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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June 28, 2007

Come Again?

There seems to be some slight disagreement about what information the Federal Open Market Committee meant to convey with today's post-meeting statement.  MarketWatch, for example, had no problem covering a lot of territory with its collection of expert opinion:

The statement was "mildly hawkish," said Bill Sullivan, chief economist at JVB Financial. "They don't want investors to get complacent about the inflation outlook even though we've had some good data recently."

The Fed softened its tone about inflation, said Tony Crescenzi, chief bond market strategist for Miller Tabak & Co., who cautioned against overanalyzing the statement, "which continues to paint a picture of monetary policy that is likely to be little changed in the months ahead."

Kevin Logan, senior market economist at Dresdner Kleinwort, disagreed. He said the Fed "haven't backed off at all" on its inflation worry.

The "softened tone" interpretation got a little support at The Wall Street Journal's Real Time Economics blog:

ING economist Rob Carnell said the FOMC, in acknowledging improvement in core inflation, took “a slight step in the direction of a neutral bias to policy...

But most of the votes were lining up in the "hawkish" camp: At FX Daily:

This language is more hawkish than the May statement, where the Fed simply said that “economic growth has slowed.”  In terms of inflation, the Fed isn’t convinced that the battle has been won.  Instead, they expect inflation to remain a problem.

... at Bloomberg ...

"The Fed is signaling it wants it proven first that inflation is down and will stay down,'' said Gerald Lucas, senior investment strategist in New York at Deutsche Bank AG, one of the 21 primary U.S. government securities dealers that trade with the Fed. "Inflation and the perception that the Fed will remain on hold is what the market is reacting to''...

"The market is pricing in a higher probability, though it's still very small, that the next Fed move is a tightening,'' said Scot Johnson, who manages $2.1 billion of government bonds in Houston at AIM Capital Management Inc. Inflation is still ``not low enough that everybody's happy.'

... and at Forbes.com...

"The statement suggests that the Fed has a ways to go in containing inflation," [Drew Matus, economist at Lehman Brothers] told Forbes.com. "But they acknowledge progress. The Fed is no closer to raising or cutting rates. They will be on hold for some time, and that is what we should continue to expect."

There were, in fact, warnings about reading too much of anything into the changes in the Committee's language.  Again from The Wall Street Journal:

... Drew Matus notes that the FOMC removed the word “elevated” from its latest description of inflation. The fact that the year-over-year inflation rate is likely to be unchanged from the readings before the May meeting “suggests that the removal of the word had less to do with a change in the FOMC’s view on the inflation outlook and more to do with removing a word that was garnering unwanted attention.”

The net change in the Fed’s position is “trivial” given the view of moderating growth and the risk that inflation won’t moderate, said Ian Shepherdson, chief U.S. economist at High Frequency Economics.

And elsewhwere at the WSJ's Real Time Economics, there is the suggestion that the language is ambiguous because the Committee is feeling -- uh, ambiguous:

With core inflation at 2% in April and perhaps about to go lower, Thursday’s policy statement by the Fed dropped its reference to inflation as “somewhat elevated.” Some analysts saw this as acknowledgement of an inflation target somewhere around 2%.

More likely, the Fed simply punted on the question...

Dropping the reference to “elevated” without replacing it with anything may have been necessary to satisfy those who don’t buy into the 1% to 2% comfort zone without arousing objections from those who do.

If you are feeling puzzled, you can always look forward to July 19 -- and the release of the meeting minutes. 

June 28, 2007 in Federal Reserve and Monetary Policy | Permalink


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while everyone seems to be focusing on the inflation issue -- a valid factor to be concerned about.

On the other hand growth may be weaker then the consensus seems to think. Todays real PCE releases implies that in the second quarter real pce growth will be under 2% as compared to over 4% in the first quarter. So even though second quarter growth may be better then the first quarter 0.7%, it will still be well below even the Fed low estimate of capacity growth. If you look at the WSJ survey the consensus for second quarter growth has already been cut about a full percentage point this month and I see no reason for this trend to reverse.

Posted by: spencer | June 29, 2007 at 09:39 AM

Hi Dave,

Nice run-through. I think that this only underlines the blurry outlook for the US economy at present in terms of just how far the slowdown will drag on and how much structural inflation pressure will come from a rising headline in the medium term.

Clearly, Fedspeak is getting increasingly difficult to gauge these days but this I think is exactly because of the reasons mentioned above. From a 'markets' point of view I think there is only one way to interpret this and that is a holding Fed, at least throughout Q3. At least this is my bet. The interesting thing of course will be how sensitive the Fed will be to any kind of boggeyman man scenario in the form of stagflation if headline pressures really intensify amidst sluggish economic growth.

Posted by: claus vistesen | June 29, 2007 at 09:56 AM

It no longer needs saying but - I agree with spencer about today's data. We are looking at a sharp slowdown in consumer spending over the past 3 months. It may be temporary. It may be gasoline related. But it may be real-disposable-income-and-MEW related. If the latter case, then the slowdown will persist a while.

Some of the comments from various economists seem to take the FOMC statement's description of the economy as an part of the Fed's expectations-grooming effort. Read through the line on the economy in statements from the past couple of years, keeping in mind economic conditions that prevailed at the time, and you may come to a different conclusion. The statement on growth, it seems to this humble reader, is as close to an objective description of recent economic activity as one or two line will allow. If the Fed is grooming anything with that line, it is market perceptions of Fed credibility and objectivity.

The characterization of inflation performance has been quite objective, as well, though there may be more room for nuance there. Note that, in shedding "elevated", the statement went to the trouble of pointing out that the recent improvement in inflation readings is not a proven thing. How that is more hawkish, I can't imagine. We have progressed from a tilt toward tightening in the description of the next likely policy move, to a tilt toward worry that the trend won't continue while inflation was elevated, to worry that the trend won't continue now that inflation is not elevated. The statement is progressing over time (or "right along with the lags" if you prefer) toward something fully neutral. Fed officials are growing more confident that their assessment a year ago was the correct one.

Posted by: kharris | June 29, 2007 at 11:47 AM

I read the statement as more of the same. The Fed is assumed to be hawkish on inflation, and this statement doesn't veer from that expectation.

they are on hold for the rest of the year. bet on it.

they cannot cut rates even in a slowdown because then they risk ramping too much liquidity into an already liquid market. they can't raise rates because they could deter future growth.

this rate seems about just right. liquidity is slowly being sopped up, and growth is not negative.

Posted by: jeff | June 29, 2007 at 02:31 PM

Jeff: What data series are you looking at when you say that "liquidity is slowly being sopped up."

According to the latest Fed report, M1 grew by 4.9% over the past 3 months, 0.8% over the past 6 months, but down -0.8% over the past year. Meanwhile, M2 grew by a whopping 7.4% over the past 3 months, 7.0% over the past 6 months, and 6.3% over the past year. Is M1 a better measure of "liquidity" than M2?

When I dump cash into a money market mutual fund (earning 5%), is that changing "liquidity" in any way?

Maybe we need to start talking about various "flavors" of "liquidity" and be more clear about how the various flavors interact with Fed monetary policy.

In any case, what data series would you recommend that we look at to measure "liquidity" in its broadest sense relative to Fed monetary policy?


-- Jack Krupansky

Posted by: Jack Krupansky | July 02, 2007 at 11:56 AM

Jack -- I use real Zero Maturity Money (MZM) as my preferred liquidity measure because it has the best record of the various measures for leading the stock market PE.

Posted by: spencer | July 03, 2007 at 07:36 AM

MZM? ... gulp...

According to the STL Fed data, MZM is zooming upwards and not showing signs of being "sopped up."

See: http://research.stlouisfed.org/fred2/series/MZM

-- Jack Krupansky

Posted by: Jack Krupansky | July 03, 2007 at 10:30 AM

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June 26, 2007

What's That Unpleasant Sound?

According to Lombard Street Research, it's a credit crunch.  From the U.K. Telegraph (hat tip, Action Economics):

The United States faces a severe credit crunch as mounting losses on risky forms of debt catch up with the banks and force them to curb lending and call in existing loans, according to a report by Lombard Street Research.

The group said the fast-moving crisis at two Bear Stearns hedge funds had exposed the underlying rot in the US sub-prime mortgage market, and the vast nexus of collateralised debt obligations known as CDOs.

"Excess liquidity in the global system will be slashed," it said. "Banks' capital is about to be decimated, which will require calling in a swathe of loans. This is going to aggravate the US hard landing."...

Lombard Street’s warning comes as fresh data from the US National Association of Realtors shows that the glut of unsold homes reached a record of 8.9 months supply in May. Sales of existing homes slid to an annual rate of 5.99m.

The median price fell for the 10th month in a row to $223,700, down almost 14pc from its peak in April 2006. This is the steepest drop since the 1930s.

The Mortgage Lender Implode-Meter that tracks the US housing markets claims that 86 major lenders have gone bankrupt or shut their doors since the crash began.

The latest are Aegis Lending, Oak Street Mortgage and The Mortgage Warehouse.

It is worth noting that those are specifically mortgage-lending corporations not commercial banks, so I am not clear on the basis of this claim:

Lombard Street said the Bear Stearns fiasco was the tip of the iceberg. The greatest risk lies in the “toxic tranches” of lower grade securities held by the banks.

Much-trumpeted claims that banks had shifted off the riskiest credit exposure on to the asset markets was “largely a fiction”, said [Charles Dumas, the group's global strategist].

In fact, the article contains more assertions than facts.  But I think it is agreed that if there is going to be a really big spillover effect from ongoing housing woes, this is where we'll find it.   

June 26, 2007 in Housing, Interest Rates | Permalink


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I'm highly skeptical of Lombard's position. Banks have used CDOs to lay off credit risk moreso than the other way around. And I don't see the link between poor performance on sub-prime MBS pools and bank loan pools.

I really think the CDO market will prevent a generalized credit crunch, rather than cause it. This is because the risk of poor performing loans is more spread out today than at any time in the past. If many banks/investors suffer small losses, the impact on liquidty system wide will be less than the classic case, where a few banks suffered large losses.

Posted by: TDDG | June 26, 2007 at 12:41 PM


Mortgage-lending companies are dying off because they cannot sell the subprime loans they are originating. With the credit well drying up---and refis becoming a distant memory---, subprime mortgage defaults will inevitably increase, creating large losses for the owners of the lower tranches of MBS and CMOs (hedge funds and banks; what is the difference between a hedge fund and a bank's trading desk these days anyway?).

As losses mount, banks will become ever more cautious, starving even the more creditworthy borrowers (typical credit crunch story). Note that lending standards have recently been tightening even on the prime borrowers. In April Senior Loan Officer Survey, a net 15% of lenders said they have tightened their standards for prime borrower (48% for nontraditional, 56% for subprime borrowers). The tighter standards hurt not only the shaky borrowers but also those who cannot sell their homes due to a dearth of buyers.

We could easily see the problems spread from the toxic products to more traditional loans and higher quality MBS/CMO tranches. If that turns out to be the case, I'd say Lombard is underestimating the problem.

P.S.: Commercial bank/investment bank distinction is no longer all that relevant. Lombard is talking about banks in general, not commercial banks per se.

Posted by: Oracle of Cleveland | June 26, 2007 at 02:41 PM

The article makes it sound like this isn't just subprime: a credit crunch like that would mean it would be difficult for even high FICO borrowers to get a mortgage. If you think housing is in bad shape now, just imagine what that would (will?) be like.

Posted by: TiP | June 26, 2007 at 05:38 PM

I also doubt that banks are big holders of CDO equity tranches. On the other hand: Bloomberg reported this weekend that junk bond buyers are getting pickier about accepting new paper that is very highly levered and/or with weak covenants. And today (June 26) the WSJ discussed the possibility that leveraged loans might become harder to place in CLOs (collateralized loan oblidgations).

Put it all together and we are seeing indications that lenders' appetite for risky paper -- be it from private equity borrowers to finance LBOs (with the hope that the loans be placed in junk debt or CLOs) or from laxly underwritten mortgages (to be repackaged as CDOs) may be on the wane.

At the top of each economic cycle we learn that excess liquidity eventually dries up. I wouldn't be surprised if that is what is starting to occur.

Posted by: JB | June 26, 2007 at 11:04 PM

I see no basis for TDDG's assertion that, "If many banks/investors suffer small losses, the impact on liquidty [sic] system wide will be less than the classic case, where a few banks suffered large losses."

Even if the individual losses experienced by the "many investors" are small relative to those suffered by the "few banks" in the classic case, those losses will not necessarily be small from the viewpoint of those investors, and the degree to which those investors retreat from lending as a result of those losses may be much greater. After all, as they are not banks, they are not "to big to fail", and not supported by the FRB commitments to guaranteed banks profitability by reducing short-term rates below long rates whenever they need to repair their balance sheets.

The dispersal of risk is more likely to increase the impact on liquidity than to decrease it.

Posted by: jm | June 27, 2007 at 03:30 AM

When I said "large" I meant proportionally not absolutely.

Let's say that a large corporation has loans with only 2 banks. If that corporation fails, those two banks may be in trouble. A bank failure surely decreases system-wide liquidity.

Alternatively, let's say that the banks securitized that loan and is now owned in a CDO structure, which is held by dozens of hedge funds. The loss is absorbed by the CDO structure and spread around many investors. Something like that doesn't sour investor appetite for credit risk.

You also have to ask yourself, where is all the liquidity going to go? Drastic oversavings by non-US investors will be invested somehow.

Posted by: TDDG | June 27, 2007 at 11:39 AM

I suspect that we are living in a rather different world of credit intermediation now than in the past. The focus on banks assumes that the risk of financial disintermediation depends on whether banks are will and able to continue lending, A lot larger share of credit flow now goes through non-bank institutions than in the past. If those institutions crack up, then disintermediation becomes a problem even with banks relatively unscathed. Having a sound banking sector means there would be a credit channel to fall back on, but the transition would be painful, if a transition is necessary.

Posted by: kharris | June 27, 2007 at 12:01 PM

One answer, TDDG, is that some of this liquidity will disappear once hundreds of billions of instruments currently carried at face value of the books of many banks and funds are marked to their true values close to zero.

You had better believe that the margin calls on bear's hedge funds will not be the last. The major ratings agencies are finally being forced to revisit their pie-in-the-sky ratings on may such securities, as press reports this week made clear.

No collateral, no loan, goodbye liquidity.

Posted by: Gary | June 27, 2007 at 12:03 PM

That assumes that the problems in sub-prime MBS will leak into other credit products.

Maybe we're arguing semantics, but I wouldn't say that sub-prime consumers experiencing decreased access to funding is tantamount to a liquidity crisis.

Posted by: TDDG | June 27, 2007 at 03:16 PM

One view among the causes of the great depression was a general loss in confidence with the financial system.

The scorecard on the sub-prime meltdown is unsettling. The fact that both the credit ratings given these instruments and the current price are complete fabrications is a much bigger problem.

Should the entities that own this phony paper be allowed to continue the sham ? Or, in the interest of free markets, should they be ordered to revalue immediately ?

What other so called financial markets have been undermined by wall street. Equities ?

This is not just an isolated incident in an obscure security. The problem has ramifications across all free financial markets.

What a dilemna.

Posted by: zinc | June 27, 2007 at 10:55 PM

TDDG replies to mine of 03:30AM, "The loss is absorbed by the CDO structure and spread around many investors. Something like that doesn't sour investor appetite for credit risk."

From the looks of things, rather than being spread around and diluted, the risk is being distilled and concentrated to 200 proof by leverage as the hedge fund managers swing for the fences with other people's money.

"You also have to ask yourself, where is all the liquidity going to go? Drastic oversavings by non-US investors will be invested somehow."

As Gary writes above, some of the liquidity is going to disappear as it becomes undeniably clear that many of these loans will never be repaid. Still more of it will disappear as falling home prices annihilate illusory wealth and reduce consumption -- the Asians can't recycle dollars we don't send them, and as their overbuilt export industries are forced to cut wages and employment, political unrest may exacerbate conditions.

Posted by: jm | June 28, 2007 at 01:15 AM

It used to be that money supply multiplication through the fractional reserve banking mechanism was limited by the reserve requirements. The classic description was that $1000 of deposits into Bank A funded $900 of loans, which became deposits at other banks and funded $810 of loans, and so on in decreasing amounts (assuming a 10% reserve requirement). But some time ago the FRB reduced bank reserve requirements to zero for time deposits (presumably because the banks otherwise couldn't compete with non-bank lenders who were unencumbered with any reserve requirement).

It is interesting to contemplate what will happen if a consensus forms that the problem of banks being unable to compete with other entities that have no reserve requirements would be better dealt with by imposing reserve requirements on those other entities, rather than by removing them from the banks.

Posted by: jm | June 28, 2007 at 01:33 AM

I disagree with the assertion that we are hearing an "unpleasant sound." On the contrary, I think we are observing and hearing a truly robust open market system as it reasonably "adjusts" to changes in "perceived" values of assets and instruments. This is what a *dynamic* system is *supposed* to be like.

On Monday, the entire first half of 2007 will be completely behind us, and without even a hint of any "systemic" crisis. Sure, we do not know what the final haircut will be for the markdown of mortgage-related assets and instruments, but the simply fact is that everybody has had more than enough time to fiddle with their portfolios to make sure that they can "handle" this "crisis." Sure, we will continue to see failures and bailouts here and there in various niches for a bit longer, but there doesn't seem to be *any* "pressure" building up that would cause a true "systemic" problem.

Geez, all this whining about the "subprime crisis" is making Paris Hilton, Chicken Little, Nervous Nellie, and The Boy Who Cried Wolf look like paragons of backbone.

Most of what is going on right now is simply the flip side of "talking up your book", where the circling vultures are trying to talk down the value of mortgage-related assets and instruments so that the harcut fire sale prices are as "sweet" as possible. That, plus the players who bailed out LTCM while Bear Stearns refused to participate in that bailout are now enjoying the "payback" of letting Bear twist slowly in the wind.

Rest assured, the system *is* working. It is a truly amazing thing to behold. Sure, it is not as smooth-running as a watch, but this is America where risk is *supposed* to be the heart and soul of our lives.

-- Jack Krupansky

Posted by: Jack Krupansky | June 28, 2007 at 01:57 PM

... without even a hint of any "systemic" crisis ...

I'd opine there are numerous hints of systemic crisis. And the fallout from ludicrously loose mortgage lending -- of which subprime is just the first component to surface, and probably not as large as the Alt-A component waiting in the wings -- has only just begun.

What we're seeing now is just the leading edge of the mortgage default wave, and foreclosures are not yet impacting market prices in most areas. But the supply glut alone is forcing prices down, such that as the still-to-come ARM resets hit home, more and more will be owing more than their home is worth and unable either to refinance or to sell without bringing money they don't have to the closing.

In Arlington Heights, IL there are now 34 homes listed at prices over $1 million, with five more at $999k or $995k. And the number of sales recorded as of May 11 in that price range? Just one. Between $900k and a million? Three. The corresponding numbers for all of 2006? Six and eleven.

Shall we do a little gedanken experiment?
Suppose the Top 40 listings on the MLS do finally sell this year, for the same prices as the Top 40 actual sales of 2006 (though it's clear even that would be optimistic). Let's line them up below and see the deltas line by line. We find that the average haircut off the asking price would be $350k, and is $250k even down at the 40th line -- one of the $995k homes would have to go for $750k. The average price drop is 28%

And this would be just the impact of oversupply -- foreclosures aren't even in the picture yet.

Top 40s
2007 Asking 2006 Sale Delta
$2,199,000 $2,478,000 ($279,000)
$1,899,900 $1,160,000 $739,900
$1,690,000 $1,100,000 $590,000
$1,580,872 $1,100,000 $480,872
$1,549,000 $1,040,000 $509,000
$1,499,000 $1,040,000 $459,000
$1,499,000 $994,000 $505,000
$1,490,000 $992,500 $497,500
$1,449,000 $955,000 $494,000
$1,425,000 $950,000 $475,000
$1,350,000 $950,000 $400,000
$1,350,000 $930,000 $420,000
$1,299,900 $915,000 $384,900
$1,299,000 $905,000 $394,000
$1,290,000 $900,500 $389,500
$1,274,900 $900,000 $374,900
$1,250,000 $900,000 $350,000
$1,250,000 $889,000 $361,000
$1,249,000 $880,000 $369,000
$1,229,000 $880,000 $349,000
$1,199,900 $875,000 $324,900
$1,199,000 $871,500 $327,500
$1,198,872 $865,000 $333,872
$1,195,000 $860,000 $335,000
$1,185,000 $855,000 $330,000
$1,185,000 $850,000 $335,000
$1,175,000 $850,000 $325,000
$1,149,000 $835,000 $314,000
$1,149,000 $825,000 $324,000
$1,125,000 $825,000 $300,000
$1,099,000 $810,000 $289,000
$1,089,000 $805,000 $284,000
$1,059,900 $797,500 $262,400
$1,049,000 $796,000 $253,000
$1,025,900 $787,500 $238,400
$999,000 $775,000 $224,000
$999,000 $774,000 $225,000
$999,000 $772,000 $227,000
$995,000 $762,500 $232,500
$995,000 $750,000 $245,000

Sum of deltas: $13,993,144
Average delta: $349,829

If someone's about to contend that these homes are owned by rich people who will be able to wait forever to get their wishing price, note that the MLS photos show more than 70% of these homes to be vacant, and most are new construction on teardown lots.

Posted by: jm | June 29, 2007 at 01:50 AM

jm: Even if all of your numbers and inferences were 100% correct, *none* of that would establish even the proverbial "hint" of a *systemic* crisis.

Your "experiment" is micro-economic in nature, whereas any "systemic" crisis would have to be macro-economic in nature. Micro vs. macro is never simply a matter of scaling up by multiplying by a large number.

Anecdotes are wonderful for illustrating issues, but they never "prove" a thesis, nor are they ever particularly useful when searching for "hints" about systemic risks.

There are still plenty of investors with huge amounts of money in liquid, low-yield financial instruments waiting anxiously for new opportunities for higher rates of return. Haircuts, the more dramatic the better, are a *good* thing in terms of opening up new investment opportunities in a low-yield "flat" world.

As far as your vacant homes, what fraction of them are "spec" homes? Add another column for the cost or "investment" that the builders/speculators have tied up in these properties. The big, open question is what hind of investment losses such "investors" can take before those losses might somehow have an impact on the big-picture "real" economy and not simply the profit picture for a narrow niche of speculative activity. I suspect that even in a worst-case scenario the big-picture impact as well as the "systemic" impact are likely to be barely noticable and lost in the noise of overall economic activity, probably even significantly less than the organic demographic growth that the U.S. domestic economy is experiencing every year.

If you actually have "hints" of *systemic* crisis... "Bring 'em on!"

-- Jack Krupansky

Posted by: Jack Krupansky | June 29, 2007 at 11:45 AM

The vacant homes are almost all spec homes, Jack, but the point is not that the builders' losses are going to cause a systemic crisis -- indeed, if their true out-of-pocket construction costs were under $100/sqft, which they may well be, then even though the teardowns probably cost them about $300k, they'll only suffer decreased profits, not losses.

The point is that these houses aren't going to sell until they cut the prices 30+%, and those price cuts are going to crush the price structure of the entire market below. When million-plus homes are selling for $750k, the people who thought they owned $750k homes, and either paid $750k for them, or refinanced out equity based on that belief, or even just were expecting to cash out for retirement at that price, are going to have a rude awakening, most especially so because nearly the entire populace has come to believe that real estate is an absolutely sure-fire investment that can never go down.

If the builders have such huge margins they can cut their million-plus McMansions 30% and still make money, the carnage down below will be even worse -- because they'll keep on building even more!

A major factor fueling the recent bubble was that young people who formerly would not have bought homes until much later in life,and then would have bought them with 10% or 20% down using fixed-rate loans at prices that would have put their payments well under 40% of income, have been lured/ panicked by the sure-thing/priced-out-forever mantras into paying ridiculous prices with toxic ARMs and nearly nothing down, with payments far above 40% of income. Not only has this pulled forward demand -- they're not going to be first-time buyers in their 30s, as they've already got a home -- many will lose those homes to foreclosure or short sale and be so damaged financially they'll not be able to buy again for a decade; and they'll be pushing homes back into the glutted market, not taking them out. As those forced sales and foreclosures hit the market, prices will fall even further.

Most important, the beliefs that real estate can only go up, and that you must buy as much as can as soon as you can, with as much leverage as you can possibly get, is going to be totally destroyed -- just as it was in Japan.

I'll never forget the day in the late 90s when some young Japanese friends came out to Narita to give me a ride into Tokyo, and along the way mentioned that they were thinking of buying a condo, but had decided to wait a few years, "because prices will be even lower then."

Once bubble psychology starts to disintegrate in the face of a glut, the process is regenerative and can't be stopped.

A 30% average fall in the US housing price level will destroy $6 trillion of illusory wealth that most people thought was completely secure, and which fueled much more leveraged buying and borrowing than the dot-com bubble. Margin debt in the dot-com era peaked around $250 billion, only a fraction of the current margin debt equivalent in mortgages (and they only let you use 2:1 leverage in stocks).

When the baby boomers realize that the wealth they thought they had in their homes was never really there, and that they're going to have to save for retirement rather than fund it by cashing out of their home (and that that sure-thing-investment second home they bought is an albatross), consumption spending is going to take a nasty hit. This will be exacerbated by the fact that pension funds are significantly exposed to a real estate bust. The savings rate is going to go back to 8+%. Think about what that means not just to US business, but also to the export-dependent economies of Asia.

But of course you won't even see a hint of systemic crisis in this, right, Jack?

Posted by: jm | June 29, 2007 at 05:27 PM

jm: Hmmm... "But of course you won't even see a hint of systemic crisis in this, right,"

That's correct. Nothing in your *hypothetical* scenario is *real* *evidence* of a "systemic" crisis. Hypothetical versus real... you do understand the difference? Of course you do, but for reasons unknown to me, you defer to hypothetical over real. Why is that?

I'm always willing to consider alternative points of view and certainly always willing to look at hard *data*, but when you've had an opportunity to come up with *real* evidence, all you come up with is a hypothetical story of a hypothetical chain of events cthat is completely divorced from reality.

So, do you have any actual, real, live evidence of any hint of systemic crisis? Not hypotheticals, but real evidence?

From all the hard evidence I have been able to access, it still appears that the overall financial "system" is humming along quite well and not showing *any* signs of a "systemic crisis" approaching the level of the S&L or LTCM crises.

You are of course certainly free to contrive any and all hypotheticals (where would the dismal science be without hyptheticals), but I would suggest that you refrain from claiming or suggesting that any hypothetical constitutes evidence (or even a hint) of a likely outcome.

-- Jack Krupansky

Posted by: Jack Krupansky | July 02, 2007 at 11:41 AM


So you consider my Arlington Heights Top 40 data above "hypothetical"? I don't think you can get more real than actual 2007 listings versus actual 2006 sales, and the actual fact that 70+% of the listings are vacant, and that as of May 11 there had been only one, repeat one, sale in the town in the asking price range of the Top 40, and only three more even down to $900k.

What matters is not whether a prediction is "hypothetical", all predictions, including that "the sun will rise tomorrow" are "hypothetical". What matters is the degree to which a prediction is based on relevant historical experience, and we know from experience that when loose lending allows assets to be bid up to prices far out of line with historical levels and other price levels (e.g., wages), a crash and severe systemic strain nearly always follow.

You wrote, "all you come up with is a hypothetical story of a hypothetical chain of events that is completely divorced from reality."

Neither the Top 40, nor the pulling forward of demand among under-30s, nor the beginning of the end of abusive mortgage lending is divorced from reality.

"From all the hard evidence I have been able to access, it still appears that the overall financial 'system' is humming along quite well and not showing *any* signs of a 'systemic crisis' approaching the level of the S&L or LTCM crises."

If you review the history of the S&L and the LTCM crises, you will see that were no "signs" at all before the latter, and that the numerous signs preceding the former were all of exactly the same nature as those I described.

In 1929 in the US, 1989 in Tokyo, and again in 2000 in the US, the overall financial systems were, at least judging by the sort of "hard data" you demand, humming along quite well right up to the point of crash, with no "hints of systemic crisis" other than numerous variations on the theme of loose-lending-fueled asset pricing excess -- and predictable disintegration thereof -- that we see around us today.

I must add that it's also a bit odd that you seem to consider the S&L and LTCM debacles as "systemic crises", and that there is no hint of problems as large as them. Relative to the crises now approaching, they were small potatoes.

Posted by: jm | July 03, 2007 at 01:27 AM

I must add that I am not one of those who believes there is going to be any complete collapse of the financial system. There was no complete collapse of the financial system even during the Great Depression (except perhaps in Germany). I do believe we are going to have a long "period of adjustment" that will be quite painful to a significant fraction of the population.

Posted by: jm | July 03, 2007 at 01:45 AM

jm: I'm sorry you misinterpreted my point that was not a reference to your specific anecdotal evidence (specific housing prices), but was a reference to the long chain of inferences that you drew about the future from that one anecdote.

As far as "relevant historical experience", I do hope that you will acknowledge the distinction between corelation and causation and acknowledge that history does tell us that we need to consider all factors and not a cherry-picked set of factors when considering any situation, and most importantly, that the future can *never* be so mechanically predicted from cherry-picked data in the manner that you have suggested. Sure, the your outcome *might* transpire, just as any other outcome *might* hypothetically transpire, but you seem to be claiming that it *will* transpire, which is a strong claim that doesn't seem justified given the nature of the financial system and economic scenario we have with us at present, in particular, the *huge* levels of liquidity combined with stubbornly low interest rates and stubbornly low inflation expectations.

If LTCM showed us one thing, it is what the Fed can do without actually doing anything.

I should acknowledge that there are a range of interpretations for the term "crisis" and it is possible that you simply interpret the term differently than I. To me, a crisis is when life comes to a screeching halt and everybody stands still with their mouths open looking at each other wondering what to do. I gather that for you a "crisis" is simply an issue that pops up and must be dealt with that even hints about a change in the status quo.

So, when you say "the crises now approaching", should I simply interpret that as "the issues and tough decisions now approaching"?

-- Jack Krupansky

Posted by: Jack Krupansky | July 03, 2007 at 11:02 AM

The less didactic tone of your response is most welcome. Regret I cannot respond in any detail until tomorrow. See you then (if not, have a good 4th).

Posted by: jm | July 03, 2007 at 04:11 PM

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June 25, 2007

Would Subtracting Housing Make Inflation All Better?

I really did not need another must-read blog added to my list, but the Wall Street Journal's Real Time Economics feature has left me no choice.  In last Friday's edition, Greg Ip detected some pebbles coming from the direction of glass houses: 

The Federal Reserve has come under fire increasingly for focusing on “core” inflation rather than headline inflation. Excluding food and energy made sense, critics said, when those two were volatile but trendless. In recent years, however, they’ve mostly headed up, and thus core inflation has consistently lagged headline inflation.

This week’s issue of The Economist joins the criticism of core inflation, saying “Bond investors are living in a world where nobody eats or drives.” It notes Bank of England governor Mervyn King earlier this month said “measures of ‘core inflation’ that strip out certain prices can be highly misleading.” The bank’s chief economist Charles Bean leveled the same criticism last year in the heart of Fed territory, the annual symposium at Jackson Hole...

Yet when the Fed hears these criticisms from the British, it may wonder if the pot is calling the kettle black. The Bank of England targets a price index that excludes almost all housing costs, notably mortgage payments. And in the U.K. overall inflation, at 4.3% in May, is notably higher than the 2.5% inflation rate as measured by the index targeted by the Bank of England. The European Central Bank also excludes owner-occupied housing from the price index it targets, though that represents more than 10% of total consumption. Given housing’s sizable contribution to U.S. inflation last year, the Fed might have preferred the British target.

Or maybe not.  Though the inflation rate measured by the CPI less its shelter component might have provided some comfort, the overall story remains pretty much the same:




I personally prefer to look at inflation over the "medium-term," say three to five years.  Any help there?  Nope.




What if that picture had turned out better?  You might have said "so what", and I would have been with you.  As far as I can tell -- and as I have said here many times before -- the predominant view among those of us who spend a lot of our lives thinking about such things is that core measures are useful insofar as they help us get a clearer real-time picture of where the overall inflation trend is headed.  The Economist's jibe that "Bond investors are living in a world where nobody eats or drives" willfully ignores the real reason that core inflation is discussed in the first place. 

June 25, 2007 in Federal Reserve and Monetary Policy, Inflation | Permalink


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If in your CPI-less-housing calculation you are using OER-derived CPI, that is the problem: OER is a theoretically defensible construct that has little correlation with reality (here in La Jolla, CA).

The problem is OER. If one used OFHEO as a proxy for changes in housing cost, the result may be different, or at least believable.

Posted by: jg | June 25, 2007 at 11:01 PM

"the predominant view among those of us who spend a lot of our lives thinking about such things is that core measures are useful insofar as they help us get a clearer real-time picture of where the overall inflation trend is headed"

In that case, those of you (read FED) should ACT based on where the overall inflation trend is headed.

Posted by: RN | June 25, 2007 at 11:32 PM

Wouldn't it make more sense to try to decompose inflation explicitly into a demand-driven versus a supply(cost)-driven component, rather than trying to exclude certain components of the consumer budget, which start looking more and more ad hoc as their number increases?

Posted by: pinus | June 26, 2007 at 02:06 AM

"... core measures are useful insofar as they help us get a clearer real-time picture ..."

Assume that CPI and core CPI (i.e. CPI. less food and energy) are both random walks with different stochastic trends. By definition, the CPI includes the core CPI, but is exposed to more driving forces.
What can we say about these stochastic trends?
Let's first plot both indices as they are. Figure 1 (all figures are easily available at


) shows that the CPI and core CPI (both all urban and seasonally adjusted) in the USA were very close (practically evolved in sync with the CPI curve slightly in lead) between 1957 and 1981. Between 1981 and 1999, the core CPI was growing faster and a gap of about 10 units between these two indices was created in 1999.
This gap has been closing by a faster growing CPI since 2003, but the CPI index has been always below that of the core CPI, as Figure 2 demonstrates.
If to extrapolate the current rate of convergence between the CPI and core CPI, as displayed in Figure 3, one can estimate the intercept time somewhere between 2009 and 2010. The convergence trend is very robust, as was the divergence trend between 1981 and 1999, but the convergence goes faster. Therefore, one can expect that price for food and energy will grow faster than that for the items in the core CPI.

So, what's the conclusion? At first glance, both variables have different stochastic trends with a structural break between 1999 and 2003. On the other hand the difference between the indices has very deterministic trends and also a break. Effectively, it means that the core CPI is a decreasing portion of CPI:
coreCPI(t)-CPI(t)=At+C or coreCPI(t)=CPI(t)+A(t)+C
where A=-1.6 (see Figure 3), i.e. the CPI closes to the core CPI by 1.6 units of index every year.

In the long run, i.e. looking at trends not at fluctuations, there is no difference to control (manipulate) the CPI or core CPI, because the difference between them results not from the control but from some other source beyond our access.

What will be further in time, beyond 2012? It is likely that the CPI will “overshoot” the core CPI and will be growing further and further above the core CPI. On the other hand, GDP deflator and CPI will drop below zero level after 2012. This means that the core CPI will be decreasing even faster than the CPI and might reach negative zone earlier than in 2012. The Fed should be very happy with that.
So, the next five years are not good for those who have personal income I lower half (or even more) of personal income distribution in the USA, since their expenditures are mainly for food and gas. They will spend a progressively larger part of their income for food and energy.

Posted by: I.O.Kitov | June 26, 2007 at 03:31 AM

My objection to that little essay is that, though we may not be able to rely on The Economist for clear thinking, we can normally expect to be able to admire the writing.


“Bond investors are living in a world where nobody eats or drives.”

is overused, trite and awfully thin on thought. Bond traders do what they do to make money, not to provide analytic services for the rest of the world. Some bond traders also traffic in the same hackneyed prose as The Economist now employs, while others manage to inject real thought into their thought.

There is lots to say about our treatment of inflation. The Economist managed to begin its essay by saying nothing, though it got around to saying a couple of things later on.

PS, Yeah, I know there is a strong link between good writing and good thinking. I meant that The Economist typically hides weak thought better. This time, the writer seemed to have a couple of things to say, but managed to sound like an weak undergrad cribbing from a blog for a term paper.

Posted by: kharris | June 26, 2007 at 10:54 AM

Shelter is one of the largest problems in the CPI. Rents haven't changed substantially in the last 10 years, but housing has skyrocketed. Historically, 63-70% of adults own, rather than rent, housing. Why would one use the OER rental number rather than an index of housing costs?

Try calculating CPI using housing inflation over the last five years and see how the trend turns out.

Posted by: drumsfeld | June 26, 2007 at 12:46 PM

The focus on "core" inflation seems to be an artifact of the Greenspan era. Not developed by Greenspan, he embraced it with both feet as a component of larger policy (philosophy) that goes hand in hand with the US' full scale twist toward trickle down economics.

Think about it. Really, the only thing that the Fed is concerned with, that is considers inflation, is rising labor wage costs. Combined with a tax and industrial policy that favors capital, shifting of the tax burden to lower income groups through SS withholding and increased sales tax dependency at the state level, and an organized opposition to the increase in the minimum wage, the US policy has been downright hostile to 90 + pct of Americans who work for a living.

Predictably, massive debt creation has become necessary to stimulate GDP as supply has increased with skyrocketing corporate profits and falling tax burden. Throw in a trade policy that all but ensures that working Americans will be less well off, and one might actually see that adherence to the core inflation rate policy makes perfectly logical sense as a part of a larger economic doctrine.

America has been on a way street toward income polarization and wealth and power concentration at the top income brackets. Long term, the doctrine will destroy the post-war American miracle. The plutocratic movement has been winning and Greenspan has been one of their best tools and promoters.

Posted by: zinc | June 26, 2007 at 09:17 PM

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June 21, 2007

Dark Matter By Any Other Name

From Austin Goolsbee, via Mark Thoma:

... The United States miracle of the 1990s was that our productivity began growing faster than that of other countries, even though we were the richest to start with...

To explain the experience in the United States, one would have to believe that Americans have some better way of translating the new technology into productivity than other countries. And that is precisely what [London School of Economics] Professor [John] Van Reenen’s research suggests.

His paper “Americans Do I.T. Better: U.S. Multinationals and the Productivity Miracle,” (with Nick Bloom of Stanford University and Raffaella Sadun of the London School of Economics) looked at the experience of companies in Britain that were taken over by multinational companies with headquarters in other countries. They wanted to know if there was any evidence that the American genius with information technology transfers to locations outside the United States. If American companies turn computers into productivity better than anyone else, can businesses in Britain do the same when they are taken over by Americans?

And in the huge service sectors — financial services, retail trade, wholesale trade — they found compelling evidence of exactly that. American takeovers caused a tremendous productivity advantage over a non-American alternative.

When Americans take over a business in Britain, the business becomes significantly better at translating technology spending into productivity than a comparable business taken over by someone else. It is as if the invisible hand of the American marketplace were somehow passing along a secret handshake to these firms.

Sound familiar?  If you can't quite put your finger on it, here's a refresher from Ricardo Hausmann and Federico Sturzenegger:

There is a large difference between our view of the US as a net creditor with assets of about 600 billion US dollars and BEA’s view of the US as a net debtor with total net debt of 2.5 trillion. We call the difference between these two equally arbitrary estimates dark matter, because it corresponds to assets that we know exist, since they generate revenue but cannot be seen (or, better said, cannot be properly measured)...

At least three factors account for the accumulation of dark matter. The first refers to foreign direct investment (FDI). Consider a simple example. Imagine the construction of EuroDisney at the cost of 100 million (the numbers are imaginary). Imagine also, for the sake of the argument that these resources were borrowed abroad at, say, a 5% rate of return. Once EuroDisney is in operation it yields 20 cents on the dollar. The investment generates a net income flow of 15 cents on the dollar but the BEA would say that the net foreign assets position would be equal to zero. We would say that EuroDisney in reality is not worth 100 million (what BEA would value it) but four times that (the capitalized value at our 5% rate of the 20 million per year that it earns). BEA is missing this and therefore grossly understates net assets. Why can EuroDisney earn such a return? Because the investment comes with a substantial amount of know-how, brand recognition, expertise, research and development and also with our good friends Mickey and Donald. This know-how is a source of dark matter. It explains why the US can earn more on its assets than it pays on its liabilities and why foreigners cannot do the same. We would say that the US exported 300 million in dark matter and is making a 5 percent return on it. The point is that in the accounting of FDI, the know-how than makes investments particularly productive is poorly accounted for.

That story might only go so far, as the Federal Reserve Bank of New York's Matthew Higgins, Thomas Klitgaard, and Cedric Tille claim...

... we review the argument that the United States holds large amounts of intangible assets not captured in the data—assets that would bring the true U.S. net investment position close to balance. We argue that intangible capital, while a relevant dimension of economic analysis, is unlikely to be substantial enough to alter the U.S. net liability position.

... but it's apparently more than a fairy tale.

June 21, 2007 in Economic Growth and Development, Saving, Capital, and Investment, This, That, and the Other, Trade Deficit | Permalink


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June 20, 2007

Apples To Apples

Today at Angry Bear, my friend pgl is doing some back-of-the-envelope econometrics:

From 1980QIV to 1992QIV, average annual real GDP growth = 3.0%.

From 1992QIV to 2000QIV, average annual real GDP growth = 3.6%.

From 2000QIV to 2006QIV, average annual real GDP growth = 2.6%.

Notice something? During the low tax eras (Reagan-Bush41 and Bush43), we witnessed lower growth rates. During the Clinton Administration – which began with its fiscally responsible policies with a tax rate increase – we saw strong growth. Maybe part of the explanation has to do with the impact on national savings from fiscal irresponsibility justified by phony free lunch promises.

I have a bit of a problem with the evidence here.  To get the gist of my objection, take the following quiz: 

Which one of these time periods did not include a recession?

a. 1980QIV to 1992QIV

b. 1992QIV to 2000QIV

c. 2000QIV to 2006QIV

If you answered b, you win the gold star.  And if you knew that, are you really surprised that the period from 1992 through 2000 had higher average growth than the other two periods, which did include recessions?  Suppose we instead make the comparisons including only the expansion years of the Reagan-Bush41 and Bush43 administrations?  Here's what you get:

From 1983 to 1989, average annual real GDP growth = 4.3%.

From 1992 to 2000, average annual real GDP growth = 3.7%.

From 2002 to 2006, average annual real GDP growth = 2.9%.

You could just as well look at those numbers and conclude that potential GDP growth -- measured cycle to cycle -- is declining through time.  And if you accept pgl's characterization of irresponsible policy, followed by responsible policy, followed by irresponsble policy, you might then conclude that policy has very little to do with that trend.

Perhaps you would want to argue that I shouldn't exclude recessions because the absence of a downturn in the 1992-2000 period is itself evidence of the superior growth effects of the fiscally responsible policies of the Clinton administration?  Let me try to talk you out of that with a few more questions: 

1. Do you really want to blame the Reagan fiscal policies for the 1980-82 recessions -- which are almost universally attributed to the Volcker Fed's fight against double digit inflation inherited from the policies of the 1970s?

2. Do you really want to characterize Bush41 as a tax cutter?  And would you maintain that position knowing that Clinton's major piece of fiscal policy -- the Omnibus Reconciliation Act of 1993 --was pretty much of copy of the Omnibus Reconciliation Act of 1990, the legislation in which President Bush the Elder famously broke his "no new taxes" pledge?

3.  Do you really want to finger the Bush43 tax cuts for the 2001 recession which began a scant two months into the administration and was over even before the tax cuts took effect?

Look -- It might very well be that "fiscal responsibility," as pgl defines it, is a central ingredient of pro-growth policy.  But those GDP comparisons don't make the point.

UPDATE: pgl responds --to no particular objection from me -- here and here.

June 20, 2007 in Taxes, This, That, and the Other | Permalink


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Macroblog asks, "Do you really want to blame the Reagan fiscal policies for the 1980-82 recessions -- which are almost universally attributed to the Volcker Fed's fight against double digit inflation inherited from the policies of the 1970s?"

The first of the two dips, no.

But let's stop and think a moment. Why did Volcker push rates up to such punishing levels? Did it have anything to do with deficits?

If you answered yes to the latter, then Reagan has to take the blame for the second, terribly damaging dip of the recession.

One can argue that Reagan's increase of military spending far beyond what he had promised in the campaign was necessary. I would not. One can argue that his tax cuts were essential as a growth stimulus. I would not. One can even argue that the out-of-control budgetary extravaganza that David Stockman describes was a necessary price to be paid for getting the changes Reagan wanted. I would not.

But one cannot argue that whatever the h--l Reagan was doing didn't to get paid for (it wasn't and hasn't been), which is an important reason for the Fed's severity.

Posted by: Charles | June 20, 2007 at 11:17 PM

Well I am not going to be the 'one' to argue with Charles. I would not and I do not.
Why should I rescue Volcker in preference to Reagan? or pgl in preference to our fine host David?
If you answered politely to the latter, that it is always civil to side with the host no matter how uncompassionately he posts (and fresh from declarations of sensitivity, people!), give yourself a ...gold star? Really?
I cannot be bought by these gold star thingies, you? No, ok give yourself a good slap to the forehead and know that your first swing at it was just a warm-up...to your mighty swath which would be about measuring GDP and not GDP growth rates, about the respective income distributions in those periods (ok, "expansions" look good but pgl battles the political thugs who are as arbitrary as he is.) and the increasing debt.

Posted by: calmo | June 21, 2007 at 02:16 AM

Unfortunately, I don't have time to dig up the actual numbers, but a few years ago I computed annualized real GDP growth as a function of Democratic or Republican Presidents, going back to about 1920-1930 (I don't remember the exact year). I also tried lagging it by 1 or 2 years (assuming there is a delay from when the president takes office to when his policies can have an effect).

The result was quite dramatic. In all cases (0, 1, 2 year lag), the annualized real GDP growth was significantly higher during Democratic presidents.

I'm not sure exactly what it proves, but it was a much larger sample than the one referenced in this blog entry.

Posted by: ErikR | June 21, 2007 at 08:27 AM

You have a valid point that the recessions can distort the comparisons. But the recovery period immediately after a recession also distort comparisons. So if you are going to remove the recession years from the comparisons you should also remove the snap-back years of the recovery that are just as much a distortion.

For the 1980s this implies your should remove 1984 and 1985 when growth was 4.5% and 4.1%. Without these two observations your average growth for the Regan years is much lower. However, you do not get this distortion for the Clinton years since the early recovery period only had 3.3% real gdp growth in 1992.

You are correctly pointing out one data distortion only to replace it with an even more distorted comparison.

Posted by: spencer | June 21, 2007 at 08:53 AM

David - you have a point here, but I would have praised it quite differently. I follow up over Angrybear with re-phrasing what I was trying to say as well as what I think your point is here.

Posted by: pgl | June 21, 2007 at 09:08 AM

To attribute it all to the President at the time? Well, that is seeing a lot more power in the executive branch than I see.

Posted by: wally | June 21, 2007 at 09:26 AM

Wally - it's not the name of the President at issue. It IS the fiscal policy chosen by the government "at the time".

Posted by: pgl | June 21, 2007 at 09:48 AM

Calmo, I'm not quite sure what you are saying.

Let me try to explain why I chose to focus on the very narrow issue I did. Many Net debates try to deal with too much and end up resolving nothing. But on the issue of the twin recessions of the early 1980s, we actually have fairly good inside evidence as to why things unfolced as they did. We have David Stockman's account from inside the Administration. We know that there was tension between conservatives (GOP president, GOP Senate, nominally Democratic but boll weevil-controlled House) and the Fed. We know that monetarism was driving monetary policy, and that fiscal policy was very loose (see www.time.com/time/magazine/article/0,9171,954012-3,00.html, for example). So, there's not really much question that interest rates were held high because of deficits, nor is there any question that Republicans had the upper hand in government, nor is there any question that high interest rates diminish growth.

If David will re-consider this one point, we could move onto the next and the next and maybe come to a conclusion.

Posted by: Charles | June 21, 2007 at 11:29 AM

Thank you for casting that 'one' into the drink Charles. Seriously, one can be a pain in the butt, you know?
And thank you for not enumerating your points for us flow-an-go guys who have trouble even with "points" and "moving forward" sometimes even to conclusions....you know?
Ok, now you know.
This is not a debate...I am unable to act as a fair and balanced moderator and am not about to concede that role to anyone else, you?
I accept 'discussion' when sober and polite, nearly civil...like now.
I appreciate your detail and your bravery at accepting Stockman's account as the veritable truth, but I also appreciate spencer's skill in unraveling this "comparison" of economies over broad horizons and see serious problems of referential opacity...much to the chagrin of economists who need to feel that certain eras were managed better than others...and that their profession, still in its infancy, counts for something.

Posted by: calmo | June 21, 2007 at 12:13 PM

If you measure from the recession bottom there has been no significant difference in real gdp under Clinton and Bush II. Moreover, both experienced weaker growth then Reagan did in the 1980s and he experienced weaker growth then Kennedy/Johnson did in the 1960s.

However, when you look at the composition of growth there are significant differences between Clinton and Bush. Under Clinton investment made a much larger contribution while under Bush it has been consumption and housing that led growth.

To be honest, I do not much care about the debate over why growth is that much different under democratic and republican presidents. However, I do care that the theory that supply-side economics leads to greater investment and higher standards of living is simply incorrect as it has been practiced under Republican administrations over the last quarter century.

Posted by: spencer | June 21, 2007 at 04:26 PM

It is very difficult to compare. With Reagan, he was starting out in such a hole, you had to get some parts of the economy started, let alone to stop sputtering. He also increased defense spending, and at the same time Congress increased social spending as well. This greatly inflated the deficit more than it normally would have.

Clinton decreased defense spending and increased taxes. Remember the peace dividend? He also increased social spending. Both Bush I and Clinton started from a firm base, and good consumer confidence. Expectations were higher than they were under the beginning of the Reagan presidency. Bush I was not a good fiscal policy planner, and stupidly raised taxes and lowered expectations, inducing a recession.

None of these Presidents had to deal with what Bush had to deal with, a crashed stock market, an unprecedented terrorist attack. Bush's largest mistake came by not using his veto pen to cut the spending of an unchecked Republican Congress.
Hastert and Frist also should assume a lot of the blame.

The interesting thing to look at is what will happen in the future. Congress is debating a new tax bill, and it looks like they will raise taxes, and change a lot of the tax code. If expectations change, it will have a far greater effect on fiscal policy than a deficit or surplus.

One thing is clear, people respond to incentives. If you lower taxes, they will produce more. Raise them and you change their incentives. The one bill I have read about changes the AMT and rates of tax over 250K. You will see a lot of people seeking tax shelters that make above 250K. Cayman Islands anyone?

Posted by: jeff | June 21, 2007 at 05:40 PM

You'd think people writing about economics would understand the difference between correlation and causation. Do tax cuts and deficits cause recessions, or could it maybe just be the other way around? Do Republicans cause slower growth, or do Republicans get elected to clean up the messes created by Democrats (see Reagan, Ronald)?

Posted by: jimmyk | June 22, 2007 at 07:58 AM

Jeff says Reagan started in a deep hole but he should check out my second reply to David (which David provides a link to in his update). According to the CBO, the GDP gap was only 2.4% as of 1980QIV. From mid-1980 to mid-1981, real GDP grew by about 4.3%. Maybe Jeff is thinking about where the economy was at the end of 1982. But didn't Reagan become President in early 1981?

Posted by: pgl | June 22, 2007 at 09:25 AM

My estimate of spencer grows boundlessly it seems (iz he gettin help, people?) and I feel compelled to fall in behind the (political) defusing sagacity of remarks like this:

"To be honest, I do not much care about the debate over why growth is that much different under democratic and republican presidents. However, I do care that the theory that supply-side economics leads to greater investment and higher standards of living is simply incorrect as it has been practiced under Republican administrations over the last quarter century."

And not, say, (the lame, and media cultivated and propagated, and reminder that some of us were born on Thursday) remarks like this:

"None of these Presidents had to deal with what Bush had to deal with, a crashed stock market, an unprecedented terrorist attack. Bush's largest mistake came by not using his veto pen to cut the spending of an unchecked Republican Congress.
Hastert and Frist also should assume a lot of the blame."

Posted by: calmo | June 22, 2007 at 12:38 PM

The reason political parties act as they do is because the only relevent statistic we seem to focus on is GDP growth over their term.

I am thinking Ravi Batra provides the best summary of Greenspn era crap. According to Batra, the Reagan tax cuts were payed for by a huge increase in the most regressive of taxation, social security. People were fooled into thinking they were putting money aside for retirement while, just like now, they are funding a renegade tax-cut-for-the-rich, budget busting, debt induced spurt in GDP.

Like the Reagan-Bush-Cheney-Rumsfelt-Greenspan real estate scam and debt splurge of the 80's, the Bush-Cheney-Rumsfelt-Greenspan real estate scam and debt splurge of the 00's will end badly, ie; recession and deficits.

Posted by: zinc | June 22, 2007 at 03:37 PM

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June 19, 2007

Housing, Wherein We Learn Not Much

What can you say about this month's housing news?  Calculated Risk suggests:

[Today's Census Bureau New Residential Construction] report shows builders are still starting too many projects, and that residential construction employment is still too high.

The Skeptical Speculator seconds the emotion...

As I've said before, the housing market will take a while to recover, especially with the prevailing trend in interest rates.

... and Barry Ritholtz makes it unanimous:

... despite the hopes of the bottom-callers, there is still a ways to go.

The Nattering Naybob likes the way the folks at the National Association of Homebuilders sum up the situation:

Inside the number: The lowest builder confidence since 1991. NAHB President Brian Catalde:

"Builders continue to report serious impacts of tighter lending standards on current home sales as well as cancellations, and they continue to trim prices... to work down sizeable inventory positions."

Flyin in the face of Fed speak: "Home sales most likely will erode somewhat further in the months ahead and improvements in housing starts probably will not be recorded until early next year.

As a result, we expect housing to exert a drag on economic growth during the balance of 2007

I'm not so sure "flyin' in the face of Fed speak" is a completely apt characterization.  Calculated Risk, for example, cites Nouriel Roubini citing the Financial Times citing Ben Bernanke:

Changes in house prices could have a bigger effect on consumption than the traditional “wealth effect” suggests, Ben Bernanke said on Friday in comments that offer some insight into how the Federal Reserve may think about the continuing problems in the US housing market.

The Federal Reserve chairman told a conference hosted by the Atlanta Fed that, in addition to making homeowners richer or poorer, changes in house prices might influence the cost and availability of credit to consumers.

Greg Ip expands on that theme (hat tip, Brad DeLong):

Ideas that Ben Bernanke pioneered years before becoming Federal Reserve Chairman could prove important in evaluating how financial stress, such as the subprime mortgage mess, affects the economy.

... Although Mr. Bernanke doesn’t say so specifically, the record level of consumer leverage today means a change in asset prices (such as homes or stocks) can produce a much larger change in consumers’ net worth, and as a result their ability to borrow and spend. “If the financial accelerator hypothesis is correct, changes in home values may affect household borrowing and spending by somewhat more than suggested by the conventional wealth effect,” that is, the tendency of a changes in asset prices to make consumers feel more or less wealthy, and thus spend differently. That is because “changes in homeowners’ net worth also affect their … costs of credit.”

It is clear that some are willing to assert that this scenario is more than hypothetical.  Again from Calculated Risk:

From the LA Times: Report from UCLA team skirts the R-word

"We suspect that the weakness in the housing market is finally spilling over into consumption spending," wrote senior economist David Shulman in the quarterly forecast being released today. "Retail sales appeared to stall in April and automobile sales have become decidedly weak.

"This is not a recession, but it is certainly close," Shulman said.

To tell you the truth, I'm not quite sure what Dr. Shulman finds so convincing.  Under the category of spilling over, I think Greg Ip offers the right entry:

As yet, there has been little spillover from these developments into consumer spending or the economy overall.

As for a conclusion, I'll sign on with The Capital Spectator:

For mere mortals, the only reaction is wait, wait for more data. Yes, we've been waiting now for months and still we've no clarity. Grin and bear it.

June 19, 2007 in Data Releases, Housing | Permalink


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In SoCal, where credit's STILL readily available to all except the downtrodden, we ain't seen nothing yet. I don't think we'll feel the brunt of the fallout until we see a significant tightening in lending standards &/or a hike in int. rates above AG's glass ceiling of 7%.
In the meantime an entire generation of Bubble-zone dwellers is being locked out of buying into the American Dream.
Sorry, but I don't see how this can benefit us in the long term. If someone has an inclination I'd love to hear why a recession would be such a bad thing?

Posted by: bailey | June 19, 2007 at 11:01 PM

Would ya sit in a tree during a tornado? We're up a tree... and a recession, in my humble opinion, would be a VERY BAD THING.

Posted by: Gayla | June 19, 2007 at 11:31 PM

I'm so glad this blog is here. I'm new to economics and when I read all the negative views about the economy out there, I get quite frightened.

But I feel better coming back to this blog where David will always be there to assure us there's nothing to worry about, everything's perfectly all right.

Posted by: Amy | June 19, 2007 at 11:55 PM

Real consumer spending growth in April and May averaged 0.1% vs 0.3% over 6 and 12 months. New light vehicle sales, on a units basis, have fallen for 5 months. Chain store sales, having posted one of the worst months on record recently, have recovered to something just over 2% y/y growth, well below the average of the past couple of years. Paul Kasriel has deflated retail sales by the CPI goods series (since we don't have May real PCE yet) to show that real goods sales have fallen in the past two months.

Timing allows us to blame gasoline prices, but there is a fairly large pile of evidence that consumer spending is not as strong now as it has been in the recent past. For longer-term analytic purposes, we would like to be able to tease apart the effects of the wealth effect and gasoline prices, but I'm think I detect a bit of inertia in the recent "all better now" story that is keeping the Ips of the world from acknowledging various consumer demand data series show.

Posted by: kharris | June 20, 2007 at 10:50 AM

Regarding Bernankes "financial accelerator hypothesis": are increases in mortgage equity withdrawals (MEW) pumping up personal consumption expenditures (PCE)? If they are then will declining MEW drive down PCE?

James Paulsen at Wells Capital thinks that there's no relationship between MEW and PCE. In fact he observes that MEW is related to new home sales. His conclusion: as MEWs decrease the new home market shrinks. He expects a housing bust but not a consumption bust. Read it here (PDF format alert):


Posted by: W_T_F | June 20, 2007 at 11:25 AM

Yes, wait and wait some more. Now we are awaiting a second half recovery but from where will that recovery come? The longer we wait, the more likely a mishap will occur.

Posted by: Lord | June 20, 2007 at 01:46 PM

Thanks for the mention Dave,

I just wanted to sit in the hammock or putt around on the boat...

but you made me think, so back at ya...


Oh yeah, SoCal's real pain will start in October...

We are up a tree...

Dave makes me think, and that doesn't feel good.. in fact its downright painful at times and difficult most times... (I kid Dave, I kid)

Consumption in Japans 17 year deflation stayed the same...

Consumer spending is way off in unit sales, ask a trucker. Since its measured usually in $ amounts, the stagflated prices make it look OK.

And the LORD is right, a large miscalculation is coming.

Posted by: The Nattering Naybob | June 20, 2007 at 04:26 PM

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June 15, 2007

Comfort In Core?

If you had even a glance at today's report on consumer-price inflation in May, it would have been hard to miss the pretty significant dichotomy between the growth in overall prices and the inflation rate measured by so-called core measures.  And if you did miss it, you can fill yourself in at The Street Light, at The Prudent Investor, at The Capital Spectator, and at the Big Picture.  For some, like my friend (and Brandeis professor) Steve Cecchetti, the core report feels like victory:

I wish that the Boston Red Sox were doing as well in maintaining their lead in the American League's Eastern Division as the Federal Reserve's Open Market Committee is at keeping inflation under control.  The former have been slipping badly, losing six of their last ten games at the same time that the dreaded Yankees have won nine of ten.  By contrast, this morning's Bureau of Labor Statistics release confirms that the latter is right on track to bring inflation down to levels that make us all comfortable.

Today's numbers do show a rather large increase in the all-items CPI for the month of May: 8.4 percent at an annual rate (a.r.). But this hefty rise is primarily a result of yet another large gasoline price increase.  Energy prices overall rose 5.4 percent for the month; that's 88 percent at an annual rate.

Core measures of inflation, designed to remove short-term volatility, increased by much less.  The traditional core, the CPI excluding food and energy. rose 1.8 percent (a.r.), while the Median CPI computed by the Federal Reserve Bank of Cleveland increased an extremely modest 1.0 (a.r.).  And the 16 percent trimmed mean, increasingly my favorite inflation indicator, is up only 2.3 percent. Looking over the past 12 months, we see that headline inflation of 2.7 percent, while various core measures registered between 2.2 and 3.1 percent. 

The Nattering Naybob, on the other hand, is none too impressed with Steve's attitude:

This on the heels of a CPI proving stagflation is ragin in double digits with the 2nd largest monthly increase in 16 years.

Where do they hand out these PHD's??? (Piled High and Deep)....

That's a little harsh, especially when there are plenty of good reasons to champion core inflation as a guide to monetary policy.  Still, I'm unwilling to argue that the critics of core, nattering and otherwise, are completely off base.  Earlier this week, Cleveland Fed president Sandra Pianalto had this to say:

... inflationary risk can occur when large and persistent relative price shocks temporarily ripple through the inflation data. The obvious example is energy prices, although we see such changes in commodity prices more generally.  These price pressures are temporary and so do not represent changes in the inflation trend.  Still, a central bank cannot ignore them if it hopes to maintain credibility for delivering low and stable inflation. 

Since 2005, the three- to five-year moving average of U.S.inflation has hovered around 3 percent. This is above where I would like to see the trend settle in the longer run.  The reality of rising oil and commodity prices is evident, and my Federal Reserve colleagues and I have been clear that we believe the impact of these influences will dissipate over time.  But until our beliefs are validated by the data, there is a risk that the public's trust could erode and inflation expectations could move higher.

Unfortunately, the data is definitely not validating:




And if "the public's trust" were to erode?  Well, that would be bad.      

June 15, 2007 in Data Releases, Inflation | Permalink


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Tim Duy says the Fed is not quite ready to give up its inflationary bias: Fed Not Ready to Declare Victory on Inflation, by Tim Duy: Fed officials like to remind us that inflation remains above their comfort level, but [Read More]

Tracked on Jun 18, 2007 1:35:24 AM


America's claims on future global output are diminishing; our government is aiming for political deniability by allowing inflation to make this adjustment surreptitiously.

Posted by: eightnine2718281828mu5 | June 15, 2007 at 10:56 PM


As Aunt B. would have said re: Opie Taylor...

"Oh Andy, aren't you being a bit harsh on the boy."

Thanks for the mention.

As Napoleon Solo would have said... "Interesting Codicil"

Energy Equilibrium and The Extinction of Specie...


Posted by: The Nattering Naybob | June 16, 2007 at 01:37 PM

I understand that the core and median trim CPI are intended to remove volatility. But looking at you graph (and considering that a 5 year CPI average is more than enough to remove any volatility) seeing the 5 year average above 3% is not very comforting.

Posted by: Fernando Margueirat | June 17, 2007 at 10:59 AM

An interesting conundrum to me is that we ignore oil price inflation as if it were a domestically produced good, expected to fluctuate with the ebb and flow of the economy. Perhaps because it has always done so in the past.

Oil is by and large an import to the US. One would think that the 40-45 pct decline in the value of the dollar might actually mean that oil prices are inflating.

Come to think of it, why are we pretending that dollar devaluation isn't defacto inflation ? Because the yuan and yen are being devalued faster ? Like inflation, a devalued currency buys less for more. What's the difference, really.

Come to think of it, what's the difference between us and other third world economies ? They have exportable manufactured goods and we don't ?

The core rate is a very odd duck. With the US trade and budget deficits in uncharted territory, historical comparisons tend to lose their meaning. As with all aspects of this new economic frontier, we will have to wait for the great rebalancing to see what is actually going on.

Posted by: zinc | June 17, 2007 at 04:10 PM

This bit needs some eraser work:

"Core measures of inflation, designed to remove short-term volatility, increased by much less. The traditional core, the CPI excluding food and energy. rose 1.8 percent (a.r.),"

First of all volatility is always short term, so let's just demonstrate our sensitivity to double negatives irregardless...an just bean our readers with the admission that the orthodox prefer the smooth nonvolatile line nomatterwhat. Economists abhor the jaggies like Nature abhors the vacuum.
Something about food prices especially being excore wounds me deeply. Izzit because we all eat pretty much the same amount (really, compare the variation with clothing or shelter or entertainment --orders of magnitude differences, yes?) and on that basis alone, we should not be excluding it?
Why not a post-smoothing? [There is no will to include it and this strikes me as more than sloppy or arbitrary...yes slippery and slimey...possibly devious.]
The managers, who are not studied in CPI, are not moved by food prices which comprise a minuscule portion of their incomes.
There outa B a BMS to reflect the other consumers the BLS misses, no?

Posted by: calmo | June 18, 2007 at 01:17 AM


"Volatility most frequently refers to the standard deviation of the change in value of a financial instrument with a specific time horizon." (Wikipedia).

That time horizon can be anything you choose, so it is not "always short term" by any means.

Kind host,

Your chart shows 2% as the center of some kind of band or other, and the title of the chart calls 2% an "objective" but I believe more Fed officials would put 1.5% at the middle of the relevant band of objectives, with 1% and 2% the limits of the band.

Posted by: kharris | June 18, 2007 at 12:41 PM

Alright alright (Wikipedia is going to hear from me and get it straight. Dang, I've been lax and allowed an error to be propagated on the public!).
Let it B known the recent glacier recession proves the kharris point that volatility could be in eons...it all depends on your "specified" time frame...and possibly total mind blindness to the connotations that the specific time horizon is bloody short rather than bloody long.......you know?
Now I'm not sayin that environmentalists don't talk (technically) [and shoot, stupidly] about the glacier volatility over the last hundred years, but they are probably more human and just use something like "The Big Melt"...because they know when they are offending the common ear...not like say Decartes who went out of his way to offend usall, yes?

Now, why izzit that Nat's provocative and appealing line:

"Energy Equilibrium and The Extinction of Specie."

can be met (ignored) with a complaint about the accuracy of a title (David's)...that is off (possibly totally rotten following the setser use of the term I believe) by 0.5%. kharris prolly cuts her front lawn with scissors izall I can say.

Posted by: calmo | June 19, 2007 at 02:32 AM

I think Barry Ritholtz made the case very effectively that that the way owner equivalent rent is used in CPI can't be justified. Why not focus on that issue?

One could, for example, re-calculate CPI using 25% OER and 75% median home price to get a more realistic value of core.

I think that the key test of any model is that it forms part of a *consistent* picture. A major element of the American picture is of rising debt. Incurring debt is rational economic behavior in times of inflation.

Why should we believe that this generation of Americans is profligate if a more likely explanation is that they do not experience incentives to save? The dichotomy in savings behavior between middle class Americans and the wealthy-- who do have incentives to save, because they have the leisure time to play the market--is striking.

Posted by: Charles Utwater | June 19, 2007 at 11:13 AM

Charles, OER is a proxy for housing costs that represents the *consumption* (Consumer Price Index/Personal Consumption Expenditures), not the investment portion. It is the (pruning) knife (lets talk workers and what they eat with those wages) that separates the European concept of inflation from the American concept...the men from the boys.
(Actually, the citizens from the workers and consumers... the HF managers do not show up in the BLS which measures the managed, no?)
Moreover, the compilation of OER allows the managers to come up with just about any number they like for CPI by adjusting the weighted factor (currently 24%?) yes? You would be hard pressed to discover that the US had a record housing boom by examining the OER stats. It is a device to ensure official inflation is not only lower than reality but controllable...something handy for all those "inflation protected" government payments to the entitled, yes?

Posted by: calmo | June 20, 2007 at 12:46 AM

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June 13, 2007

Still The Place To Run

Just when you think you have it figured out.  From Bloomberg:

Treasurys rallied Wednesday, after recent sell-offs in bond prices sent the benchmark yield to a five-year high, attracting money from investors amid speculation the economy will continue to grow at moderate levels.

The buying spree occurred despite news of a jump in May retail sales, higher- than-expected import prices and a Federal Reserve Beige Book survey of regional economies that depicted an economy with tame inflation and moderate growth.

One explanation for the sudden reversal in the Treasury-yield trend is that there is no explanation required: On a day-to-day basis asset prices rise and asset prices fall.  Unless you are one of the relatively few who makes his or her fortune vacuuming up the arbitrage pennies, it really is of no consequence.  Still, it's fun (if not particularly productive) to speculate.  One line of argument might be that the strong retail sales were really not quite as strong as they seem.  From the Wall Street Journal Online:

We do not advise looking at either the very weak April or the robust May result alone, as neither is an accurate representation of underlying consumer spending… While May saw a bounce, the two months together don’t paint a particularly ebullient picture, particularly when looked at excluding large, price-related gains in gasoline purchases. –Joshua Shapiro, MFR, Inc.

But if you don't like that one, the Bloomberg article has plenty more:

"There are lots of rumors out there" to explain the unexpected rally, said T.J. Marta, fixed income strategist at RBC Capital Markets. "Our rumor is that there was a huge purchase of 30-year notes by an Asian buyer."

After the purchase "a sheep-like mentality" set in, inspiring more buyers to return to the market, Marta said...

Kim Rupert, fixed-income strategist at Action Economics, attributed the day's gains to "an oversold condition."

"We've come a long way in a short time," she said.

Renewed concerns about the deteriorating subprime mortgage market may have spurred some safe-haven buying. BusinessWeek online Wednesday reported that a 10-month-old Bear Stearns Companies Inc. (BSC) hedge fund is down 23% for the year largely due to subprime problems.

That last one is the one that catches my eye, as it reflects a point that seems to prove itself over and over again: When the players get nervous, it's still to the U.S. Treasury market they run.

June 13, 2007 in Data Releases, Interest Rates | Permalink


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It has been a long time since I felt that securities markets were efficient markets or, for that matter, markets at all.

Any movement, especially sudden movement, always appears to me to be coordinated and planned, with the objective of short term profit for a segment of the financial community or industrial oligopoly. Witness the coordinated surge in crude oil refinery "maintenance" driving the price of gasoline.

The depressed interest rates over the past three years of inflation is much more suprising than the recent snapback. Some overleveraged, market manipulator probably just lost his grip on the market or is making a short term run. Probably a speculative bank with tentacles into the Fed.

Why has the carry trade continued without correction, even though financial theorey has predicted an adjustment for over three years. It sure ain't market efficiency.

Posted by: zinc | June 14, 2007 at 11:02 PM

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June 12, 2007

Putting The Money Back In Monetary Policy?

The Wall Street Journal's Joellen Perry reports (page A8 in the print edition) on the latest debate within the European Central Bank:

With euro-zone interest rates near a six-year high, European Central Bank policy makers are clashing over the role of the swollen supply of money in pushing up prices.

That rare break in the bank's public facade of unity suggests policy makers are divided about how high to push interest rates in the 13-nation currency bloc, and it could rekindle a global debate on the merits of monitoring money supply...

Years of low interest rates have fueled a global liquidity glut that has inflation-wary central bankers world-wide paying attention to money-supply data. The ECB, as the only major central bank to give money-supply growth an official role in its decision-making, has led the charge. But other policy makers, including at the Bank of England and Sweden's Riksbank, have also cited strong money-supply growth as a reason for recent interest-rate rises.

Actually, Claus Vistesen was thinking about this last week, while I was in Frankfurt attending a joint conference on Monetary Strategy: Old issues and new challenges, jointly sponsored by the Deutsche Bundesbank and the Federal Reserve Bank of Cleveland.  The question of whether or not central bankers ought pay attention to money, and talk about it when they do, did come up. Gunter Beck and Volcker Wieland, both from the Goethe University Frankfurt (and the latter formerly of the Federal Reserve Board), offered up a theoretical argument for why the money-guys in the ECB might be on to something:

... we develop a justification for including money in the interest rate rule by allowing for imperfect knowledge regarding unobservables such as potential output and equilibrium interest rates. We formulate a novel characterization of ECB-style monetary cross-checking and show that it can generate substantial stabilization benefits in the event of persistent policy misperceptions regarding potential output.

... We assume that the central bank checks regularly whether a filtered money growth series adjusted for output and velocity trends averages around the inflation target. If the central bank obtains successive signals of a sustained deviation of inflation from target it adjusts interest rates accordingly.

Our simulations indicate that persistent policy misperceptions regarding potential output induce a policy bias that translates into persistent deviations of inflation and money growth from target. In this case, our “two-pillar” policy rule may effectively overturn the policy bias. Cross-checking relies on filtered series of actual money and output growth without requiring estimates of potential output. Indirectly, however, it helps the central bank to learn the proper level of interest rates.

Some of the conference participants noted that there are lots of alternative (and established) statistical techniques for forecasting in the face of uncertainties about concepts such as potential output and the equilibrium real interest rate, but another of the conference papers -- from the Bundesbank's Martin Scharnagl and Christian Schumacher -- suggested that Beck and Wieland may just be on to something when they say the ECB money-guys may just be on to something:

This paper addresses the relative importance of monetary indicators for forecasting inflation in the euro area. The analysis is carried out in a Bayesian framework that explicitly considers model uncertainty with potentially many explanatory variables...

The empirical results show that money is an integral part of the forecasting model... The key finding of the paper is is that the majority of models include both monetary and non-monetary indicators.

To paraphrase, when it comes to short-run forecasts, the kitchen sink works best.  But the result that got my attention was Scharnagl and Schumacher's finding that, in their experiments, the trend in the money supply is the only factor that appears useful in forecasting inflation once you get out beyond about 6 quarters.

That may surprise you, but it probably shouldn't.  The Scharnagl and Schumacher study is on the technical side, but some years ago economists George McCandless and Warren Weber offered up some evidence which was pretty easy to grasp:




That's a graph of the relationship between average money growth (measured by M2) and average inflation for a large cross-section of countries, over the period from 1960 through 1990.  If you are an old hand on this topic, you probably remember that it was around 1990 that both the ECB and the Federal Reserve lost confidence in the money measures they were tracking.  The ECB responded by moving from a narrow measure of money to the very broad M3 concept.  The Federal Reserve responded by more-or-less abandoning monetary measures all together.

OK, let's take a look at the McCandless and Weber picture post-1990:




Hmm.  The Wall Street Journal article correctly notes that there is still a great deal of skepticism about the usefulness of monetary measures in formulating monetary policy:

The U.S. Federal Reserve is among the doubters. Fed Chairman Ben Bernanke said in November that a "heavy reliance" on money-supply data as a predictor of U.S. inflation was "unwise."

I don't think either the Beck-Wieland or Scharnagl-Schumacher work contradicts that skepticism about "heavy reliance." But maybe money deserves just a little more love on this side of the Atlantic than it currently gets?

June 12, 2007 in Europe, Federal Reserve and Monetary Policy | Permalink


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Tracked on Jun 18, 2007 4:27:30 PM


And, maybe credit is more important than money, in the sense of the increasing ease with which economic actors can find credit which is less and less under the "control" of even the influence of the Fed.

For example, when vendors offer 0% interest out of desperation to get business, how effective is modest tweaking of the money supply?

Or, when "investment" flows into the domestic economy from outside the U.S. and the attraction is the rate of return of the investment irregardless of the level of "general" interest rates that the Fed might seek to influence.

Even banks have access to far more "capital" than the "money" they might borrow at the federal funds target interest rate, right?

And with securitization, banks don't even need much capital to sustain a "lending" business, right?

Mostly we simply accumulate "money" in money market mutual funds where it earns relatively high interest rates and effectively "grows" even more money (M2) much faster than the economy's need for capital in the form of "money", right?

We need to radically rethink our conceptions of "money" relative to "capital" and the needs of the economy for each.

-- Jack Krupansky

Posted by: Jack Krupansky | June 12, 2007 at 11:05 AM

MxV=PxQ. Problem is that central banks only look at P for goods and services, if they included P of assets then the mystery is solved. What makes this period different from others since 1960 is that Chinda 'beavers' have built a dam that prevents M flowing into price inflation the stream being diverted into asset inflation, which according to CB's isn't inflation at all. Heaven help when the dam gives way (protectionist/ USD depreciation/ excess foreign domestic demand).

Posted by: voltaire | June 12, 2007 at 05:44 PM

Am I reading those graphs correctly, in that the inflation axis goes from 0 to 100% CPI inflation (per year)?

If so, it seems completely irrelevant to modern concerns about inflation in the 1-4% range.

It would be interesting to expand the relevant portion of the graph, say from 0-5% inflation, and see how strong the correlation is in that range.

Posted by: ErikR | June 13, 2007 at 11:12 AM

Thanks for the reference! Here is a relevant quote from the paper Jef found:

"Our second finding is that this strong link between inflation and money
growth is almost wholly due to the presence of high-inflation or hyperinflation
countries in the sample. The relation between inflation and
money growth for low-inflation countries (on average less than 10% per
year over 30 years) is weak, if not absent."

Posted by: ErikR | June 17, 2007 at 12:49 PM

First, there is no ambiguity in forecasts. In contradistinction to Bernanke, forecasts are mathematically "precise” (1) nominal GDP is measured by monetary flows (MVt); (2) Income velocity is a contrived figure (fabricated); it’s the transactions velocity (bank debits, demand deposit turnover) that matters; (3) “money” is the measure of liquidity; & (4) the rates-of-change (roc’s) used by the Fed are specious (always at an annualized rate; which never coincides with an economic lag). The FOMC, etc., has learned their catechisms;
Friedman became famous using only half the equation, leaving his believers with the labor of Sisyphus.
The lags for monetary flows (MVt), i.e., real GDP and the deflator are exact, unvarying, constant. Roc’s in (MVt) are always measured with the same length of time as the economic lag (as its influence approaches its maximum impact; as demonstrated by a scatter plot diagram).
Not surprisingly, adjusted member commercial bank free legal reserves (their roc’s) corroborate/mirror both lags for monetary flows (MVt) –-- their lengths are identical. The BEA uses quarterly accounting periods for real GDP and deflator. The accounting periods for GDP should correspond to the economic lag, not quarterly. Monetary policy objectives should not be in terms of any particular rate or range of growth of any monetary aggregate. Rather, policy should be formulated in terms of desired roc’s in monetary flows (MVt) relative to roc’s in real GDP. Note: roc’s in nominal GDP can serve as a proxy figure for roc’s in all transactions. Roc’s in real GDP have to be used, of course, as a policy standard.
Because of monopoly elements and other structural defects which raise costs and prices unnecessarily and inhibit downward price flexibility in our markets (housing being most notable), it is probably advisable to follow a monetary policy which will permit the roc in monetary flows to exceed the roc in real GDP by c. 2 percentage points. In other words, some inflation is inevitable given our present market structure and the commitment of the federal government to hold unemployment rates at tolerable levels.
Some people prefer the devil theory of inflation: “It’s all OPEC’s fault.” This approach ignores the fact that the evidence of inflation is represented by actual prices in the marketplace. The "administered" prices would not be the "asked" prices were they not “validated” by (MVt).

Posted by: flow5 | July 29, 2007 at 01:37 PM

There is no one alive that understands money & central banking.

No accolades here:

Milton was loath to grant central bankers much discretion in formulating and executing monetary policy.

(1) Friedman couldn't define/kept changing the definition of the "money" supply to target. Money is the measure of liquidity, the "yardstick" by which the liquidity of all other assets is measured.
(2) the "monetary base/high powered money” [sic] is not a base for the expansion of the money supply.
(3) the "multiplier" is derived from "money" divided by member commercial bank legal reserves, not the monetary base..
(4) aggregate demand is measured by monetary flows (MVt), i.e., income velocity is a contrived figure (WSJ, Sept. 1, 1983)
(5) the rates of change used by the Fed are specious (always at an annualized rate having no nexus with economic lags; Friedman pontificated variable lags; economic lags are unvarying)
(6)Friedman (1959) has long advocated the payment of interest on reserves at a market rate in order to eliminate the distortions associated with the tax on reserves.

A. Friedman didn't know the difference between the supply of money and the supply of loan funds.
B. didn't know the difference between means-of-payment money and liquid assets.
C. didn't know the difference between financial intermediaries and money creating institutions.
D. didn't recognize aggregate monetary demand is measured by the monetary flows (MVt) not nominal GDP.
And the technicians at the Fed:
E. don’t recognize that interest rates are the price of loan-funds, not the price of money
F. don't recognize that the price of money is represented by the price (CPI) level.
G. don't realize that inflation is the most important factor determining interest rates, operating as it does through both the demand for and the supply of loan-funds.
That's some legacy.

Posted by: flow5 | July 29, 2007 at 01:54 PM

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June 11, 2007

One Savings Glut That Carries On

From the Wall Street Journal:

China's monthly trade surplus soared 73% in May from a year earlier, a state news agency reported Monday, amid U.S. pressure on Beijing for action on its yawning trade gap and the possibility of sanctions.

Exports exceeded imports by $22.5 billion, the Xinhua News Agency said, citing data from China's customs agency. That figure, close to the all-time record high monthly surplus of $23.8 billion reported in October, came despite repeated Chinese pledges to take steps to narrow the gap by boosting imports and rein in fevered export growth. The report gave no details of imports or exports.

The U.S. government has been pressing Beijing for action, especially steps to raise the value of the Chinese currency. Critics say the yuan is kept undervalued, giving Chinese exporters an unfair advantage and adding to the country's growing trade gap.

Apparently, the U.S. Senate is about to officially jump into the yuan-peg fray.  From Bloomberg:

The U.S. Senate will introduce a bill this week to pressure China to strengthen its currency, the Financial Times said today, citing unidentified people close to the situation.

The market, on the other hand, suggests that maybe things aren't so straightforward:

The gap may increase pressure on China to let the yuan appreciate to reduce tensions with trading partners and cool the world's fastest-growing major economy. The currency today had its biggest decline in 10 months and has reversed gains made in May when Chinese and U.S. officials met for trade talks in Washington...

The yuan declined 0.2 percent to 7.6691 against the U.S. dollar at 4 p.m. in Shanghai today, the biggest one-day fall since Aug. 15.

The currency has strengthened 7.9 percent since China scrapped a 10-year peg to the dollar and revalued the currency in July 2005. The 0.74 percent monthly gain in May was the biggest since the end of the fixed exchange rate.

I'm not sure what the story is there, but Nobel Prize winner Robert Mundell warned this weekend that too much pressure on the Chinese may not imply an appreciating yuan.  From the Wall Street Journal (page A9 in the weekend print edition):

... in the unlikely event that the yuan were suddenly made fully convertible, Mr. Mundell predicts that the value of the currency would fall, not rise. Many Chinese savers would want the security of keeping at least some portion of their wealth in foreign currency and would convert quickly, worried that the government might slam the door shut. This might become a self-fulfilling prophecy. In the U.K. in 1947, the Bank of England saw its reserves evaporate in a matter of weeks, and reinstated capital controls. The movement to full convertibility is fraught with danger and must be approached cautiously.

Meanwhile, yet another Nobel Prize winner, Michael Spence, suggests there is something much deeper in play than mere currency policy.  From China Daily:

China has been in a high growth mode since it started economic reforms in the late 70s. Its almost three decades of high growth is the longest among the 11 high-growth economies in the world and part of "a recent, post-World War II phenomenon". And the Chinese economy will sustain its fast growth for at least two more decades...

The high levels of savings and investments both in the public and private sectors, resource mobility and rapid urbanization are the important characteristics of China's high growth, says Spence, who is also the chairman of the independent Commission on Growth and Development. The commission was set up last year to focus on growth and poverty reduction in developing countries. China's saving rate of between 35 to 45 percent is among the highest despite the relatively low level of income of its people. Resource mobility has generated new productive employment to absorb surplus labor in a country where 15-20 million people move from the rural areas to the cities every year.

The most important feature of sustained high growth is that it leverages the demand and resources of the global economy, says Spence. All cases of sustained high growth in the post-War period have integrated into the global economy because exports act as a major high-growth driver.

Enumerating the reasons why the Chinese economy will sustain its high growth rate for another two decades, he says: "There are basically two reasons. One is that there is still a lot of surplus labor in agriculture. The engine for high growth is still there. The second is that the Chinese economy has diversified very rapidly. It's quite flexible and entrepreneurial."

Spence clearly believes that the Western complaints of too low a value for the Chinese currency and too high a surplus in its trade balances will self-correct, with a little help from government policy:

The only way to stop China's high growth would be to shut the economy off from the rest of the world. "It's just not going to happen." Even 20 years later, China will continue to grow because its currency will appreciate, helping raise the income level and increase the wealth of the people...

... To balance the huge trade deficit, Spence hopes China would boost domestic consumption and bring down the saving rate.

He acknowledges, though, that the relatively high-income younger generation is spending more despite the fact that East Asians traditionally are good at saving. A solution to the trade imbalance could also be found by increasing social security and the pension system, making them available to everybody, improving the medical coverage in the rural areas and making education at all levels affordable.

Meanwhile, the move to liberalize domestic financial markets in China took another step forward this weekend.  From Reuters, via China Daily:

China Export-Import Bank (EximBank) is set to issue 2 billion yuan (US$261 million) in yuan-denominated bonds in Hong Kong this month, making it the first Chinese lender to do so, sources told Reuters on Monday.

Exim Bank is to sell the 3-year bonds only to institutional investors, an investment banking source said, adding that the bank would decide on the yield later.

Never boring, is it? 

June 11, 2007 in Asia, Economic Growth and Development, Exchange Rates and the Dollar, Trade , Trade Deficit | Permalink


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Mundell's comments make no sense to me. Why would chinese citizens convert a rising Yuan to a falling USD or falling Euro? Security? If chinese citizens are so concerned with security, why are they pumping money into equities at an alarming rate?

Those who think the Yuan is undervalued can never explain why the PBoC have to excahnge an awful lot of Yuan for USD to keep the currency peg. It's never the other way around.

Posted by: Charlie | June 11, 2007 at 07:38 AM

Mundell may be right about short term allocation issues, but comparing a relatively declining UK do a relatively ascending China isn't analogous.

Posted by: cb | June 11, 2007 at 01:17 PM

Mundell also went for the "everything all at once" approach. It doesn't have to be that way. The yuan can be allowed to float without allowing full convertability. That has been done before, has it not?

Posted by: kharris | June 11, 2007 at 01:47 PM

"Even 20 years later, China will continue to grow because its currency will appreciate, helping raise the income level and increase the wealth of the people..."

by correlation: the US currency will continue to fall helping to reduce the income level and decrease the wealth of the people ....

Posted by: zinc | June 11, 2007 at 10:38 PM

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