypePad account, please Sign in

Google Search



Recent Posts


December 2014


Sun Mon Tue Wed Thu Fri Sat
  1 2 3 4 5 6
7 8 9 10 11 12 13
14 15 16 17 18 19 20
21 22 23 24 25 26 27
28 29 30 31      

Archives


Categories


Powered by TypePad