The Atlanta Fed's macroblog provides commentary and analysis on economic topics including monetary policy, macroeconomic developments, inflation, labor economics, and financial issues.

Authors for macroblog are Dave Altig, John Robertson, and other Atlanta Fed economists and researchers.

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July 30, 2005

The Enemy Of The Good?

No props for the Bush administration on the passage of CAFTA.  So saith pgl and Brad Delong, pointing to this story:

It was just before midnight on Wednesday when Representative Robin Hayes capitulated [on his opposition to the passage of CAFTA]...

But the House speaker, J. Dennis Hastert, told him they needed his vote anyway. If he switched from "nay" to "aye," Mr. Hayes recounted, Mr. Hastert promised to push for whatever steps he felt were necessary to restrict imports of Chinese clothing, which has been flooding into the United States in recent months.

As it turned out, the switch by Mr. Hayes was decisive.

If BD and pgl are looking for more ammunition with which to pursue this line of attack, I'll throw in the reminder that, in some circles, commentators were comforting themselves with rationale that the steel tariffs of 2002 were the price of breaking down resistance to the "fast-track" trade authority -- actually renamed Trade Promotion Authority (TPA) -- that ultimately led to the successful passage of CAFTA.   But even then that authority came with significant strings attached.  Here's a blast from the past from Larry Kudlow:

This week, the Senate added the Dayton-Craig amendment to a bill that would have given the White House greater negotiating authority on international trade. But what this amendment does is allow individual members of Congress to veto specific provisions of any presidentially negotiated trade pact. Say good-bye to fast-track trade-promotion authority for the White House.

This is a big backslide on trade for the U.S. And the finger can be pointed directly at the flawed strategy created by White House Senior Adviser Karl Rove and U.S. Trade Representative Robert Zoellick. Their original idea was to bring protection to the steel industry in order to capture the rustbelt states of West Virginia, Pennsylvania, and Ohio in the 2004 election. Also, steel protection (and now lumber protection against Canada) was designed to win votes from House members and Senators who might waver on a new fast-track negotiating package.

But apparently, a lean and mean trade-negotiating bill is not coming. The White House trade strategy has completely unravelled.

The Dayton-Craig Amendment did not wholly survive the House-Senate conference but that does not mean it faded into irrelevance:

On another difficult issue, the Dayton-Craig provisions in the Senate version, conferees dropped the provision but agreed to additional reports and oversight if negotiations might result in possible changes to U.S. trade remedy laws.

That last passage comes from an excellent overview of the legislative process (beginning in the Clinton administration) that led to the passage of the Trade Promotion Authority.   

And yes, it was a rather messy sight.  And pgl and Brad DeLong are shocked, shocked to find it so. 

Look.  pgl and Brad may be right in the larger scheme of things.  It may indeed be the case that the constellation of compromises required to get CAFTA -- in itself admittedly smaller potatoes -- are more costly than whatever benefits might be derived in terms of the deal itself or whatever it buys in terms of making future progress on the free trade front.  But observing that political outcomes involve politics, as odious as that seems, does not a compelling argument make.

July 30, 2005 in Trade | Permalink


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Unfortunately, pgl and Brad are "typical" economists who are enamored by theories and find the real world all too messy and -- well -- too real.

They cannot admit that the only way "free trade" makes its way in the world is as a fig leaf for capital crushing the working class.

Posted by: General Glut | July 30, 2005 at 12:01 PM

General Glut, it is the "working class" that has grown richer every year ... it is the "working class" whoes life expectancy grows longer every year ... it is the working class whose preference for imported luxury goods grows every year ... its the "working class" who owns more capital very year

Let's cut the class story ... it means nothing ... it is the part of Marx that has been proven wrong ... if one must play with stories lets tals about under dog

Posted by: simon | July 30, 2005 at 05:17 PM

Seriously David - with the pork in the highway bill, with the all pork energy bill, and all the sausage in CAFTA which likely makes it a movement away from free trade - why would any conservative defend this GOP dominated Federal government? See more at Angrybear where I guess I have changed my name to PGC (c for conservative).

Posted by: pgl | July 30, 2005 at 05:51 PM

pgl -- I posted my response over at Angry bear. I think you misread my remarks as an apologia for the administration, which it was not. It was, rather, a plea to focus on a discussion of the balance between costs and benefits, not just the costs. I certainly wouldn't object, however, if you changed your moniker to pgc.

Posted by: Dave Altig | July 31, 2005 at 08:39 AM

Pork in a highway bill? Pork in an energy bill? No way!?!?!?! Those damn right-wingers. How dare they put pork in a bill!

Posted by: cb | August 01, 2005 at 11:53 AM

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July 29, 2005

One Non-Fan Of Chinese Appreciation

Writing for the opinion page of today's Wall Street Journal, Stanford University's Ronald McKinnon explains what he doesn't like about the path the Chinese central bank has set out upon:

(1) With the fixed exchange rate now unhinged, the People's Bank of China (PBC) will have to come up with a new anchor or rule that governs monetary policy. None was announced when the PBC let the exchange rate go. Will the PBC institute an internal inflation target? What will be the financial instruments it uses to achieve this target?

(2) Because China's inflation rate had converged to the American level (or slightly less), any substantial sustained appreciation of the RMB (the Americans want 20% to 25%) will drive China into deflation -- preceded by a slowdown in exports, domestic investment, and GDP growth more generally.

(3) If the PBC allows only small appreciations (as with the 2% appreciation announced on July 21) with the threat of more appreciations to follow, then hot money inflows will accelerate. If China attempts further financial liberalization such as interest rate decontrol, open market interest rates in China will be forced toward zero as arbitrageurs bet on a higher future value of the RMB. China is already very close to falling into a zero-interest liquidity trap much like Japan's -- the short-term interbank rate in Shanghai has fallen toward 1%. In a zero-interest liquidity trap, the PBC (like the Bank of Japan before it) would become helpless to combat deflationary pressure.

(4) Any appreciations, whether large and discrete or small and step-by-step, will have no predictable effect on China's trade surplus. The slowdown in economic growth will reduce China's demand for imports even as exports fall so that the effect on its net trade balance is indeterminate.

(5) Because the effect of appreciations on China's trade surplus will be ambiguous, American protectionists will come back again and again to complain that any appreciation is not big enough. So abandoning the "traditional" rate of 8.28 yuan per dollar will, at best, result in only a temporary relaxation of foreign pressure on China.

Point (2) was addressed in the Cleveland Fed's 2002 Annual Report essay titled "Deflation":

Those who believe that deflation is everywhere and always associated with recession must account for the situation in the People’s Republic of China, where real GDP has been growing between 6 percent and 8 percent per annum for several years, despite deflation.

... the contrasts between Japan and  China—a struggling, mature economy versus a
robust, developing country with a relatively small  capital stock (hence, high return to investment)— are central to our assessment of the impact of falling prices.

The main point was that mild deflations are only problematic when nominal interest rates are extremely low.  McKinnon makes the argument (in point (3)) that this is the relevant case in China today, but there is another reason, in my mind, to be skeptical about the deflation story.

The monetary impact of maintaining an exchange-rate policy that pegs the nominal interest rate below the level where a free float would take it is an increase in the domestic money supply.  I will stick close to my essentially monetarist roots and point out that therein lie the seeds of domestic inflationary pressures.  One interpretation of why it was prudent for the Chinese to move as they did is that it was necessary to keep these inflationary pressures from emerging.  Thus, there is an argument to be made that maintaining central bank credibility to sustain low rates of inflation -- the issue in McKinnon's first point -- required the sort of adjustment that the Chinese actually implemented.

I might agree with point (5) -- but that should be our problem, not theirs.

July 29, 2005 in Asia, Exchange Rates and the Dollar | Permalink


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Yes -- there has been no shortage of money or credit growth in China. And during Japan's deflationary liquidity trap, investment was falling as savings stayed constant, while in China investment is rising like mad relative to GDP. the situations are not analogous.

that said, one of the big puzzles out there is why very fast money and credit growth in China have not produced more inflation, and more real appreciation through the channel McKinnon prefers ...

Posted by: brad | July 29, 2005 at 10:25 AM

Check out Brad Setser who only briefly mentions McKinnon (I left a few comments under Brad's post). It does turn out that Hastert was promising continued tariffs on Chinese textiles as part of the deal for CAFTA. My Angrybear post cites Jacob Viner's classic on trade diversion. Simply put - the actual CAFTA deal was not really a movement to free markets after all.

Posted by: pgl | July 29, 2005 at 01:10 PM

Brad and Dave,

Einstein famously said 'keep the explanation simple, but not too simple'. I think we are indanger of hopelessly overcomplicating the 'global impbalances situation' There is one simple key paramater which explains a hell of a lot of the differences: median age. Why isn't this being recognised? Well my guess is that the leading role of US economists in the global debate, and the fact that the US is still a relatively young country means that this problem doesn't come on the radar. It's as simple as that.

What am I talking about? well....

If you checkdown a list of median ages you will find some quite interesting correlations:

You will notice the top three countries - Japan 42.64, Germany 42.16 and Italy 41.77 - are all having conspicuous problems with generating internal demand growth. Finland (in 4th place with a MA of 40.97 years) is now begining to have similar problems. Based on this evidence,I draw the tentative conclusion that there is a critical number somewhere in the range median age 41 and 42.

Going down the list, he UK 38.99 and France 38.85 are in a remarkably similar situation, and it should be noted that despite all the social model criticisms, France is not that bad growth wise. It is certainly very different from Germany. Domestic consumption has been perky, and the housing market is not dead. (Another sysmptom in Germany and Japan is the long term decline in house prices, it will be interesting to see if Italy now goes down this road).

The US at 36.27, is a demographically young country, and will not be up where Germany is for another 20 years. This explains a lot about the current US growth strength. Remember, if we look at the balance of trade situation, US companies seem not to be as efficient as their German and Japanese rivals, the extra growth is largely due to the virtuous circle of a rising labour force and age-related credit driven demand (See Dale Jorgenson - various - for the role of increasing labour inputs in US growth. The age-structure component in credit demand I think isn't difficult to argue on the basis of the kind of fushion between liquidity constraints and life cycle ideas suggested eg by Angus Deaton).

Then come Ireland 33.7 years and China 32.26 years. They are obviously in the "really good" moment. This detail about Euope's tiger (Ireland now has the highest per capita GDP in Europe after Luxembourg) is not often commented on. China is obvious, but is so big that the consumer boom hasn't extended across much of the country yet. Just wait till
the median age rises a little bit more and things should take off.

Well, that's my two cents worth, but judging by the repose it is getting it's a good job I was an avid reader of Nietzsche's 'Thoughts Out Of Season' in my late adolesence. Pay now, live later, as they say.

Posted by: edward | July 30, 2005 at 02:33 AM


"And during Japan's deflationary liquidity trap, investment was falling as savings stayed constant"

You speak in the past tense. This is far from over. The BOJ claim that deflation will only be over 2006 at the earliest. So right now Japan is still in a liquidity trap. I doubt it is coming out anytime soon. Making a judgement on this is hard, as we really don't know what the current growth path is for the Japanese economy, or what the business cycle really looks like. Certainly the time between recessions is reducing in both Germany and Japan. Japan still has a higher growth potential than Germany judging by the kinds of growth attained in odd quarters here and there, but this seems largely due to the greater capacity to leverage China.

The latest 'ray of hope' comes from the statistical drop in unemployment in Japan. But this is simply because the younger cohorts are smaller. Tracking the 15 - 65 labour force in Japan is harder because they don't use this statistic, the working age population is defined as everyone over 15, so this isn't declining yet. But the 15 - 65 age group is, hence the 'tightening' observed in the labour market (the US has a 'soft' labour market for precisely the opposite reasons).

So people now are saying that internal demand can take the strain. This I doubt. Especially since the hairline balancing act which constitues Japanese public finances means that at the first signs of sustained internal demand they will slam on a consumer tax (as Merkel also proposes in Germany). What will be interesting will be to see how the rising labour costs that the tightening labour market implies actually pan out. In theory everyone is predicting capital deepening. But standard growth theory suggests diminishing returns limits to this. Also the pass through into the export sector poses problems, and it is interesting to note that the yen has eased against USD significantly of late: ie the stronger dollar isn't an exclusively weak euro story.

Bottom line: I don't rule out that Japan could have one or two quarters of very weak inflation at some stage, measurement issues mean that deflation on the margin isn't exactly rocket science. But what I do think is excluded - until and unless that is the Japanese state does a sovereign default (and we're nowhere near that) - is sustained and 'healthy' inflation. When the inflation finally comes, it probably won't have anything healthy about it.

Posted by: edward | July 30, 2005 at 02:52 AM


First let me say that I consider McKinnon a pretty superficial and sloppy thinker. Otoh this doesn't mean that everything he says is completely off target.

Taking your point 2:

Now you are absolutely right to draw attention to this:

"Those who believe that deflation is everywhere and always associated with recession"

I don't know who the people are who believe this, but they should obviously be banned from any serious minded economics association. Deflation does not mean zero, or negative growth. It doesn't even necessarily mean a liquidity trap. People seem to have difficulty with issues like necessary and sufficient conditions.

Japan and China are very different issues. China is growing at around 9%, and the dangers of an actual recession (ie negative growth during 2 quarters) seem pretty remote. What we will see is a 'slowdown'. I don't buy the short term crash argument, since I think the US and China will mutually prop each other up. This doesn't mean to say that there might not be problems, and that the longer term endgame will be a happy ending.

The US has international competitivity issues. It has issues about labour force quality. Allowing China to hollow-out large chunks of your 'bread and butter' economy over long periods of time might leave you rather naked at a later date. So there certainly are issues to address.

The problem is that the proportion of GDP in China devoted to fixed capital investment has been extraordinarily high. This has given rise to overcapacity issues when the housing boom in China and the global economy generally slow. I don't think this is especially and Rmb issue. The danger is not one of deflation internally, but rather of China exporting deflation to Japan, Germany, Finland, and why not, the US?

The situation is comparable in some ways to the last quarter of the 19th century when technology changes, and cheap widely available land in the US made for a global deflationary tonic. Today it is technology and cheap, and to all intent and purpose 'limitless', labour. If Japan is in a liquidity trap, China and India mean that the global economy may be in a 'reserve army of labour' one.

Deflation in Japan is very different. Japan has a liquidity trap, and cannot sustain internal demand growth. The problems are quite simply different.

"The main point was that mild deflations are only problematic when nominal interest rates are extremely low."

This is true, but the danger of China's overcapacity issue is that what we may get is not mild drip-feed deflation, Japan style, but a more severe decline in prices in some leading edge sectors, which could well influence global prices in a way which produces the other, mild inflation in a low nominal rate environment in other regions.

Posted by: edward | July 30, 2005 at 04:01 AM

edward --

I spent a lot of time working on argentina from 99 to 01, and at least in that case, deflation was bad for growth. and there are some parallels with the US -- namely, just as a deflating argentina still ran a current account deficit (a reasonable large one), so too would a deflating USA, if that was the mechanism for real exchange rate adjustment. Deflation is a slow way to bring the real exchange rate down, particularly if the needed real depreciation is large.

And attracting external financing to a deflating economy proved hard in Argentina's case ... of course that was linked to the absence of growth in argentina during its deflationary adjustment as well.

In any case, we should get a second experience -- italy looks set to go through a deflationary adjustment as well. That implies higher than euro average real interest rates even if their only a small nominal italy premium attached to italy's euro bonds

Posted by: brad | July 30, 2005 at 05:38 PM

Edward -- what is spain's average age? lower than Germany's? If the world was limited to the G-3, I can see an equilibrium outcome where old (relatively speaking) Japan finances the young USA (though that implies future us workers will have to "pay" for the retirement of their parents and japan's elderly (Bill Gross has written on this), and old germany finances younger parts of europe (ireland, spain -- i assume, etc).

I don't think that describes the world right now tho. Europe is not financing the US in aggregate -- the eurozone bop is in balance, and surpluses elsewhere in western europe (switz/ sweden/ norway) are offset by deficits in the east. and Japan is not the only country financing the USA.

So to is China (younger population), most of the middle east (ever looked at the average age of Saudi Arabia ... ) even Brazil ...

Bernanke is certainly right to note that the surge in "Savings" has happened mostly in the emerging world, and that is comparatively speaking, younger than the USA.

Posted by: brad | July 30, 2005 at 05:43 PM

Hey edward -- I thought you were on vacation!

Posted by: Dave Altig | July 31, 2005 at 08:53 AM

"Hey edward -- I thought you were on vacation!"

I am Dave, but so far it has been a kind of busman's holiday :).

I have taken time out to read and think, and comment on a few blogs :). I think there is a growing interactivity between economics bloggers, and I think this is a good thing. The more points of view the better.

Now Brad.....

"what is spain's average age?"

Actually I don't want to appear pedantic, but the metric which seems to work best is median age. Spain's median age is Spain 39.51, and of course Spain right now has a huge housing boom.

What happens (lo que pasa - these days I think in Spaanglish) is that in theory the Spanish median age is about to rocket forward between now and 2010 (this is due to the cohort structure) and Spain will at some point overtake Italy and Japan to become the oldest old country.

I say in theory, because Spain is currently undergoing a huge immigration boom (see eg Vicenzo Guzzo in MS GEF last week for some info on this) with an incredible 1.5% of total population per annum arrival rate. This is not sustainable IMHO for very long. It is tied in with the construction boom (so there are nice virtuous - and then vicious - circle effects at work here) and with the growing number of oldest old, and large numbers of Latin American women coming in to care for them since there is very little in the way of old age care provision.

The interesting issue is what happens when the boom turns down. My guess is that Spain will crash , and not come back. If this is so, then we will have further confirmation of the age structure thesis.

I also am saying that Spain 'in theory' will be vaulted into the vanguard, as this does obviously depend on what happens to the immigration in the downturn. I have spent some time studying theories of immigration, and again what I would argue you find are chain mechanisms, and non-linearities. Which again makes for potential instability, and great difficulty in drawing too many conclusions from partial analysis (eg Guzzo is very optimistic since he just doesn't see the potential inter-connections).

Look Brad, Dave, in the end I'm an empiricist. I'm a great fan of Karl Popper. I think science advances by making risky predictions, and then trying to get people to shoot them down. Counter examples will be important, but right now we are short on them. I once met Imre Lakatos, he has a beautiful piece called proofs and refutations, about how paradigmatic theory tries to save itself from transition by an ever growing series of add-ons (you have to remember that Popper, Lakatos, even Paul Feuerabend were all around the LSE when I was 'supposed' to be studying economics). This is what we are seeing now, from Japan had a bad NPL problem (true, but this is now much better controlled), Japan was a form of financial socialism (ditto), Japan's deflation is simply a monetary phenomenon, what Japan needs of structural reforms etc, etc, etc. As an empiricist I'm in favour of trying out all these ideas to see if any of them work (I don't agree in that sense with the oft cited view that economics is different from other sciences since we can't conduct experiments. Wrong, we conduct experiments all the time - Argentina, China's float, the euro - often unfortunately at others expense. Being an economist is, in this sense, a high risk occupation, it's just that others bear the burden of risk). As I said, I'm in favour of trying them out, but if they don't work you need to be prepared to draw conclusions. In Lakatos's terms you need a 'monster barring' methodological ground rule.

"I spent a lot of time working on argentina from 99 to 01, and at least in that case, deflation was bad for growth."


Me too, or at least folowing what happened, and again this shows how difficult it is to generalise about deflation. I certainly would never advocate deflation, I think it's too much like bleeding the patient back to good health. But what we need are detailed, case by case, analyses.

The thing about Argentina was that it had an overvalued currency because of a peg, a consequent balance of payments problem *and* and unsustainable public debt trajectory. Of course the similarity with Italy simply cries out to be noticed. Where I would argue that the median age factor comes in (Argentina's median age is 29.42) is that Argentina gets a second run at the problem (as we are seeing now, and as you are pointing out on your blog). Italy may get no second opportunity, it may, like Venice, simply sink under water. Everything in the end depends on one unknown: is it possible for fertility to recover from a rate which has fallen below 1.5 TFR. To date no-one has done that. The question is again, are the non-linearities such that escape from this fertility trap becomes impossible, or does a society reach a stage where per capita GDP falls below a certain level and the birth rate picks up again. Only the future will tell us this.

So, summming up, I would say that several years of study of the role of population theory in macroeconomics has lead me to these two points: the importance of median age, and the critical nature of a 1.5 TFR. The really big headache would be if all the developing countries currently passing through the second stage of the demographic transition start overshooting the 1.5TFR one after the other. There's something about the pace of the change which is worrying me.

Summer reading: well Oded Galor has a piece on unified growth theory on his home page (from the handbook on growth). The really interesting issue is to let your mind wander over what happens if you run the story he tells there backwards.

OK, that's it. I really am off. I'm shutting down the computer, putting the tent into the car, and over the frontier we go to visit to La Douce France. Ohhhh, that European obsession with holidays!!!

Posted by: edward | August 01, 2005 at 03:14 AM


I am looking for someone with a special interest in the PBC, someone who would like to help me develop www.centralbank.cn

If you are interested, please email me at andrewudstraw@yahoo.com and we can talk further.


Andrew Straw

Posted by: Andrew Straw | August 01, 2005 at 11:36 PM

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Is CAFTA The End Of The (Free Trade) Road?

Probably not, but the road may get even bumpier, according this report from the Wall Street Journal (page A1 in the print version):

Congressional approval of a trade pact with six small Central American countries nudged forward the Bush administration's free-trade agenda. But the close vote and bitter fight underscored anxiety about the pace of globalization and clouded prospects for approval of future deals...

But the push to encourage globalization is faltering elsewhere. In Geneva this week, the global trade talks being held under the auspices of the World Trade Organization and known as the Doha Round have been languishing, stymied by the reluctance of the U.S., Europe and others to make concessions, especially in the key area of slashing agricultural subsidies. And there is little visible movement toward the long-promised hemispheric Free Trade Area of the Americas. This effort to knock down trade barriers throughout North and South America began in late 1994 and missed its January 2005 target date for sealing a deal.

With scant progress in those areas, the close call with Cafta raised doubts around the world about the willingness of the U.S. Congress to take the politically painful steps that are sure to be part of any future trade deals. It may also encourage the move in other countries, particularly in Asia, to form free-trade zones that exclude the U.S...

Of particular concern to those who see virtue in globalization is the erosion of support among Democrats. The House vote was much more partisan than the 1993 vote for the North American Free Trade Agreement, which lowered trade barriers for the U.S., Canada and Mexico. Republicans voted 202 to 27 for Cafta. Democrats and the lone House independent voted 188 to 15 against it.

I'm not sure if this should encourage me or not...

Mr. Destler suggested that the partisanship may say more about the dynamics of Congress -- "where the parties don't talk to each other anymore" -- than partisan divisions among the public. A recent poll of 821 adults by the University of Maryland's Program on International Policy Attitudes found 50% of self-described Republicans in favor of Cafta and 51% of Democrats.

While the poll found three-quarters "support the growth of international trade in principle," it picked up widespread dissatisfaction with "the way the U.S. government is dealing with the effects of trade on American jobs, the poor in other countries and the environment."

... as the conditionality of the support suggested by this poll is not necessarily inconsistent with the Congressional divide.  In any event, these are definitely not encouraging words:

In Asia, the perception that American political support for globalization is weak could accelerate moves to form regional free-trade pacts that exclude the U.S. China reached a deal in November 2004 with the 10-member Association of Southeast Asian Nations to create one of the world's biggest free-trade areas by 2010 and is pursuing separate pacts with countries as distant as Chile. India is pursuing bilateral deals, too.

For Latin American governments mulling their own free-trade pacts with the U.S., the Cafta cliffhanger raised an unsettling question: If the tiny, ardently pro-U.S. economies of Central America can barely get a deal, what can we expect? That may make Latin leaders less willing to expend political capital at home to win approval for trade deals that grant greater access for U.S. goods. While individual countries like Panama will continue to seek bilateral pacts with the U.S., the Bush administration's already troubled plan for a Free Trade Area of the Americas faces an increasingly uncertain future.

July 29, 2005 in Trade | Permalink


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Bishop Alvaro Ramazzini from Guatemala spoke out against CAFTA before the U.S. House of Representatives and at Berkley U. He said CAFTA would help only a very few in his country and the impoverished would not benefit from it. Subsistent living farmers would lose their farms while a new wage slave working class would be created. He has a $50,000 price on his head.
Two people were killed an ten were injured protesting against CAFTA in Central America.
Free Trade is called a brutal "flexibilization of labor".
It must be noted that the U.S. Government start funding the moving of U.S. factories to Mexico and Central America in 1956. It was supposed to be a temporary measure to help out those econmies. Later the U.S. Government supported the Maquiladora factories in Mexico where U.S. companies could contract a factory, workers and more for a fraction of what it cost to produce the products in the U.S. This all happened prior to NAFTA passing. From 1956 to 1994, 2000 factories were moved to Mexico. NAFTA in essence just confirmed the process and speeded it up. After NAFTA was passed in 1994, the number of factories moved to Mexico doubled to 4000 quickly. During the same time President Clinton rushed billions of dollars to Mexico to save the Peso.
So this thing called Free Trade is not really new. It has a history and that history demonstrates total failure and it shows that the drive for Free Trade was not accidental. Free Trade has been based on moving factories and not really about trading products. Workers have no voice in the process while a working poor class has been created in the USA and a destitute working class outside the USA.
For more information see Tapart News and Art that Talks global issues at http://tapsearch.com/tapartnews or see http://tapsnewstory.filetap.com
or search on Google, Yahoo, Donkeydo for thousands of more references under Tapart News. View the Cross 9/11 Tangle of Terror Art by Ray Tapajna asking who will now untangle the terror Globalism and Free Trade have bred.

Posted by: Tapsearch Editor | July 31, 2005 at 11:11 PM

I don't know how big an element this is in the breakdown of bipartisan trade policy, but I used to work with some of the Democratic trade staff on the Hill and they had many examples of their efforts to work together with the majority being rebuffed. It seemed like, to a large extent, the free trade Democrats were constantly being told to buzz off and given absolutely none of the respect or voice that free trade Republicans were granted under Clinton.

I'm not surprised that, at some point, so many of them decided that a message had to be sent. Or, put another way, it becomes really easy to put your free-trade beliefs aside to vote against a bill that doesn't even play lip service to Democratic concerns and for which the Administration is going to give you zero credit if you vote to approve it.

Posted by: Drew | August 02, 2005 at 01:35 PM

Drew --
Well, your tale is distressing for sure, but I wouldn't overstate the degree to which things have changed all that much.
The greater voice given to free-trade Republicans in the Clinton administration probably had a lot to do with the fact that their votes were essential -- 60 percent of House Democrats and a majority of Senate Democrats voted against NAFTA, after all. Still, it would be nice to have ideas trump party.

TE: Thanks for the comments. But with all due respect, the conversation pretty much ends with the claim that the history of the world is the history of the failure of *free* trade and free trade policies. I just cannot proceed beyond my belief that the idea is intellectually incoherent and empirically false. Perhaps you are arguing that the nature of global economic arrangements and treaties are such that they actually inhibit rather than promote free trade? If so, then I think I am capable of being educated. But somehow I don't think that is what you have in mind.

Posted by: Dave Altig | August 02, 2005 at 05:11 PM

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July 28, 2005

CAFTA Moves Ahead

From Bloomberg:

The U.S. House of Representatives approved the Central American Free Trade Agreement early today, overcoming objections by unions, sugar producers and textile makers in what was the most contentious trade fight in Congress in more than a decade.

The vote was 217-215 in favor of Cafta, in an hour-long vote held just after midnight in Washington. With only a minor procedural step in the Senate ahead, today's vote effectively completes a yearlong battle for U.S. ratification of Cafta...

Cafta ends most tariffs on more than $33 billion in goods traded between the U.S. and Costa Rica, the Dominican Republic, El Salvador, Guatemala, Honduras, and Nicaragua. That includes removing duties on 80 percent of the $15 billion in annual U.S. exports to the region and making permanent the duty-free access to the U.S. that most products from Central America already have...

The legislation must now go back to the Senate for completion in a procedural step. Senators already voted 54-45 in favor of the measure on June 30.       

Legislatures in El Salvador, Guatemala and Honduras have already passed Cafta, while governments in Costa Rica, the Dominican Republic and Nicaragua are still debating it.         

As usual, there were compromises...

The administration was able to garner just enough votes by pledging to maintain caps on sugar imports, getting commitments from Central America to renegotiate some textile export provisions, and by meeting with U.S. lawmakers at least twice this week about Cafta's "geopolitical'' necessity.

... but on balance, I'm impressed. 

July 28, 2005 in Trade | Permalink


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Spoken like someone with great job security & a retirement fund he trusts. Without a Global agreement insuring intellectual property right protections what can be gained? When will voters get fed up with those who easily espouse macro policies designed solely to increase the wealth of a few at the expense of many?

Posted by: bailey | July 28, 2005 at 12:58 PM

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Posted by: Jaco Condos | February 27, 2007 at 04:45 PM

Kuaför Malzemeleri says macro policies designed solely to increase the wealth of a few at the expense of many?

Posted by: Kuafor Berber Koltugu Koltuklari | March 09, 2007 at 03:51 AM

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Laying The Foundation For A Yuan Float -- Or At Least Talking About It

In a story primarily devoted to pressures on the Japanese yen, there was this  from today's Financial Times:

The yen losses came even as the Chinese renminbi rose to its strongest close against the dollar since Beijing revalued its currency last week. The renminbi firmed to Rmb8.1080 to the dollar, from Wednesday’s close of Rmb8.1128.

Wednesday's close was a post-revaluation low for the currency, but it looks like the market is testing Chinese resolve. From Reuters:

The central bank intervened in the final minutes of trade on Wednesday to push the yuan to close at a post-revaluation low of 8.1128 against the dollar.

Dealers said it was trying to send a signal to the market that it did not want the yuan to appreciate further for now. To play down speculation of further moves, the central bank had posted a statement on Tuesday saying the revaluation did not mean there would be more adjustments.

But the Reuters story is all about laying the foundation for further reform:

China will let the market decide the level of the yuan in the wake of last week's revaluation, a senior central banker was cited on Thursday as saying, making comments consistent with Beijing's intention of eventually floating the currency.

In preparation for that step, Beijing planned to launch foreign exchange derivatives -- including options and futures -- though timeframes were uncertain, Wu Xiaoling, a vice governor of the central bank, said in an exclusive interview with the official Shanghai Securities News...

"The foreign exchange rates will move along with changes in supply and demand on the markets, and you cannot expect the central bank to control its fluctuations," Wu was quoted as saying by the paper, again giving no timeframe.

"So we will prepare to launch forex derivatives as tools for financial institutions and enterprises to control risks."

That would be a very positive development, as better tools for managing the transition to a more flexible exchange rate regime will lower the probability of big disruptions resulting.  For now, the Chinese are talking the good game:

... money supply growth was returning to "reasonable" levels, [vice governor Wu] said -- implying Beijing would not ramp up efforts to cool the economy.

The country's M2 money supply grew 15.7 percent in the 12 months to June 30, slightly faster than the central bank's target of 15 percent M2 growth this year, while yuan loans rose 13.3 percent, Wu said.

"Both indicators have fallen to reasonable levels, indicating the central bank's stable monetary policies have attained their goals," Wu said. "So there should be no changes in the policies in the second half."


July 28, 2005 in Asia, Exchange Rates and the Dollar | Permalink


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am curious: who would, given the scale of PBoC intervention -- which could be scaled back at a moment's notice -- sell "insurance" against further RMB appreciation? The only obvious seller of protection in this cirucmstance seems to me to be the central bank itself ....

consider the opposite case. A central bank is intervening heavily to keep its currency from falling (say brazil, 02). the "seller" of insurance against further falls in that market is almost always the central bank -- not market participants. Brazil did this largely through the sale of dollar linked debt -- effecively a form of exchange rate insurance. it changed the currency composition of its debt stock to try to ward off pressures in the fx spot market.

i still don't really understand how the Chinese think the hedging market will work when the market is, fundamentally, nothing more than a bet on what the PBoC itself will do.

Posted by: brad | July 28, 2005 at 12:11 PM

David - good post. Two of the reasons I enjoyed Jeff Frankel's paper are: (1) he notes the caveats about how imprecise this Balassa-Samuelson style estimate is; and (2) he also notes that other policy considerations might suggest that quickly moving to a PPP-equivalent exchange rate would not be optimal exchange rate policy. And I agree with you that trying to ascertain what the Chinese government will likely do is an interesting economic issue - regardless of what one might surmise is their optimal policy response.

Posted by: pgl | July 28, 2005 at 12:28 PM

brad -- I guess I would point out that this type of market already exists in the nondeliverable forward market. The change here (I think) is that the market would move onshore to an organized exchange, presumably with the advantages of access, standardization, and liquidity that would imply. If today's rather imperfect market arrangements functions, I'm not sure why a set of improved arrangements wouldn't.

Posted by: Dave Altig | July 29, 2005 at 08:22 AM

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July 27, 2005

More Than The Weather Was Hot In June

From Bloomberg:

Manufacturing and housing, two pillars of the U.S. economy, showed unexpected strength in June, suggesting growth may accelerate in the last half of the year.

Orders for durable goods rose 1.4 percent, building on a May increase that was the biggest in three years, the Commerce Department said today in Washington. Sales of new homes increased 4 percent to a record 1.374 million at an annual rate, Commerce also said.

"Growth is going to reaccelerate,'' said Brian Jones, an economist at Citigroup Inc. in New York. Jones forecast a 2.2 percent rise in durables orders. "The demand side of the economy is really solid.''

Factories received more orders for machinery, computers and military equipment in June. Business investment in new equipment is speeding up after companies limited their orders to work off excess stockpiles from the first quarter, economists said. At the same time, low mortgage rates continue to fuel a housing boom that analysts forecast will produce a fifth straight record year...

Investors "should not be fooled by a low second-quarter GDP'' figure, said Stephen Stanley, chief economist at RBS Greenwich Capital. Stanley lowered his second-quarter growth forecast to 3 percent from 3.3 percent. ``The economy is, if anything, gaining strength, and the third-quarter GDP number could be an eye-popper.''

A similar sentiment could be found at Reuters...

"Business spending on capital equipment is pretty healthy. What it suggests is that we might have somewhat stronger GDP growth than was expected in the second quarter, and we are doing well moving into the third quarter," Logan said.

... and at the Washington Post...

The durable-goods report was "one more indication that the pace of growth is accelerating," said Nariman Behravesh, chief economist at Global Insight, an economic research and analysis firm.

... and at the Financial Times...

“It looks as if the manufacturing sector is off and running again,” said Joel Naroff, chief economist at Naroff Economic Advisors. “With demand strong, the growth in backlogs should persuade manufacturers to expand production.”

... and you get the idea.  Today also saw the latest edition of the Federal Reserve Beige Book, which seems to support the optimistic urge.  Here's the skinny, courtesy of Market Watch:

The latest Federal Reserve Beige Book report on current economic conditions found seven of the Fed's 12 district banks saying the economy was getting stronger or remaining solid. Read full Fed survey.

Only one bank district, covering the New York region, said growth was slowing.

This is in contrast to the June beige book, when three regions reported uneven or poor growth.

The report suggests the economy ended the second quarter in good shape...

Shouldn't someone be complaining about those housing sales?             

July 27, 2005 in Data Releases, Housing | Permalink


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» New GDP data and recession probabilities from Econbrowser

The Bureau of Economic Analysis today released its advance estimates for the second quarter, reporting real GDP growth of 3.4%, implying a very slight increase in the recession probability ... [Read More]

Tracked on Jul 29, 2005 2:40:02 PM

» Further thoughts about the latest economic statistics from Econbrowser
I've had a little more time to ponder the meaning of some of the economic data released last week, and here's what I've come up with. [Read More]

Tracked on Jan 6, 2006 9:01:06 PM


We have been beating this drum for awhile. More encouraging latent economic data to come in the 2nd half. The dollar will rise, interest rates are going to go up beyond expectations. Short copper and buy the VIX, a nasty squall is coming.

Posted by: The Nattering Naybob | August 06, 2005 at 10:50 AM

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An Excellent Reminder From Angry Bear

Although this makes me a bit dizzy, it is convenient if I start by quoting pgl quoting me (and Nouriel Roubini) at Angry Bear:

In the recent Roubini v. Altig debate... David replied:

In the overall scheme of things, if you put any faith at all in markets' ability to provide best guesses of such things, the expected magnitude of RMB-appreciation looks pretty moderate. By the last update I received, non-deliverable forward foreign exchange contracts were suggesting a total appreciation of about 8% over the next twelve months. That includes the 2% today. This is up a bit from yesterday, when 6% was the bet, but it still doesn't add up to great drama.

At this point pgl steps in:

David’s forward rate evidence suggests the market’s expectation of yuan appreciation is less than 10%. Suppose the market assigns a very small probability (say 10%) to the Chinese Central Bank letting the yuan appreciate significantly (say 40%) and a large probability (say 90%) to a modest revaluation (say less than 90%). David’s evidence would be consistent with the results [suggesting a large appreciation] derived from the Balassa-Samuelson relationship.

Well, all I can say is that is a really good point.  The difficulty of gleaning the distribution of expectations from a simple forward or futures contract is exactly what motivates the use of options in calculating federal funds rate probabilities that I report each Monday. 

That said, I'm not sure this example unambiguously cuts against the argument I was making.  I might equally propose that pgl's figures are a variant of the "peso problem": An effect on an asset price that arises when there is a relatively small probability of an extreme event.  What I was trying to say -- not as precisely as I should have, to be sure -- was not that I completely discount Nouriel's assertion that sizable RMB appreciations are possible, but that the market seems to be placing a larger probability on modest outcomes. 

OK, that said let me second pgl's (and Brad Setser's) endorsement of Jeffrey Frankel's paper on this topic.  It is clear, evenhanded, and flat-out one of the best analyses of the to-float-or-not-to-float debate that I've read.  As pgl notes, Frankel employs a theoretical concept known as the Balassa-Samuelson effect to suggest that the Chinese currency is undervalued by nearly twice as much as Nouriel suggested.  Here's a key passage from the paper:

Purchasing Power Parity (PPP) is often calculated as a guide for what the exchange rate should be, for China as for other countries. But the overwhelming majority are estimates of relative PPP, that is, based on price indices. They do not necessarily show the yuan to be strongly undervalued. But that may be because they use the past as the benchmark, and the yuan may have been undervalued in the past.

Comparisons of price levels across countries are difficult, because such absolute PPP  data are much less available than relative PPP data (for which one only needs price indices and exchange rates). But some data are available. As of 1990, China’s price level was reported as only .119 of the US price level, according to the Penn World Tables, Mark 5.6.

I have no complaint about those comments at all, but this warning from the people who construct the Penn World Tables is important:

The wide range of PPP estimates for China and the large size of their difference from the exchange rate suggest that substantial uncertainty is associated with these numbers... the basis for purchasing power estimates for China is very little improved over previous versions of PWT. Further, the need to look seriously at the current and
constant price estimates of China remains.

Note that these comments pertain to a newer vintage of the Penn World Tables than the version Frankel references, and he repeats the warning himself:

Few economists would seriously recommend a revaluation over a short period of time of the yuan on the order of magnitude suggested by this interpretation of the Balassa-Samuelson equation. In the first place, a sudden revaluation of the currency of this magnitude would be disruptive. In the second place, other considerations matter in addition to the Balassa-Samuelson regression, including current monetary conditions. In the third place, one would first have to investigate the reliability of the Chinese price data. It is possible that the numbers in the Penn World Table have been extrapolated extensively from a slender base.

When it comes right down to it, all I have really been saying is this: For all practical purposes, China is still a black box.  I don't have a lot of confidence in events playing out in the relatively benign fashion I envision, but that doesn't imply any greater confidence in more sinister scenarios.   

Foornote: If you are new to the idea of Purchasing Power Parity, here is the link to the Wikipedia entry.

July 27, 2005 in Asia, Exchange Rates and the Dollar | Permalink


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The Leading Indicator Tea Leaves Say Measured Growth Ahead

Although the news is really from last week, Caroline Baum helps us catch up today:

At a press conference last week to discuss changes to the LEI, Gail Fosler, chief economist of the Conference Board, said the industrial economy is "slowing down; actually it's slowing down quite quickly.''

Perhaps anticipating protestations that the U.S. is no longer an industrial economy, Fosler noted that "the direction of the economy and direction of the industrial economy move hand in hand.''

Here's the picture of that, in case you are doubtful:


The article continues:

In a subsequent telephone interview, Fosler said she looks at the LEI's "rate of change, rather than the level, to tell you whether the economy is accelerating or decelerating. It's decelerating.''

The growth rate of the LEI slowed from a peak of 10.3 percent (six-month annualized rate) in October 2003 to 1.2 percent in June of this year.

Extrapolating from the current growth rate, "we expect to see the economy slow to about trend or below trend in the next three to six months,'' said Ataman Ozyildirim, an economist with the business cycle indicators group at the Conference Board.

It does turn out that the Conference Board came to the conclusion that the term structure relationship of old needed to be rethought:

The Conference Board made two changes to its leading index last week. The first was the introduction of a "trend adjustment'' to the LEI, which will make the level of the LEI grow at the same rate as the coincident index even if the components change, according to Ozyildirim.

The second change was to the way the interest-rate spread -- specifically the difference between the yield on the 10-year Treasury note and the overnight federal funds rate -- contributes to the index.

Previously, a narrower spread compared with the prior month contributed negatively to the index. With the current revision, the Conference Board will use the cumulative sum of the yield spread to determine the component's contribution.

As a practical matter, the spread will subtract from the index only when it inverts (when the funds rate is higher than the 10-year note yield), not when it is narrowing.

In the big scheme of things, the LEI still says not to worry...

The slowdown in the LEI's growth rate is not signaling a slump. Historically, it takes a six-month annualized decline of 4.5 percent or more and a six-month diffusion index below 50, both for an extended period, to send a recession signal, Ozyildirim said.

The six-month growth rate of the LEI is still positive, and the six-month diffusion index, which measures the number of components that are rising, stood at 55 in June. (It's been at 50 or below in six of the last 12 months.)

... but the occasion to take a shot in the direction of the Fed is still too good to pass up:

So what would she say about Greenspan's assessment that policy is still accommodative and more rate increases are needed?

"I would say to Mr. Greenspan that there are more downside risks evident in the dynamics of the LEI that are not described in the Fed's current position,'' Fosler said.

July 27, 2005 in This, That, and the Other | Permalink


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If you don't like what an indicator (or a set of indicators) is saying, why than just rejigger it!

While one can understand making industrial output count less (although that's a value judgement that ignores the fact that we as a nation now manufacturer less) -- making any yield curve flattening short of inversion a positive is simply indefendable.

A flattening yield curve is not stimulative, its LESS stimulative -- why one would imagine that its somehow a net positive (Hey let's celebrate -- the yield curve still isn't inverted! Whooppee!) is beyond me.

If you had any doubts that the Conference Board were little more than a group of hack cheerleaders, consider that concern resolved.

Posted by: Barry Ritholtz | July 30, 2005 at 12:45 PM

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July 26, 2005

Are American Consumers Responsible For The Large Trade Deficits? Some Further Thoughts

I had many good comments on my post from a few days back, wherein I suggested that the recent drop-off in the personal saving rate in the United States has been more a result of events that have led to large trade deficits than large trade deficits the result of the low saving rates.  James Hamilton made one observation -- endorsed by pgl who also posted on this topic over at Angry Bear -- that provides me the opportunity to follow up on my initial comments.  James says:

... the decline in the U.S. saving rate has been a continuous process for the last 20 years. It seems to me we've seen enough ups and downs in real interest rates over that span to make it hard for me to see as clear a connection as the one you're describing.

I should clarify that I am not attributing zero role to a "consumption binge," especially if that term is meant to describe any changes in consumption not attributable to interest rates.  I certainly believe that the relative strength of U.S. economic growth versus other developed countries has had a role in driving our trade deficits, as had asset-appreciation representing changes in wealth not captured by income flows.  I might even factor in stimulus from tax cuts emphasized by pgl (but will note at the same time that I am not generally a fan of changes in tax policy driven by motivations other than long-term structural reform).   What I was saying is that I struggle with a story in which autonomous or policy-induced consumption spending is the centerpiece of the current account story since, say, the end of the 2001 recession.   

If you are looking for a consumption binge, the period from 1997-2001 looks like a better candidate than the period since:


It is certainly true that the consumption share has remained at an historically high level, but it has not accelerated in the past several years -- even as the trade deficit continued to grow relative to GDP.

The National Income and Product Account measure of consumption does not, of course, include the purchase of new homes.  That's a category of investment, although some may want to ignore that accounting formality and associate residential investment with consumption.  If you do that, you might find the "binge" you are looking for...


... but what you are seeing is exactly my point: It is precisely the really interest-sensitive part of household-related spending that has expanded unusually in the post-recession period.  A generalized consumption binge it is not (in the eyes of this beholder, anyway). 

James takes not much consolation in this, and I'm not saying he should (although I do lean to Mark Thoma's assessment).  I've said many times that if and when long-term real interest rates rise -- which, heaven help me, I still believe is going to happen sooner or later -- the housing market will take the hit.  That need not be such a problem, of course, if interest rates are rising in an environment in which whatever has been restraining business fixed investment ceases to be. That it won't worries me a lot more that than the low personal saving rate per se. 

One interesting aside. In my previous post I bemoaned the fact that firms have been slow to spend the funds that they have at their disposal.  But the flip side of this is that they are engaging in a relatively large amount of saving.  The result of this is that net private saving rate -- the sum of personal and business saving rates, defined relative to GDP -- has actually risen since 2001:


If you believe that households "pierce the corporate veil" and treat business saving as if it is being done on their behalf, then consumers have actually reversed the trend of the past 20 years!

July 26, 2005 | Permalink


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» Which came first: the savings chicken or the deficit egg? from Econbrowser

David Altig at Macroblog raises some very thoughtful questions about the relation between the drop in the U.S. saving rate and the current account deficit.

[Read More]

Tracked on Jul 30, 2005 10:46:09 PM


I suspect that we need to go both global and local on this one.

local: given the level of mortgage rates, the lose criteria of lenders, the need for households to rebuild assets damaged by the 2000-01 market crash - including their 401K etc, and their probable low appetite for risk these days, it seems logical that we observe both a consuming restraint and investment in hard, tangible assets such as housing. Where consumers took dangerous and possibly insane risks is when they refinanced fixed mortgages with variable rate mortgages some time ago. If they have not locked in the low present long term rates, they may be in for a lot of trouble regarding the affordability of their properties in the future.

Conversely, D. Wessel's point in the WSJ regarding low corporate investment - eg a long digestion time for the excesses of the late 1990's - sounds interesting too.

global: US interest rates are not low. Global interest rate levels are low and US rates, short and long, are rising quite rapidly in relative terms. The alternative safe investment to US Treasuries is esssentially JJBs or Euro area bonds.

Global investors have likely become more risk-adverse than they were pre-2000 as they lost fortunes when corporate spreads exploded upwards, and thus the demand for government bonds globally is rising, "all yields being equal". Note as well that the rapid expansion of private retirement savings vehicles in Europe is de facto (and very often by law) heavily tilted towards Govies or AAA signatures. This shows up in rapidly falling yields in the euro area. US yields are simply remaining constant. In this sense, one might argue that the crowding out effect is there in the US whereas a crowding in effect is there in Europe.

So, my question would be, are we really talking about a global savings glut, or are we describing a global investment dearth.

Posted by: 4degreesnorth | July 27, 2005 at 04:37 AM

While we're on the subject of national savings rate, let me ask the question I've asked of other econbloggers: for the national savings rate to rise doesn't the savings rate among the top income quintile (or decile) need to rise? Or, said another way, since much of the income growth has been in the top quintile (or decile) for quite some time now doesn't much of the increase in savings need to come from that group, too, in order for the national savings rate to rise?

Posted by: Dave Schuler | July 27, 2005 at 01:06 PM

Bernard -- Nice point. I vote for the investment dearth.

Dave -- The arithmetic answer is "no" -- the increase in saving can come from any part of the income distribution. But I think that the other way to think about your question is this: Has the decrease in saving rates been associated with the upper tail of the income distribution. The answer there seems to be yes -- as documented in this study feom the Federal reserve Board: http://www.federalreserve.gov/pubs/feds/2004/200432/200432pap.pdf
These guys find that the dip in savings rates since the mid-80s has been concentrated in consumers who owned stock. There was no change in the behavior of non-owners. So, the answer to your question then becomes yes: Saving rates would recover if the upper income groups -- they are the stock owners -- reverted to their previous behavior. Of course, we might want to ask whether that would, indeed, be a good thing, as off-the-shelf economic theory suggests they are behaving more-or-less as they "should."

Posted by: Dave Altig | July 27, 2005 at 11:10 PM

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July 25, 2005

Fed Funds Probabilities: The Early November Results Are In

I'm a little late posting these today because I have been attending a workshop on -- using market data to uncover expectations about future federal funds rates.  As a bonus, though, we have our first pass at the probabilities implied by options on the November contract on fed funds futures, which will include the November 1 meeting of the Federal Open Market Committee.   It looks like the market doesn't expect 3.75% to be the end of the trail.

The pictures:



And the data:

Download october_pdfs_072505.xls

Download imp_pdf_slides_for_blog_072205.ppt

Download imp_pdf_slides_for_nov.ppt

July 25, 2005 in Fed Funds Futures | Permalink


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Actually the numbers are higher than you're methodology indicates.

Essentially the market is pricing almost full certainty of an unconditional 25 basis point move in November, irrespective of what happens before.

All one needs to do is compare the October 96.25 call to the November 96.1875 calls which are the most actively traded in the FED FUNDS options.

If the November is about the same price as the October.. this is a zero cost contingent bet on the FED "not going in November".. put call parity then impies that the probability of a FED miss is approximately zero, hence the probability of a go 100-0, or 100%...

Posted by: sjonas | July 25, 2005 at 11:46 PM

sjonas --

I don't disagree that the probability may be higher than what is indicated by these calculations. There may be some bias in the methodology because the contract is actually written on the average effective funds rate, not the target. The effective rate of late has been running above the target rate for a variety of technical reasons, and that may be causing our methodology to load some probability into the higher rate that that shouldn't be there. On the other hand, there may be term premia considerations that could distort things in the opposite direction. We're working --- or the people who created these things are working, I should say -- on improving our approach. Maybe your suggestion can help us find our way to some of those improvements. Thanks for the input.

Posted by: Dave Altig | July 26, 2005 at 07:20 AM

The effective rates' running over the target is a function of the certainty of the FED's moves when the FOMC meeting occurs early in the maintence period..

This is by now a well known aribitrage and requires a small adjustment that everyone in the marketplace is aware of and takes into account..

That of course is how martingales get formed..

As to the term premia I don't even know what the "term" means.. Which direction do you think it lies in??

Either the FED goes or it doesn't unless you assume that for some reason there are more borrowers than lenders, or that in some Lucasian sense that higher FED FUNDS rates are correlated with a good or bad state of nature..

Posted by: sjonas | July 26, 2005 at 10:41 PM

The difference between the 100 percent probability calculation by Mr. Jonas and the roughly 65 percent calculation in the chart probably relates to two factors.
1. The chart is from July 22, and prices moved just a little bit from July 22 to July 25.
2. The calculation by Mr. Jonas essentially uses a single option price to solve for the probability of the FOMC moving to 4.0 in November. The calculations in the chart use several options from November and consider more than just two possible outcomes for the November meeting.

I do think it is a slight overstatement that the method proposed by Mr. Jonas would yield a 100 percent probability of a move to 4.0 percent in November. Rather, the probability from this method is more like 80 percent, still above the roughly 65 percent in the chart.

Fundamentally, it is clear that the market is becoming increasingly convinced that the FOMC will move to 4.0 percent in November.

Posted by: Will Melick | July 28, 2005 at 04:29 PM

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