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May 02, 2007
Mervyn King Reflects
The Financial Times records some thoughts from Bank of England Governor Mervyn King, reflecting on the Bank's performance over the past ten years:
He regards one of the Bank’s biggest achievements over the past 10 years as grasping early on the scale and significance of migrant labour from eastern Europe after the enlargement of the European Union in 2002.
“It’s our equivalent of [former US Federal Reserve chairman] Alan Greenspan [realising] the faster growth of output in the late 1990s was the result of faster productivity growth.”
He continued: “That was an absolutely correct judgment at the time and that’s what we have to do with every variable that we look at, work out why it’s growing faster or slower than it was before and not to use some rather mindless regression.”
What were those insights of which King is so proud? From the Telegraph:
Immigration from eastern Europe has helped keep inflation - and therefore interest rates - low, the Governor of the Bank of England Mervyn King said last night.
Speaking to business leaders at a dinner outside Bradford, Mr King praised globalisation as a way of increasing productivity and transferring new ideas, goods and services across borders.
In particular, he said immigration had reduced wage inflation in Britain: "If the increased demand for labour generates its own supply in the form of migrant labour then the link between demand and prices is broken, or at least altered. Indeed, in an economy that can call on unlimited supplies of migrant labour, the concept of the output gap is meaningless."
The output gap is a measure used by economists to see how much spare capacity is left in an economy.
"Increasing productivity and transferring new ideas" is certainly equivalent to the Greenspan insight. But on the output gap bit, a better comparison is to Federal Reserve Bank of Dallas President Richard Fisher:
One key capacity factor is the labor pool. There is a shibboleth known as the Phillips curve, which posits that beyond a certain point too much employment ignites demand for greater pay, with eventual inflationary consequences for the entire economy...
How can economists quantify with such precision what the U.S. can produce with existing labor and capital when we don’t know the full extent of the global labor pool we can access? Or the totality of the financial and intellectual capital that can be drawn on to produce what we produce?
As long as we are able to hold back the devil of protectionism and keep open international capital markets and remain an open economy, how can we calculate an “output gap” without knowing the present capacity of, say, the Chinese and Indian economies? How can we fashion a Phillips curve without imputing the behavioral patterns of foreign labor pools? How can we formulate a regression analysis to capture what competition from all these new sources does to incentivize American management?
Until we are able to do so, we can only surmise what globalization does to the gearing of the U.S. economy, and we must continue driving monetary policy by qualitative assessment as we work to perfect our quantitative tool kit. At least that is my view.
And, apparently, Governor King's view as well. Back to the FT:
“The secret of good policy is to try and think through what are the economics of the shocks hitting the economy at present,” he says. “That in a nutshell is my philosophy of how you should do policy. Don’t rely on regressions from the past.”
OK, but I'm not sure I would recommend entirely forgetting those recessions from the past either, lest we find ourselves repeating their lessons.
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February 24, 2007
The Euro Vs. The Dollar
Although I've not written much about the topic lately, I have been monitoring the debate of the last several months about the rise of the euro, and the related question of whether it will eventually emerge as the world's dominant international money. The discussion has been prompted in part by the fact that euro appreciated by about 11 percent from December 2005 to December 2006, but also by some really splashy news: The observation that the value of euro notes in circulation has surpassed the value of dollar notes, the reported desire of oil-producing countries to diversify their foreign-exchange reserves, and the fact that euro-denominated debt has become a larger share of the global cross-border total than dollar-denominated debt. Yesterday Brad Setser published some ruminations about whether the Japanese yen can ever be the "un-dollar", but the reality is that the euro remains the only real contender for the foreseeable future.
A couple of pictures (constructed by my colleague Owen Humpage) helps to put things in perspective. To begin with, international currency reserves are still dollar dominated:
There are definitely some problems with those statistics -- see, for example, the picture provided by Brad Setser, provided by Menzie Chinn -- but here is another relevant fact: The overwhelming share of foreign exchange transactions involve dollars:
It seems pretty clear that most of the euro activity is still taking place on the European stage. That could change -- there is an interesting discussion about the expanding importance of the export sector being conducted at Eurointelligence and at Eurozone Watch -- but my guess is that the "tipping point" for the euro depends critically on whether the eurozone ultimately expands.
As I have noted in the past, the research of Menzie Chinn and Jeffrey Frankel suggests that the wildcard involves the UK's designs on the euro. But the incorporation of the so-called "accession countries" is at issue as well. For that reason, this, from the Financial Times, got my attention:
On Monday Standard & Poor’s lowered the outlook for Latvia’s long-term sovereign debt from stable to negative. The country has a huge current account deficit, accelerating inflation and loose monetary policy, just like Thailand in 1997. And, as in Asia a decade ago, the symptoms are not limited to one country. As growth has accelerated in the European Union’s 10 newest central and eastern members, it has become unbalanced, propelled by consumers rather than exports. The results are predictable – worsening trade imbalances, mounting inflation and wage pressures. Only Poland and the Czech Republic currently meet the inflation requirement for euro membership, while current account deficits in six of the EU-10 hover near or beyond 10 per cent of gross domestic product. Meanwhile, credit is expanding dramatically – at more than 50 per cent year-on-year in Latvia, Lithuania and Romania, according to Danske Bank.
If the EU were to fracture, the natural fault-line would be the edge of the euro zone, as Toomas Hendrik Ilves, Estonia ’s thoughtful president, has observed...
The common currency includes most of old Europe, but excludes most of the new democracies (including his). What would happen to the outsiders? It would be nice to think, as a worst-case scenario, that the single market would hang together, and that the baker's dozen of countries outside the euro zone would at least remain part of this thriving free-trade area...
Probably, however, the unraveling would go further. The EU already finds it a huge effort to make the Poles, for example, abide by European competition law. Without a seat at the top table in Brussels, no Polish government would allow foreigners to claim full national treatment, especially when it came to buying the country’s big companies. With that, the single market would unravel too.
That all may be a bit alarmist -- the worst-case scenario is important to think about, but it rarely happens. The point is that, despite the challenges that undeniably confront policy makers in the United States, there are equal, if not more daunting, challenges elsewhere. I have my doubts that the "exorbitant privilege" of being the world's dominant currency is likely to pass from the dollar any time soon.
UPDATE: Export activity in Germany (and Japan) is also on the mind of Edward Hugh, at Bonobo Land.
UPDATE II: Claus Vistesen uncovers an article from the Financial Times suggesting that central bankers are chasing yield by by taking on more risk, as well as by diversifying the currencies in their reserve portfolios. My sense is that this sort of motivation drives "investment" decisions at the margin, but that core portfolio choices are still driven by "fundamentals" related to trade flows, financial market activity, and internal exchange rate policies. But as the FT article notes, central bankers are "a secretive bunch," so there is a lot we -- or at least I -- don't know.
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January 10, 2007
Sometimes it's nice to hear a little good news. From the Financial Times:
The transatlantic push to conclude the troubled Doha round of global trade talks got a wary welcome from the head and some members of the World Trade Organisation on Tuesday.
Details of any deal to reconcile the US and European Union positions remain elusive, but Pascal Lamy, director-general of the WTO, said the determination expressed this week by US president George W. Bush and José Manuel Barroso, president of the European Commission, was a marked advance.
Similar expressions of enthusiasm from Mr Bush and other heads of government during the Group of Eight summit in St Petersburg last summer were not followed by concessions at the negotiating table, and the Doha talks were suspended in July amid bitter transatlantic recriminations.
But Mr Lamy said prospects were better. “The signs we are seeing now are qualitatively different from what we heard last year,” he told the Financial Times. “The political chemistry is beginning to work.”
And from The Wall Street Journal (page A1 of the print edition):
With Fidel Castro ailing and absent from the public stage, some influential Cuban intellectuals are laying plans for a more market-oriented approach to fortify the island's ailing communist economy...
Together, the Cuban economists' proposals would cut down on state interference in businesses and aim to wring more productivity out of the island nation's economy. Among the steps under discussion: decentralizing control, expanding the power of managers at privately owned agricultural cooperatives, extending private ownership to other sectors, boosting investment in infrastructure and increasing incentives to workers.
None of the plans would shuck communism for capitalism or open the island further to foreign investment -- which economists outside Cuba say are critical for the island to prosper. But the fact that the government is permitting -- and perhaps even encouraging -- the debate suggests regime officials might find these kinds of changes acceptable, though it may take Mr. Castro's death to put them into action.
There are lots of devils in all the details of both stories, but hey, it's a new year. Why not start it with a little hope?
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January 02, 2007
Economy Poised For '07 Rebound,Forecasters Say
Weakness in Housing, Manufacturing Is Likely To Take a Lighter Toll
Other than a few economists, the overwhelming consensus view is for a soft landing and GDP growth of 2.5% to 3.0% in 2007.
The Economic Cycle Research Institute, an independent forecasting group, said its Weekly Leading Index slipped to 138.5 in the week ending Dec. 22 from 139.7 in the prior week, due to higher interest rates and more jobless claims.
However, annualized growth in the week ended Dec. 22 rose to 3.8 percent from 3.4 percent in the prior period, a reading not reached since last February.
"Given the steady improvement in the WLI, recession is no longer a serious concern," said Lakshman Achuthan, managing director at ECRI.
Ten-year Treasuries and mortgage rates have not gone through the roof. As a result, housing is going to be OK -- and a thousand doomsday forecasts must be put aside.
... the next few months will show whether my mid-2006 forecast of a US hard landing in 2007 will be proven true or not. Certainly some of my more recent forecasts for financial markets (equities fall, fixed income rally), about Fed easing in 2007, lack of real economy decoupling in the rest of the world are highly conditional on this US hard landing call. I am still of the view that the risks of a hard landing are high.
The economists surveyed expect year-to-year inflation to decline to 1.7% in May from 2.0% in November. As a result, they expect the Fed to shift its focus from fighting inflation to helping the economy grow, lowering short-term interest rates to 4.75% by the end of 2007 from the current 5.25%.
It looks like the Bank of England may not be done with interest rate hikes. Not with the continued house price increases reported by Reuters...And there could be more rate hikes from the European Central Bank as well. Reuters reports:
The case for more euro zone rate hikes got a boost from stronger than expected November money supply data on Friday and from comments on Thursday by ECB Governing Council member Yves Mersch, who said rates remain low in historical terms...
At Eurozone Watch, Daniela Schwarzer and Sebastian Dullien concur:
Is the ECB going to raise interest rates towards 4 percent?
Yes. The strong growth outlook will push the ECB to raise its interest rates to 3.75 percent in the first half of the year and by a further 25 basis points later on. As inflationary pressure is still limited, the ECB will refrain from tightening much faster. Risks to this call are, however, a stronger than expected US downturn or a strong appreciation of the euro. In these cases, the ECB might delay a further hike beyond 3.75 percent.
They also predict:
The euro will most likely further gain in value. There is a significant risk that it rises above 1.40 $ in 2007. Two factors are supporting the young currency: With further interest rate hikes by the ECB, investment in the Eurozone will become more attractive. Moreover, the possibility of a rate cut by the US Federal reserve still remains. Finally, there is a risk that central banks in Asia and from OPEC countries continue to diversify their portfolios and buy euros.
For their part, the consensus among WSJ group is that the dollar will stabilize near 1.3 per euro, about where it is today (though Claus Vistesen thinks there has already been enough appreciation and monetary policy to make a "dent" in eurozone growth).
Now we'll all wait and see how it is we will be wrong.
UPDATE: Cotango is going to "hold to my view that 2007 is going to be a rough year for the US economy: 1.5 % GDP growth" and beleives that "If it does get rough, the Fed will have to open the liquidity valves full blast". David K. Smith reports on forecasts for the UK (where projected growth is close, but still higher, than expectations for the US).
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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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October 05, 2006
ECB On The Move
Claus Vistesen reports on the European Central Bank's decision to raise its overnight interest rate target by 25 basis points, and awaits "the hints we are given to the future course" of policy. The hints have arrived. From Bloomberg:
European Central Bank President Jean- Claude Trichet said more interest-rate increases may be needed to curb inflation after the bank raised its benchmark rate for the fifth time in 10 months today.
"The market has in mind further moves, I wouldn't say anything to correct this sentiment,'' said Trichet at a press conference in Paris after the central bank raised the refinancing rate to 3.25 percent from 3 percent. "It will remain warranted to further withdraw monetary accommodation'' should the economy progress as the ECB forecasts...
"The tone of Trichet's commentary at the ECB press conference remains hawkish,'' said David Brown, chief European economist at Bear Stearns International in London. "The suggestion of progressive further withdrawal of monetary accommodation implies that the ECB probably intends to extend its tightening cycle beyond December into next year.''
That opinion was certainly shared by others. From the International Herald Tribune...
The ECB "clearly has a tightening bias and would like to raise rates to 4 percent," said Andreas Rees, an economist at HVB Group in Munich. "The question is whether the economic data will allow it to. We think growth will slow, and that will prevent the ECB from raising rates next year."
... from the Financial Times...
“We consider the ECB is following a normalisation process to bring the short-term rate close to a hypothetical ‘neutral’ level that could be estimated at between 3.5 to 4 per cent,” said Vincent van Esch, economist at ING Financial Markets.
Commerzbank economist Michael Schubert said recent hawkish rhetoric from the ECB suggested it would "stick to its key message" that further gradual monetary tightening is still warranted.
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September 28, 2006
Have Interest Rates Peaked?
Edward Hugh thinks so. Though Edward notes that commentary from the ECB suggests otherwise -- an observation made about the Federal Reserve by Tim Duy -- the belief that interest rates will fall before they rise is being driven by a sense that economic growth in developed countries is slow and getting slower. Slower economic growth means less demand for borrowing by consumers and businesses, and hence lower real (or inflation-adjusted) interest rates. And, so the story goes, as with the U.S. and Europe, so with the world.
The opinion that a nontrivial slowdown may be in full bloom is not hard to find, but in case you are looking you can start in Europe -- at Alpha.Sources-CV (here and here), at Bonobo Land, and at The Skeptical Speculator. And don't forget the UK.
As for the US, I could just say Nouriel Roubini and leave it at that, but if you are particularly interested in the global connections you can soak in Martin Wolf's take from Economist's View. On the interest rate part of the scenario, here's the view from The Capital Spectator:
Let's start with the bond market, where the benchmark 10-year Treasury yield has dipped below 4.6% for the first time since February. In fact, the 10-year yield has been on a slippery slope for since July, when a 5.2% current yield prevailed early in the month. The catalyst for the decline is, of course, the ongoing stream of economic reports that show the economy is slowing. (The latest is this morning's update on new orders for durable goods, which tumbled for the second straight month in August--the first back-to-back tumble in more than two years.)
I'll tell you the truth -- that durable goods report was not to my liking, as the weakness appears to be fairly broad-based:
I hear you: Don't get carried away with one report. I'm with you, but I will note that one of the keys to the whole soft-landing scenario is that capital spending will stay robust even as residential investment and, to a lesser degree, consumer spending fade. If that doesn't happen, the arithmetic starts to get tricky, and those bets on lower interest rates may start to look pretty good.
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July 24, 2006
Why Don't Rising Productivity Tides Raise All Boats (Equally)? A Clarification.
Last week I contrasted some comments by Ben Bernanke on productivity growth in the U.S. relative to other industrialized economies with the a results of a paper by Ian Dew-Becker and Robert Gordon titled "The Slowdown in European Productivity Growth: A Tale of Tigers, Tortoises and Textbook Labor Economics." My claim was that while Bernanke points to things like greater labor market flexibility and competition in the U.S., Drew-Becker and Gordon's research points to tax policy in Europe.
Ian -- the author of the aforementioned research -- took me to school in the comment section of that post:
In that paper, I don't think we so much disagree with Bernanke's explanation as argue that there is more to the story (as you say). If you break the LP growth gap into TFP and capital deepening, TFP accounts for the majority -- that's what Bernanke is referring to. The problem is, TFP is pretty tough to talk about -- it's just a residual.
When Bob and I talk about the effects of tax rates, we're referring to capital deepening. It's also important to note, as have other papers recently, that capital deepening in the US recently has been driven by low hours worked, rather than high investment -- slightly troubling.
Well, those are certainly great points. Lesson learned.
UPDATE: While we are on the topic, this comes from today's Wall Street Journal (page A1 of the print edition):
After a long slump, strong exports and new flexibility in companies' labor relations are laying groundwork that could sustain economic recovery in Germany and some other parts of Europe...
The euro region is poised to post its strongest economic growth since the technology boom of 2000. The 2.2% expansion projected for this year would be the largest improvement in the growth rate among the world's big, developed economies. Amid signs that U.S. growth is losing steam, it is a timely revival that could help prevent a global slowdown...
...Germany is Europe's largest economy and in recent years has been one of its most stagnant. But the nation has led in developing a robust export industry and in the corporate restructuring that has finally begun to create jobs.
... Europe's economic slump has given companies new muscle in their negotiations with workers. Governments in Europe have been slow to overhaul worker-friendly labor laws for fear of incurring voters' wrath. That slowed job growth as companies transferred operations overseas where labor costs were lower. High unemployment in Europe depressed consumer spending, helping limit economic growth in the past five years to a meager 1.4% average in the 12 countries that use the euro...
German industry has gone furthest in overhauling work practices within the strict labor laws and union accords common across Europe. Companies now are pressing their employees to work longer, more flexible hours and to forgo pay increases, using the threat of moving jobs abroad as bargaining leverage. While pinching employees, the changes have made operating in Germany more attractive, stimulating local investment and helping the country hold on to more jobs.
If you are the type who likes to think in terms of what developments like these could mean for, I don't know, the value of the dollar or something, the WSJ article might be usefully read along with this.
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May 23, 2006
OECD To FOMC: Keep On Going
For economies already close to full employment, such as the United States, the possibility of a prolonged imported inflation shock, coupled with an upward drift in inflation expectations, may tilt the balance towards further tightening.
In the U.S. country survey, the advice is a bit more direct:
The stance of monetary policy, currently near neutral, needs to tighten slightly to keep the economy in balance.
The good folks at the OECD are less convinced that the recent hawkish talk from the ECB ought to be followed up with action:
For the euro area, where wages and unit labour costs are increasing slowly, the starting point is one where slack is substantial and thus a source of falling inflation. At the same time, if commodity price pressures persist and as evidence builds up that the recovery is firming, the need for monetary tightening should become clearer. Its actual pace, however, should be conditional on unambiguous signs that economic slack is shrinking, which hard data is not as yet confirming.
There you have it.
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May 04, 2006
On The Growth Train
Yesterday's news was the hot service sector in the U.S., and what it might mean for monetary policy. Today's news is the hot service sector in Europe, and what it might mean for monetary policy. From Bloomberg:
Growth at service companies in the dozen euro nations accelerated to the fastest in more than five years in April, giving the European Central Bank more leeway to raise interest rates.
An index based on a survey of 2,000 purchasing managers at companies such as banks and airlines rose to 58.3 from 58.2 in March, said NTC Economics Ltd., which compiles the measure for Royal Bank of Scotland Group. That's the highest since September 2000. A reading above 50 indicates growth.
Europe's economic growth is quickening as an increase in exports filters through to the domestic economy, helping banks including UBS AG report record earnings. As accelerating expansion and near-record oil prices threaten to fuel inflation, the ECB may signal today it is likely to increase rates in June for the third time since the start of December, economists said.
More, from Forbes:
The service sector data comes on the back of an equally strong reading in the manufacturing sector equivalent.
'It will provide further support to expectations of a June rate hike in the euro zone and a hawkish press conference today,' Calyon economist, Mitul Kotecha said.
UBS economist Ed Teather noted price pressures in the service sector release.
He said the rise in the prices-charged sub-index to its highest level since February 2001 is 'perhaps a preliminary sign of price pressure moving down the supply chain'.
This is a key element as the ECB is expected to cite the recent run of strong economic indicators in the region as a key reason for a hike in June even though its meeting today is predicted to result in no change.
Looks like June will be an interesting month.
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- Cumulative U.S. Trade Deficits Resulting in Net Profits for the U.S. (and Net Losses for China)
- The Slump in Undocumented Immigration to the United States
- A Quick Pay Check: Wage Growth of Full-Time and Part-Time Workers
- Back to the '80s, Courtesy of the Wage Growth Tracker
- Introducing the Atlanta Fed's Taylor Rule Utility
- Payroll Employment Growth: Strong Enough?
- Forecasting Loan Losses for Stress Tests
- Men at Work: Are We Seeing a Turnaround in Male Labor Force Participation?
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