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

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

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July 26, 2007

It Never Was Just Subprime

So now the dissecting of today's market jitters begins, and there is no shortage of diagnoses. Today's data releases -- described here, here, and here, for example -- were certainly not great, but the most popular explanation seems to be that market players have developed a newly found sense that the world is a risky place.  Barry Ritholtz sums it up nicely:

The Dow is off 395 points as I type this. There will be some short covering shortly, and a rally attempt. But what I want to address is the change that has taken place:

What has changed? What is different today than yesterday? Are the prospects of the economy and/or corporate profits so different today than they were merely a week ago?

What has changed is Credit: Risk appetite for anything less than AAA -- and that includes the ABX stretched definition of AAA (see WTF is going on in the ABX Markets?) -- has waned considerably.

The tinder, if not the spark, for the flare-up of credit concerns was this week's revelation from the mortgage lender Countrywide Financial that loan problems extend well beyond the subprime borrower.  From the Wall Street Journal (page C1 of the July 25 print edition):

By laying the blame for its earnings shortfall on rising defaults of prime home-equity loans -- many taken out by people who were straining to afford a house and didn't fully document their income -- Countrywide undermined the popular notion that only subprime borrowers are falling behind. And that could have a broad, negative impact on lenders' stocks.

And from from Joanna Ossinger's column at the WSJ Online:

Credit-market woes are partially rooted in the subprime-mortgage sector, which has been a source of market angst for months. But recently the problems have become more acute, as hedge funds invested in mortgage-backed securities have struggled and as default rates have risen, even among prime borrowers. Banks have been hurt by having to take loans onto their balance sheets instead of passing them on to outside investors. And major private-equity acquisitions have struggled to find financing, possibly removing one long-standing support for the market.

It "all goes back to weakness in the mortgages," said Larry Peruzzi, equity trader at Boston Company Asset Management.

But a closer look at the Countrywide development is instructive, as it reveals that the source of the problem is, not surprisingly, non-conventional types of loans.  Again from the WSJ article:

Many of the home-equity loans that are going bad are "piggyback" loans to borrowers who took out a second mortgage because they couldn't afford a large down payment and didn't want to pay for mortgage insurance.

Now, with home prices falling in many areas, some borrowers owe more than their houses are worth. That is forcing Countrywide and others to increase provisions against losses.

Another concern is the $27.78 billion of pay option adjustable-rate mortgages held on the books of Countrywide's banking arm. These loans allow borrowers to pay no principal or less than full interest each month. If they choose that option, their loan balance grows. Payments are now overdue on 5.7% of these loans held by Countrywide, up from 1.6% a year earlier.

But here's the thing -- we surely have known for a while now that the building stress in mortgage markets is not a prime vs. subprime thing, but conventional-loan vs. non-conventional loan thing:




What seems like fresher news to me is the growing skittishness in credit markets that are not so clearly associated with the housing sector.  From the Financial Times:

Stock prices plunged on Thursday amid a flight from risky credits and fears about banks’ growing exposure to leveraged buy-out debts...

Investment bank stocks led the market lower on worries that they will have to use their balance sheets to fund private equity deals. The S&P investment bank index was down 5.3 per cent.

Concerns about the possibility of a credit contraction were exacerbated this week when banks gave up attempts to sell to investors $20bn of debt for the leveraged buy-outs of Chrysler and Alliance Boots, the UK retailer.

A Financial Times analysis shows that in recent weeks, bank balance sheets have absorbed more than $40bn of high-yield debt for buy-out deals that was meant to be sold to investors.

So you have your pick -- weak economic news, a broadening of housing market woes, a fading corporate debt market.  Or just choose all of the above and keep your fingers crossed that it's only a bad week and not a perfect storm.

July 26, 2007 in Housing | Permalink


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Perhaps a time for reflection:
The risk is that banks can't sell off the loans that they've made?

Gosh.. I remember way back ...when banks actually made loans on their own books..

Its as though people are wondering.. gee where will the banks get that money to make the loan if they don't sell it??

What was a newfangled "derivative" 5 years ago is no so integral to the banking system.. that we can't even remember what banks were supposed to do...

Posted by: stan jonas | July 27, 2007 at 10:46 AM

We operate SellHomeHouse.com, a home selling site and have seen a huge increase in the number of motivated sellers in the past few months. With how many homes are on the market right now so many are having a hard time selling their homes, and are going to great lengths to sell their homes. Hopefully the market will turn around next spring as predicted so sellers have an easier time in 2008!

Posted by: TSmith | July 27, 2007 at 11:41 AM

in the last few day's we're seeing motivated sellers of stock...

but why should anyone care whether they have an easier time of it in 2008...

Perhaps we should average down in Housing too?

Posted by: phyron | July 27, 2007 at 12:07 PM

Good start Mike on a great topic, but it's clear now it IS a perfect storm, one that started gathering force back in the 90s and whose force was not an accidental culmination of unforseen circumstances.

First, FED head A. Greenspan pushed Congress to DRAMATICALLY define down inflation. (Boskin Commission recommendations over those of K. Abraham, the head of the BLS.)
Then, Congress, again following the lead of AG, TOTALLY repealed Glass-Steagall WITHOUT calling for single-body regulatory control over the resulting financial (banking/Brokerage) sector.
Let's not forget the impact on soon to be retiring boomers of Congress' 1997 $500,000 homeowners tax exclusion.
The Bush Administration added gale-like strength to the growing storm with its "ownership society". (How many programs were instituted to advance home lending to those previously determined by free-market processes to be unqualified?)
Fannie & Freddie correctly assessed the opportunity and whirled it into a full-force tornado. (They buy almost 50% of residential mortgages. Had they simply decreed they wanted no part of the scam UNLESS a deep pockets guaranteed the no-doc, no down absurdly risky loans, the storm would've topped out as subtropical at best.)
The last and greatest culprit in creating the perfect storm was the FED. Forget any simplistic explanation that it kept "low interest rates for too long", that's sophomoric. The FED alone is responsible for this perfect storm as it lead the fight for conditions needed, resused to interced when it could have stopped it and along the way provided legitimacy for it with its rhetoric.
Let's review. The FED set the atmospheric conditions by defining down inflation close to a whopping 25% (4+% to 3+%). Dean Baker ably argued (1996?) it was unreasonable to not assume other effects. Then, without explanation, the FED stopped looking at M3 - the monetary measurement that most closely tracked prior readings of inflation growth. The FED never would've been able to justify the extended period it printed so much money had it not first changed the rules.
But, the FED did more. It narrowly (and incorrectly) interpreted its supervisoral role over the mortgage lending process to its direct role of overseeing its Banks' lending policies. Guess what? The percentage of non-bank originations (& non-traditional mortgage loans) skyrocketed!
A cynic might conlude it didn't hurt BB's chances to land his FED Chairmanship appointment when he announced in 2005 that housing prices were being "driven by fundamentals". It's informative that BB never mia culpa'd on the origins of the housing bubble, he just changed his line along the way. By the time he acknowledged the problem the storm was unavoidable. Even a casual observer would now conclude the FED's role in the oncoming catastrophy was causitive. Skeptics need only look at the FED's toothless nontraditional mortgage "guidelines" issued in the fall of 2006. Instead of stating clearly, STOP THIS NONSENSE - NOW, the FED signaled the r.e. industry time to start unwinding the scam. So, here we are a year later, facing the struggle no one wanted to face last year.

You betcha, it was a perfect storm. But, let's be clear about who the driving forces were.

Posted by: bailey | July 27, 2007 at 12:34 PM

We can all look back to see the structural imbalances in the financial systems, domestic and global, these are obvious. These imbalances have created vapors of weath across the globe that have presented themselves in many forms... Wealth effects from housing, corporate earnings, employment statistics, global trade, inflation assesment, consumer vitality, etc.etc, I could go on and on, have manifested themselves in the most excessive aquisiton binge in human history. It is imppossible to place the blame on anyone as this was a collective event that occured right in fron of our eyes. It was a human event in which everyone played a role. We are all driven by self interests and we closely watch our neighbors and judge them by standards not of our own making.

A new dawn is breaking on the horizon as I write this and it is clearing away the fog, the bars are closed, the vampires, rats and cockroaches are scurrying for cover. Many who had not been invited to previous parties and lack the experience, have over indulged in the exhilirating novelty of wealth and aquisition, a few more than others. It is still very early in the morning and some of us will sleep off our hangovers to face the recriminations later in the day. Some will want to keep the party going, but the novelty has turned mundane.

As the sun rises the vapors of illussion will melt into a reality of our own making. And just as we are seeing the housing bubble deflate in front of our own eyes, so too shall the consumer, equities, coporate earnings and employment, just to mention a few. These will canibalize each other. Where is the buyer of last resort....?


Posted by: ECONOMISTA NON GRATA | July 29, 2007 at 11:23 AM

I think everyone here underestimates the power of the market. Bear Stearns had a couple of funds go bust, but the market somehow knew it was deeper than that.

What needs to happen is that all the information on how far the sub prime thing stretches needs to come out. Once the market has all the information, it can make a rational decision.

Tricky lawyers and CFO's are trying to contain the information, and parcel it out to see how much damage they can control.

I disagree with Bailey's analysis that it was all the feds fault in the late 90's. It is impossible to forecast ten years ahead of time.

Home ownership is a desirable standard for people. It gives them a stable foundation to direct their life. Banks made bad decisions on lending, and should pay the price for it.

Given all the shocks to the economy in the past 7 years, the FED has done a pretty good job. Let the capital markets work, and keep government regulation and bail outs out of the market. If some banks lose a bunch of money and go bust, it's a god thing. Part of being in a capitalistic society.

Posted by: jeff | July 29, 2007 at 12:01 PM

Most financial institutions have a notion of the overall level of risk they are willing to hold. They hold lots of assets of varying risks, and may hold various portfolios each of which has a different target level of risk, but in the end, banks cannot accept a run-up in risk in a major asset class without adjusting. When CDOs and the like began to crumble, the implication that overall risk held by financial institutions was up, and had to be brought down. Shedding assets that had become high-profile as "the problem" was unlikely to do the whole job, so other risky assets had to be disposed of, too.

Back in late 1990s, we say contagion go from mis-matches in currencies (borrow dollars, earn baht) to portfolio problems - dump emerging market assets. Portfolios that held no Thai assets still got whacked.

Contagion today starts from a different place, but the mechanism is the same. Whatever is in the portfolio that holds CDOs is likely to come under pressure, with the riskiest holdings going first - gotta fix the risk profile. Next is portfolios that didn't hold CDOs, but see their risk go up as leveraged loans begin to widen out.

Posted by: kharris | July 30, 2007 at 09:42 AM

I agree on most of what you had to say. If I may add that the new FHA bill passed by congress and signed by the president should help a lot of distressed homeowners

Posted by: Mortgage advice expert | August 14, 2008 at 06:17 AM

The new mortgage reforms will definitely have a significant impact on the housing market because many prospective homeowners will not be able to meet the stringent income to mortgage payment ratio of 28% and heftier down payments. As a result we will see more renters.

Posted by: Gmac Mortgage | June 17, 2011 at 12:57 PM

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Why Central Bankers Worry About Fiscal Policy

Today I again hand the keys to Mike Bryan -- now a fellow adjunct faculty member in the University of Chicago's Graduate School of Business -- who provides us with a contemporary example of why it behooves central bankers to speak out when a nation's fiscal situtation gets out of whack:

The reports from Zimbabweover the past year and a half are the stuff that makes for good Money and Banking lectures. It seems that inflation in that country, as officially reported, topped 1,300 percent last year and may now exceed 3,700 percent, with some unofficial reports putting the country’s inflation rate even higher.  Let’s put this inflation in perspective.  If the last reported inflation number can be believed (the country’s Central Statistical Office recently stopped reporting the inflation numbers as it reviews its methodology), prices in Zimbabwe are doubling every month. Inflation of this magnitude renders the government-issued money virtually worthless, wrecking trade and financial institutions in the process.   

While the rate of inflation in the African nation isn’t known for certain, there is little doubt it is extraordinarily high.  Also not in doubt is its cause.  All inflations originate from the same phenomenon—too much money chasing too few goods.  In this case the Reserve Bank of Zimbabwe is rapidly printing Zimbabwe dollars in order to “pay” for a large fiscal shortfall. 

In a recent IMF paper on the Zimbabwe situation the author argues that the Reserve Bank of Zimbabwe’s (RBZ) inflation problems stem not from the usual monetary or fiscal laxness that has triggered other “hyperinflations,” but rather “quasi-fiscal” losses incurred by the central bank itself.  Still, the report concludes that these losses, which stem from some combination of credit subsidies, realized and unrealized exchange losses, and losses from open market operations, were nevertheless incurred to support government policies, and the failure to address these losses has interfered with the monetary management, independence, and credibility of the RBZ.

The immediate “solution” to the Zimbabwe inflation has been the imposition of price controls, an approach that has been attempted by governments ancient and modern, including our own.  I can think of no better source on this topic than economist Hugh Rockoff of RutgersZimbabwe’s controls are actually retroactive, in the sense that merchants have been asked to reduce prices to earlier levels.  Predictably, the problem seems to have gotten worse—now there are even fewer goods for the Zimbabwe dollar to chase.  When and where will the Zimbabweinflation end?  I certainly don’t know.  But I’ve got a pretty good idea how it will end, by a sharp curtailment of their currency expansion.  And that’s the Money and Banking lesson.  If a central bank wants to end inflation, either they better start producing goods, or stop producing money. 

And that, I would add, will be a hard row to hoe unless the fiscal house is put in order.

July 26, 2007 in Africa, Deficits, Exchange Rates and the Dollar, Federal Reserve and Monetary Policy, Inflation | Permalink


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July 24, 2007

Setting Gene Epstein Straight

Some of you may be aware -- though most of you probably not -- that the proprietor of macroblog finds himself in a period of transition.  As the first sign of stress is referring to one's self in third person, let me apologize retrospectively and in advance for a period of slow blogging.  Things will, I hope return to normal productivity soon, but for today I will turn to my friend and colleague Mike Bryan, writing at the Cleveland Fed website:

Last week, Federal Reserve Board Chairman Bernanke made his midyear appearance on Capitol Hill to testify about the economy and monetary policy. Among his duties at these semiannual events is the release of the economic projections, the most recent vintage of which can be found here.

Gene Epstein of Barron’s offered his perspective on the projections (available by subscription here). He argues that, in retrospect, Chairman Bernanke’s outlook for 2006 was fairly wide of the mark in all three of the major variables—real growth, the rate of unemployment, and core inflation... But these were fortuitous errors, says Mr. Epstein, because had the Chairman seen that growth was coming in at 3.1 percent rather than the 3.5 percent projected, he might have projected unemployment to be higher and inflation to be lower, weakening “his resolve to keep hiking the interest rate,” which would have been “ill-advised.”

Mike has some problems with that take on the situation:

First, the central tendency of the semiannual economic projections reported by Gene Epstein is not necessarily the Chairman’s personal view. All Reserve Bank presidents and Fed governors offer a projection, and where the Chairman’s view lies in that set of projections cannot be determined.

In other words, the semiannual economic projections are not the prognostications of an individual, but the wisdom of a crowd:

... one article of particular interest... [authored by the St. Louis Fed's Bill Gavin] is worth repeating here. Gavin demonstrates that the midpoint taken from the full range of policymakers opinions is a better predictor of future outcomes than the group’s central tendency (which is calculated by Federal Reserve Board staff by excluding projection outliers.) While Gavin didn’t speculate on why the midpoint of the full range of Federal Reserve forecasts is superior to the group’s central tendency, I will.

Economic forecasting is a hard business and no thoughtful forecaster enters the forecasting arena without a healthy skepticism about his or her ability to see the future—a future full of unknowns. And these unknowns—risks—can sometimes be revealed by the range of opinions coming from people who see and judge them differently. In the case of the 2006 outlook, the outcomes were within the full range of Federal Reserve officials opinions for unemployment and core inflation, and just marginally under the bottom end of the range of opinions for real GDP growth (3.1 percent vs. 3.25 percent).

Most importantly, thinking that policymakers slavishly base their decisions on the point estimates derived from a forecasting exercise is -- well, wrong thinking:

Perhaps the real usefulness of economic forecasts is not their ability to see what will come next, but rather their ability to identify the risks that stand the best chance of causing the projection to go amiss. And these risks are also articulated in the Chairman’s testimony. In his February 2006 testimony, Chairman Bernanke described three such risks in the 2006 outlook. First, there was a potential for slower real growth due to problems associated with housing; second, high rates of resource utilization could add to inflation pressure; and third, “[a]dditional steep increases in the price of energy [c]ould intensify cost pressures and weigh on economic activity.”

Well, we can quibble over the accuracy of last year’s economic projections, but it’s hard to find fault with the assessment of the risks we faced.


July 24, 2007 in Federal Reserve and Monetary Policy | Permalink


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CONGRATS, DAVE A. I wish you the very best in your new & challenging position.

Posted by: bailey | July 25, 2007 at 09:41 AM

"Economic forecasting is a hard business and no thoughtful forecaster enters the forecasting arena without a healthy skepticism about his or her ability to see the future—a future full of unknowns."

I would rephrase that sentence using “fortune-teller” instead of forecaster. Then it would sound well – “no thoughtful fortune-teller …”. When a forecaster uses quantitative tools s/he should be aware of the limits of prediction. For example, AR, ARMA, ARIMA … or even random walk allow estimating quantitatively future distribution of probability of a given variable.

There is a difference between forecasting models using AR properties and the model linking two macro variables measured in independent procedures. This independency of measurements provides strong evidence in favor of the possibility to predict inflation accurately at various time horizons. Some examples for the inflation prediction:
The USA – http://inflationusa.blogspot.com/2007/07/forecasting-inflation-post-5-of-6.html

Japan - http://inflationusa.blogspot.com/2007/07/will-us-repeat-japanese-history-of.html

The UK - http://inflationusa.blogspot.com/2007/07/cpi-in-uk.html

France - http://ideas.repec.org/p/pra/mprapa/2736.html

Austria - http://papers.ssrn.com/abstract=927364

These cases provide quantitative estimation of RMSFE at various time horizons and demonstrate that one can predict inflation with the accuracy dictated by the estimates of labor force level.

Posted by: Ivan Kitov | July 25, 2007 at 02:46 PM

Congrats Dave and all the best during the transition!

Posted by: Lindsay | July 27, 2007 at 07:44 AM

I'm new here, just wanted to say hello and introduce myself.

Posted by: atteneamyViah | August 16, 2008 at 03:09 PM

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July 18, 2007

Better, Not Best

In and of itself, the report on consumer price inflation in June wasn't bad.  From the Cleveland Fed:

According to the Federal Reserve Bank of Cleveland, the median Consumer Price Index rose 0.2% (2.5% annualized rate) in June. The 16% trimmed-mean Consumer Price Index rose 0.2% (2.1% annualized rate) during the month.  The median CPI and 16% trimmed-mean CPI are measures of core inflation calculated by the Federal Reserve Bank of Cleveland based on data released in the Bureau of Labor Statistics' (BLS) monthly CPI report.

Earlier today, the BLS reported that the seasonally adjusted CPI for all urban consumers rose 0.2% (2.3% annualized rate) in June.  The CPI less food and energy rose 0.2% (2.8% annualized rate) on a seasonally adjusted basis.

Except for the CPI less food and energy -- a measure of core inflation that I would invite you to jettison in favor of the trimmed-mean -- developments on the inflation front appear to be improving:




So what, then, explains this sort of headline?

Inflation Still a Top Concern for Bernanke

Consumer Price Growth Slows in June

The Chairman explains:

Although the most recent readings on core inflation have been favorable, month-to-month movements in inflation are subject to considerable noise, and some of the recent improvement could also be the result of transitory influences...

It's pretty easy to see what Chairman Bernanke is talking about...




... and lest it isn't obvious, the Chairman's testimony highlights the concern:

Moreover, if inflation were to move higher for an extended period and that increase became embedded in longer-term inflation expectations, the re-establishment of price stability would become more difficult and costly to achieve.  With the level of resource utilization relatively high and with a sustained moderation in inflation pressures yet to be convincingly demonstrated, the FOMC has consistently stated that upside risks to inflation are its predominant policy concern.

  "Yet to be convincingly demonstrated" seems about right:




Commenting for the Wall Street Journal's Real Time Economics blog, Bank of America's Peter Kretzmer put it this way:

Bernanke, in his wording, clearly indicated that the FOMC is eyeing headline as well as core inflation. While longer term empirical research still favors the notion that current core inflation is a better predictor of future headline inflation than current headline inflation, supplying the rationale for emphasizing core inflation in monetary policymaking, a decade in which headline inflation has persistently exceeded core inflation as oil prices have generally moved only upward has the FOMC (and others) thinking about the issue… We can expect to hear more on this issue in coming months, from a number of Fed members including Bernanke.

Isn't that how it ought to be?

July 18, 2007 in Data Releases, Inflation | Permalink


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» July 18, 2007 from PrefBlog
Both Treasuries and Canadas edged up today, as Canadian inflation wasnt as bad as feared and US inflation didnt scare anybody. Not Bernanke and not macroblog, anyway! JPMorgan noted that junk is getting harder to sell and Freddy Mac agree... [Read More]

Tracked on Jul 18, 2007 11:53:52 PM

» Core Inflation: What Is It Good For? from Businomics Blog
Lots of discussion now about whether the Federal Reserve should be looking at core inflation. Core, in the typical definition, is total inflation excluding food and energy prices. On the surface, this seems silly: food and energy are significant parts [Read More]

Tracked on Jul 21, 2007 2:36:06 PM


There are some indications ( http://inflationusa.blogspot.com/2007/07/what-is-difference-between-cpi-and-core.html ) that the headline CPI has reached its maximum in the middle 2007. The core CPI lags by 16 months behind the CPI and still has some potential to grow by a fraction of pp in the next months.
In the long run, the CPI and core CPI (indices not inflation) are linked by a simple linear relation. So, there is no need to distinguish between them in formulating monetary policy.

Posted by: Ivan Kitov | July 19, 2007 at 08:58 AM

It looks to me like the Fed thinks it has created sufficient economic weakness for inflation expectations and wage gains to have peaked. But just barely. If the economic rebound turns out to be stronger than the Fed expects these gains in the fight against inflation expectations could easily be lost
and the Fed would have to start tightening again.

Posted by: spencer | July 19, 2007 at 09:43 AM

IF we can forget about prospects for inflation for just one moment I have a question.

Is it the FED's responsibility to see GDP KEEPS growing EVEN though much of the recent growth we've seen has NOT been supportable by economic fundamentals?

Robert Rodriguez of First Pacific Advisors, LLC, reminds us:
"Since 1965, the median dollar volume of single-family homes sales as a percentage of nominal GDP has averaged 8.4% versus 16.3% at the 2005 peak."
"Between 1998 and 2006, with the major changes occurring in the last two or three years: ARM % of originations rose from 0.7% to 69.5% Negative Amortization rose from 0% to 42.2% Interest Only rose from 0.1% to 35.6% Silent Seconds rose from 0.1% to 38.7% Low Documentation rose from 57% to 79.8%"

I'd add that fewer than 1/4 of Bubble states' homeowners (representing >=40% of our homes) could buy the homes they're living in at these price levels. Doesn't that call for a serious reversion to historical mean price growth trend?

Why aren't Economists questioning the wisdom of the FED "defending" against this much needed correction? When did it become the FED's responsibility to see we never again have to endure the horrors of two successive quarters of negative GDP growth?

Posted by: bailey | July 20, 2007 at 07:20 PM

What is a "16% trimmed-mean" CPI? Is this another way of taking out all the unwanted numbers so that your stats look better, like the so-called "core"? Do you people actually eat? but then again, if I earned what you do, I wouldn't care about food prices, either.

Posted by: alan | July 24, 2007 at 04:30 AM

EVERYONE knows inflation is a generational concern & holds NO monthly significance. Short term gyrations make ALL microeconomic attempts to predict the future irrelevent to all but tactical market players. So, why does the FED continue to argue WHICH microeconomic tool offers the most promise for "predicting" inflation?

How can anyone seriously discuss inflation without first agreeing upon a measurable definition that's supportable by a representative population sampling?

Dave A. was right 100% right on the mark when he brought up the issue of FED credibility. It's by far the single most important issue for BB and this FED to consider. Will BB's FED servilely continue to backfill minutia in defense of AG's societally altering agenda? Or, will it strive to find & set its own course to address the enormous economic challenges our country faces. Obviously, I'd prefer a path stressing the importance of the checks & balances so revered by our country's founders.

Posted by: bailey | July 24, 2007 at 12:00 PM

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July 17, 2007

US Assets: Still Looking Tasty

It appears that the appetite for dollar-denominated assets is not sated quite yet.  From Bloomberg:

International buying of U.S. financial assets unexpectedly climbed to a record in May as investors snapped up American stocks and corporate bonds.

Total holdings of equities, notes and bonds climbed a net $126.1 billion, from $80.3 billion the previous month, the Treasury said today in Washington...

Brad Setser does his usual fine job with the details: 

Demand for US equities and corporate bonds was particularly strong, which does suggest the persistence of private demand for US assets abroad.  Private investors tend to buy corporate bonds and equities; central banks tend to buy Treasuries and Agencies -- though that is changing.

What causes me trouble is the split between private and official purchases, and specifically the absence of any official inflows in the May TIC data.

In case you need visual confirmation:





Brad isn't buying it:

I have a hard time believing that. May was a record month for official reserve growth. China, Russia and Brazil all added to their reserves like crazy.   Those three together combined to add close to $100b to their reserves – and a host of other countries were adding to their reserves too. That money has to go somewhere...

... the Fed’s custodial data doesn’t show a comparable fall off in official demand in May (June is another story).   

The Treasury helpfully explains why the custodial data may differ from its own data:

    1. Differences in coverage: The most important reason for differences between holdings reported in the TIC and the FRBNY custody accounts is a difference in coverage. First, not all foreign official holdings of Treasury securities as reported by the TIC system are held at FRBNY. In particular, Treasury securities held by private custodians on the behalf of foreign official institutions are included in the TIC but not in the FRBNY figures. In this sense, the coverage of the TIC system is broader than that of the FRBNY custody holdings. Second, the custody holdings at FRBNY include securities held for some international organizations as well as for foreign official institutions. In this sense, the coverage of the FRBNY custody holdings is broader than the foreign official designation in the TIC system.

That description suggests advantage Treasury to me, but Brad offers other reasons for distrusting the official (that is, government) flows reported in the TIC data, and sticks to his guns on the belief that central bank diversification continues on.  I won't -- can't really -- argue.  But at the very least the latest report does little to vanquish the sense that global asset demand retains a strong attraction to the USA.

July 17, 2007 in Capital Markets, Trade | Permalink


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Congratulations David. I heard about your wonderful job as research director at the Atlanta FRB. I hope you will be able to continue to share your insights with us. Welcome down here to Atlanta.

Posted by: me | July 17, 2007 at 09:37 PM

Congrats. Hope you continue to blog. If not; thanks for the balanced insights.

Posted by: dd | July 17, 2007 at 09:57 PM

congrats Professor Altig. Stay away from the biscuits and gravy!

Posted by: jeff | July 17, 2007 at 11:17 PM

Dr. Altig -- I am behind the times, so I didn't realize congrats were in order until reading the comments. let me join the chorus.

With respect to the differences between the TIC data (the treasury also does the survey, so there are really two treasury data sources)and the FRBNY data, i would note the fourth reason for the discrepancy noted on the treasury web page:

"A fourth source of discrepancy arises because the TIC system of monthly net purchases or sales of long-term securities is specifically designed to capture only U.S. cross-border transactions. If a foreign official institution acquires a Treasury security from a private foreign entity on a foreign securities exchange and then has the security held in custody at FRBNY, reported custody holdings will increase. However, there will not be a corresponding TIC-reported foreign official purchase because this is not a U.S. cross-border transaction: it is a foreign-to-foreign transaction."

given that the survey data has consistently revised the TIC data on foreign purchases up -- and given that official reserve growth easily exceeded $100b in may, i would have to give the advantage to FRBNY here. Note that in the tic data showing foreign holdings of treasuries, there is a very consistent pattern -- the series is revised, and chinese holdings of treasuries go up (russian and chinese holdings of agencies also go up, but it isn't as visible) and the UK's holdings go down.

the uk's holdings then build up (in the tIC data) over the course of the year and then get revised down after the survey ...

that seems to me to be a pattern very consistent with 4) in the treasury explanation.

incidentally, i suspect foreign demand for US corp bonds -- a category that includes "private" mbs -- fell dramatically in june, which is why the $'s may rally didn't last.

Posted by: bsetser | July 18, 2007 at 12:00 AM

I wanted to also say congratulations. I read about the promotion yesterday and I do also hope you continue to blog.

Posted by: Nathan | July 18, 2007 at 11:58 AM

are not the foriegners considered dumb money?

Posted by: dh | July 21, 2007 at 03:47 PM

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July 16, 2007

China Skeptic

When it comes to Chinese economic growth, this is the type of story to which we have become accustomed...

Goldman Sachs said it is forecasting second quarter GDP growth for China of 11 pct year-on-year, overcoming the high base from a year earlier, with CPI growth of 4 pct for June.

... and this is the type of picture we have come to expect:




That sort of data is impressive -- even scary -- but Jeremy Haft, writing in today's Wall Street Journal (page A12 in the print edition), suggests there may be less to those pictures than meets the eye:

If you visited a typical Chinese factory, you'd see why. It lacks capital, technology and know-how. Its workers place obedience over quality. And it sits along an endless chain of middlemen.

On average, it takes China 17 separate parties to produce a product that would take us three. Unlike Japan in the 1980s, little companies drive China's economic growth, not big ones. China's industries are composed of hundreds of thousands of tiny factories and farms -- plus traders, brokers, haulers and agents, all of whom take control of the goods and materials but add little value to the product. With every additional player in the chain, the cost, risk and time grow. Effective quality control in this environment is difficult.

So is effective cost control. Despite cheap labor, making goods in China is often more expensive than in the U.S. Far from being a bottomless ATM of cheap consumer goods, China is a risky, costly and time-consuming place to do business.

Yet polls show a majority of Americans believe China has mastered basic manufacturing -- and it's now barreling into our high-tech backyard. That's false. As the product recalls demonstrate, China can barely make low-value goods reliably, much less higher-value ones. The problems are structural, not the result of a few bad apples.

To that last point, consider this not-long-ago assessment from the OECD:

China’s staggering economic growth rate has stood at almost 10% for the last 20 years. One cause is strong exports underpinned by low production costs. Information and communication technology now claim the lion’s share of China’s export trade, accounting for approximately 30% of its exports in 2005. The year before, China ranked as the largest exporter of IT products, outstripping the EU, Japan and the US. Since 1996, China’s IT goods trade has been growing at almost 32% a year...

That certainly sounds like some "barreling into our high-tech backyard," but the underlying reality is complicated:

Some 55% of China’s total exports are attributed to production and assembly-related activities, and 58% of these are driven by foreign enterprises, of which 38% are entirely foreign-owned. In fact, among the top 10 high-technology companies by revenue, not one of them is Chinese...

Although regarded as the world’s largest potential IT market, China has not reaped the full benefit of its large-scale IT output, particularly in terms of productivity. Apart from mobile phones, the vast majority of Chinese do not yet use IT. In general, IT spending is lower in China (about 4.5% of GDP in 2005) than in leading OECD countries (about 9% of GDP in 2005).

One paradox is that while low IT costs brought about by China’s competitive supply has helped OECD-based firms upgrade, reorganise and boost productivity, the actual uptake of IT within Chinese firms is lagging behind too. Notions like supply-chain management, resource planning or knowledge management software that are standard currency in dynamic OECD firms are still rather undeveloped in China.

All of which leads Mr. Haft to suggest that the Chinese century may take awhile to develop:

To compete head-to-head with the American economy, China will have to revolutionize the very way its industries are organized. It must shake out the thousands of low-value middlemen and integrate the tiny factories into larger, more competitive companies. It must train a workforce in modern technology and business practices. And, it must instill transparency and a uniform rule of law. Such an effort could span generations.


July 16, 2007 in Asia, Economic Growth and Development | Permalink


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» China's product quality from Trade Diversion
Via David Altig, a WSJ piece that's skeptical of China's ability to ascend the product quality ladder: China's industries are composed of hundreds of thousands of tiny factories and farms -- plus traders, brokers, haulers and agents, all of whom take c... [Read More]

Tracked on Jul 18, 2007 5:26:46 PM

» China's Economic Growth: Grounds for Skepticism? from Businomics Blog
China's economic growth topped 11 percent in the first quarter, which is pretty darn fast. For comparison, we think that long-run U.S. growth is about 3 percent. (Both figures are inflation adjusted.) There are skeptics. Macroblog has a good commentary [Read More]

Tracked on Jul 21, 2007 2:53:10 PM


Personally, I was in China for a couple of years and I should say that the ideas in this article are very applying..

Posted by: Marius | July 17, 2007 at 04:07 AM

Per capita GDP in developed countries is characterized by fluctuations (normally distributed) around constant annual increment, as presented in my paper

Real GDP per capita in developed countries http://ideas.repec.org/p/pra/mprapa/2738.html .

Therefore, the growth rate is not a good representation of economic growth. The same annual increment in GDP per capita means very fast growth for relatively poor countries, as China, and for rich countries - slow growth. In past, developed counties had the same rapid growth, which corresponded to low GDP per capita.
Thus, economic trend for growth rate is proportional to the reciprocal value of the attained level of GDP per capita.

For the sake of consistency, the curves presented in your post have to be multiplied by the attained level of real GDP per capita. Then you can compare economic performance of poor and rich countries. I did it already and found that China and Russia are not so much impressive in annual increments as in growth rates - they are just catching up. There is no way for them, however, to really join the club of rich countries, the absolute gap, as expressed by per capita GDP, is not decreasing. The situation is similar for new members of the EU. Unfortunately for them, they are lagging further and further I term of absolute GDP per capita.

Posted by: Ivan Kitov | July 17, 2007 at 06:17 AM

Here is the link to the figure showing annual increment of real GDP per capita as the function of the attained level of real GDP per capita in China, Russia, and India compared to that in France.


Posted by: Ivan Kitov | July 17, 2007 at 08:11 AM

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July 11, 2007

Core Blind?

Barry Ritholtz is unimpressed by Chairman Bernanke's latest speech:

Peter E. Kretzmer, senior economist for Bank of America, explains (more or less) what the Fed means  by relating "inflation expectations" to the ability of the Fed to impact price rises (i.e., stability):

“This Fed much more so than prior Feds puts a very heavy emphasis on the role of inflationary expectations,” he said. “They believe, and research shows, that inflation expectations and the Fed’s inflation-fighting credibility has a large impact on private sector wage- and price-setting behavior.”

In other words, the Fed's emphasis on Core inflation -- jawboning, PR, propaganda, whatever -- is every bit as important to future prices as the actual underlying causes (excessive monetary creation, demand exceeding commodity supplies) of inflation.

I am not sure I buy that. Surely, psychology is important, and the collective expectations of either higher or lower prices can impact subsequent price behavior. 

But this approach puts the Fed into the role of a low price cheerleader, and runs the dangerous risk of well, artificially emphasizing the irrelevant core rate of inflation rather than dealing with reality of the actual price increases as experienced by consumers.

That representation is not really wrong, but (as I have said here before) it rather stubbornly misses the point of the FOMC's intent in focusing attention on core inflation measures.  The Chairman, in an earlier speech:

A commonly used analogy takes the U.S. economy to be an automobile, the FOMC to be the driver, and monetary policy actions to be taps on the accelerator or brake. According to this analogy, when the economy is running too slowly (say, unemployment is high and growth is below its potential rate), the FOMC increases pressure on the accelerator by lowering its target for the federal funds rate, thereby stimulating aggregate spending and economic activity. When the economy is running too quickly (say, inflation appears likely to rise), the FOMC switches to the brake by raising its funds rate target, thereby depressing spending and cooling the economy. What could be simpler than that?...

[One] problem with the automobile analogy arises from the central role of private-sector expectations in determining the impact of monetary policy actions. If the automobile analogy were valid, then the current setting of the federal funds rate would summarize the degree of monetary stimulus being applied to the economy, just as the pressure a driver exerts on the accelerator at any particular moment determines whether the automobile speeds up or slows down. However, in fact, the current level of the federal funds rate is at best a partial indicator of the degree of monetary ease or restraint.

Barry seems to prefer what Ben described as a "simple feedback rule"...

... Under a simple feedback policy, the central bank's policy instrument--the federal funds rate in the United States--is closely linked to the behavior of a relatively small number of macroeconomic variables, variables that either are directly observable (such as employment or inflation) or can be estimated from current information (such as the economy's full-employment level of output)...

A classic example of a simple feedback policy is the famous Taylor rule... In its most basic version the Taylor rule is an equation that relates the current setting of the federal funds rate to two variables: the level of the output gap (the deviation of output from its full-employment level) and the difference between the inflation rate and the policy committee's preferred inflation rate. Like most feedback policies, the Taylor rule instructs policymakers to "lean against the wind"; for example, when output is above its potential or inflation is above the target, the Taylor rule implies that the federal funds rate should be set above its average level, which (all else being equal) should slow the economy and bring output or inflation back toward the desired range...

... but the Chairman emphasized that there is another way:

The second general approach to making monetary policy is what I am today calling a forecast-based policy... As the name suggests, under a forecast-based policy regime, policymakers must predict how the economy is likely to respond in the medium term--say, over the next six to eight quarters--to alternative plans for monetary policy....

Taking both their baseline forecast and the various risks to that forecast into account, policymakers then choose the plan that seems most likely to produce the best results overall. Their current choice of interest rate corresponds to the first step in implementing the preferred plan. This process is to be repeated at each meeting, with the policy plan being modified as necessary in response to new information or new knowledge about the economy.

The role of inflation forecasting was a prominent feature of BB's speech yesterday, and it is precisely in a forecast-based policy framework that the rationale for core inflation takes root.  From today's Real Time Economics blog:

The Federal Reserve’s focus on core inflation has renewed attention to alternative measures that aim to separate the underlying inflation trend from month-to-month volatility, and some such measures are suggesting higher prices ahead.

Both the Cleveland Fed and the Dallas Fed produce “trimmed mean” price indexes that generally exclude the most volatile categories in a given month. The presidents of both banks have expressed concern that core inflation may not adequately capture current inflation risks.

Michael Bryan, an economist at the Cleveland Fed, says the bank’s trimmed mean consumer price index does a better job in the short term at predicting future overall inflation than core inflation does. “It’s really reducing the noise and improving the signal,” Bryan said. “There’s almost no signal in the overall month-to-month CPI.”

In his comments yesterday the Chairman made it perfectly clear that the general idea is to get a bead on the inflation trend:

The forecasting procedures used depend importantly on the forecast horizon. For near-term inflation forecasting--say, for the current quarter and the next--the staff relies most heavily on a disaggregated, bottom-up approach that focuses on estimating and forecasting price behavior for the various categories of goods and services that make up the aggregate price index in question. For example, we know from historical experience that the prices of some types of goods and services tend to be quite volatile, including not only (as is well known) the prices of energy and some types of food but also some "core" prices such as airfares, apparel prices, and hotel rates... Conceptually, one might think of this effort to distinguish transitory from persistent price changes as a more nuanced way of estimating the underlying inflation trend, analogous to the trend measures provided by more mechanical indicators such as trimmed-mean or weighted-median inflation rates.

An accurate forecast of very near-term inflation is important not only for its own sake but also because it provides a better "jumping-off point" for the longer-term forecast. Because inflation continues to exhibit some inertia, improved near-term forecasts translate into more-accurate longer-term projections as well.

Barry is not swayed...

... all of the prior chatter about removing volatile food energy prices due to their erratic price behavior was quite simply [bovine excrement]. Based on yesterday's Bernanke speech, we learn that the emphasis on the Core rate of inflation is about influencing psychology and sentiment -- not smoothing out volatile data.

... but I think that Mr. Bernanke's words speak for themselves.

July 11, 2007 in Federal Reserve and Monetary Policy | Permalink


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Tracked on Jul 19, 2007 2:47:39 PM


Barry finds a cloud in every silver lining , his comments are a bit too boring and conspiratorial...... spare me the tin-hat crowd drivel

Posted by: Bernanke | July 11, 2007 at 08:10 PM

I would be scared if inflation could be dependent on the behavior and imagination of central banks. Presumably, there would be so many people who could make a big profit playing against the Fed as the only anchor of the future inflation. A number of economic agents would always try to rape the outer frontier of inflation expectation and accelerate it, at least temporarily, to get all trophies belonging to winners - higher cash flow from higher prices.
Fortunately, true driving force behind inflation is different from "inflation expectations" and the overnight borrowing rate. The change in labor force level explains 95% of the observed inflation variability since 1960 (i.e. where more or less accurate data are available) and provides a RMSFE=0.8% at a two-year horizon.


Posted by: Ivan Kitov | July 12, 2007 at 04:28 AM

In his speech Bernanke cited a number of "expectations" metrics he looks at: the Michigan Survey, ISM prices paid and the TIPS spread.

The speech was telling in what he left out: commodity prices.

It appears the Chairman believes changes in commodity prices result from "one-time" supply or demand shifts. But they can also result from changes in inflation expectations that change the demnd function.

Is it purely a coincidence that commodity price took off during the Fed's experiment with 1% Fed Funds rates?

Or could it be that the emerging markets countries are swimming in excess dollars, which they (wisely) convert in greater numbers into hard goods.

The fact that the Chairman left out commodity price increases on his list of expectations speaks volumes.

Posted by: David Pearson | July 12, 2007 at 09:25 AM

I don't know how to communicate this any clearer than this: Prices are rising, and have been for quite some time. Food. Energy. Education. Housing. Medical Care.

The Fed has recognized this -- but they were painted into a tough spot by Easy Al. As a prior poster noted, ever since the Greenspan Fed cut rates to 1%, all dollar denominated assets -- oil, grainm, gold, real estate, etc -- have skyrocketed.

The Fed can't (and shouldn't) say "Inflation is out of hand, and there's not much we can do about it."

Similarly, they cant say "We are concerned about a consumer led slow down leading us to a recession."

So we started with a lot of denial about inflation, which morphed into a focus ont he core rate, and now we here about inflation coming in as the economy decelerates.

There's no conspiracy here -- and hardly a dark cloud. I am trying to acknowledge what the reality is beneath the misleading data headlines, and without the typical cheerleading that is so common in the MSM / biz press . . .

Posted by: Barry Ritholtz | July 13, 2007 at 08:38 PM

David Pearson re: Commodities...

Bernanke did in fact mention commodities (futures):

For forecasting horizons beyond a quarter or two, detailed analyses of individual price components become less useful, and thus the staff's emphasis shifts to inflation's fundamental determinants. Food and energy inflation are forecasted separately from the core, using information from futures prices and other sources. However, forecasts of core inflation must take into account the extent to which food and energy costs are passed through to other prices.

"Futures" is a clear reference to commodities, although there are in fact direct, private business contracts for commodities that do not funnel through the futures markets. In fact, some business contracts merely make reference to futures contract prices without passing the transactions through the futures markets, so futures prices can be misleading since they only reflect a subset of actual supply and actual demand.

The two big problems with using commodities (futures) prices as an inflation indicator are: 1) the difficulty of disaggregating the demand in commodities as an investment asset (especially when you are in the middle of a speculative commodities bubble as we are now) from the real demand for actual consumption and 2) the degree of uncertainty of passthrough since businesses frequently have opportunities for reducing demand via substitution and product design changes or recouping rising commodity costs by cost-cutting in other areas, especially as you go further out on the forecast horizon.

At least some people take it as an article of faith that over time commodities prices are a dwindling factor in overall prices.

-- Jack Krupansky

Posted by: Jack Krupansky | July 15, 2007 at 01:08 PM

Oops... I mangled that comment by putting the quote in angle brackets. Here's Bernanke's statement from his remarks to the NBER Summer Institute:

"For forecasting horizons beyond a quarter or two, detailed analyses of individual price components become less useful, and thus the staff's emphasis shifts to inflation's fundamental determinants. Food and energy inflation are forecasted separately from the core, using information from futures prices and other sources. However, forecasts of core inflation must take into account the extent to which food and energy costs are passed through to other prices."

He is clearly stating that futures (commodities) prices are used by the Fed to forecast food and energy inflation beyond the very short term.

-- Jack Krupansky

Posted by: Jack Krupansky | July 15, 2007 at 01:12 PM

What's the relevance of having a core vs. headline debate when the FED is not willing to support its "findings" with real data supported by representative population samplings?

Is there an Economist alive (who's not carrying an axe) who believes continuing profligate credit policies at this stage of the game will better position us to deal with the problem we've created?

Are any Economists questioning the wisdom of directing efforts to "growing" our economy out of our ills rather than addressing the fallout from our profligate lending practices now? (How much of our growth has been financed based?)

If you're reading, BB, how are FED policies encouraging BANKS to becken me to borrow even more (three credit card offers this week alone offering 0% interest for 12 month for loans, purchases & balance transfers) helping to meet your stated goal of balancing savings and spending.
Why, ten months after the FED advised against funny mtg. loans, are So. Californians besieged with no fewer than three infomercials daily informing us we can refinance our mtgs. cheaply even if we have low or poor credit? And, why have only 35 states signed on to the csbs-aarmr guidelines of last Nov.?

PLEASE, let's stop the pseudo debates. It should be clear to all since Glass-Steagall's repeal the FED & Treasury are now following the same drummer. (Hasn't anyone noticed what the stock market's done since Paulson came aboard?) The best any outsider can do is to ask the FED to define its terms - simply and clearly, and to support its contentions using real data from representative population surveys.

Posted by: bailey | July 16, 2007 at 08:12 PM

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July 06, 2007

That's Odd

If you were looking for signs of stagnation in second quarter growth, you (once again) failed to get it in the latest employment report:




So where are the skeletons in last month's labor closet?  Most commentators pointed to the failure of construction employment to behave like it should in a good sector in distress.  As Calculated Risk says:

The expected reported job losses in residential construction employment still haven't happened, and any spillover to retail isn't apparent yet. With housing starts off over 30%, it's a puzzle why residential construction employment is only off about 4%.

Macro Man agrees...

While the headline payroll report was as close to consensus as you'll ever see, sure enough there were some revisions that suggested a stronger US labour market that previously thought. Quelle surprise! Perversely, construction payrolls showed another modest 12k gain.

... as does King at SCSU Scholars...

The hard part to figure is how residential construction employment can do so well when all we ever hear is how housing is being hit hard (I've said it myself.)

... who highlights this comment from Real Time Economics (aka The Wall Street Journal econ blog):

The persistent weakness in nonresidential construction payrolls has been every bit as puzzling as the absence of large cuts in the residential sector, though it has not gotten much (any?) fanfare. We continue to believe that the reporting is imperfect and that some housing job losses are showing up in nonresidential while some nonresidential hiring is showing up in residential. –Stephen Stanley, RBS Greenwich Capital

The Journal blog entry also includes a warning about getting too comfortable with recent employment gains:

The behavior of residential construction payrolls remains one of the ongoing mysteries of the monthly employment data, as they are so far out of touch with the behavior of housing construction and home sales that they hardly seem credible… We think an even larger story looming off in the distance will be the annual benchmark revisions to be released in January… It is likely that the annual benchmark revisions will reveal that job growth has been slower than suggested by the monthly reports. –Mission Residential Research

Does such a revision seem plausible?  Well, sure.  The good folks responsible for the ADP National Employment Report claim...

There is a very powerful statistical tendency for estimates of growth of establishment employment, as reported by the BLS after annual benchmarking, to be revised in the direction of estimates previously published in the ADP National Employment Report.

... and year-over-year ADP employment growth has been running below the corresponding BLS payroll rate:




And if we take Jim Hamilton's advice and average the payroll data with the information gleaned from the BLS' household survey, the picture would look just a little less rosy than it does with the payroll data alone:




Tom Blumer at BizzyBlog concludes:

June's number was decent.  When combined with pretty significant revisions and no change in the overall unemployment rate, you have the picture of an employment market growing nicely but not spectacularly.

That's a fairly modest assessment, but if you are still a skeptic I guess you are not without ammunition.

Elsewhere: Dean Baker notes that the decent employment growth may not bode well for productivity growth. pgl is unimpressed with reported wage gains.  Max Sawicky wants you to stop looking at the unemployment rate.

July 6, 2007 in Data Releases, Labor Markets | Permalink


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I with Max. The employment to population ratio has fallen in the past 6 months but that pesky old participation rate fell too. Mark Thoma has more on this theme. As far as being unimpressed with real wage growth, check out the silliness from Kudlow as well as that USNews fellow (my 3rd and 4th updates).

Posted by: pgl | July 06, 2007 at 06:43 PM


Doesn't it surprise you a little at how the numbers are "squared"?

As you say, the modestly positive employment gains might show up in lower productivity numbers for the quarter.

Except last quarter, hours worked fell in the productivity report, and -- presto! -- it was better than expected.

Will hours worked fall again? What might explain the discrepancy between rising employment and falling hours worked?

Posted by: david pearson | July 07, 2007 at 08:50 AM

I'd like to extend Max Sawicky's suggestion. Let's stop looking at ALL the monthly data and instead work some simple math on easily verified stats, and think about the dilemma we face.
Let's assume the median CA house sold for $200k in '97 and median CA household income was about $40k. A buyer qualifying for a 100% fixed-rate 30 yr. mtg. at about 8% would have allocated 1/3 of his income to his mortgage.
Now let's assume CA home prices have tripled since '97, median family income has risen to $57k & a 100% fixed 30 yr. mtg. can be had for 6% (I'm being pretty generous on all assumptions). It would now take a buyer devoting 1/2 of his income to his mtg. more than 45 years to own the house.
Is this a problem? Well, in addition to those who continue to greatly extend themselves to buy homes in CA today using using funny money loans, way too many have refinanced to take out cash to subsidize their existences.
Unless my "logic" is seriously flawed I suggest we hold any applause until six months after the easy credit, free money days come to an end. In CA, that clock hasn't even started yet.

Posted by: bailey | July 07, 2007 at 11:50 AM

Northern Trust was more critical about the rise in residential construction numbers given the starts and wondered/suspected the birth/death model...me too.

I'd like to extend bailey's extended look of Max's extension: how many illegals does it take to blunt the econometric pencil?
WSJ, not always a flawless windbag for economic opinion, (but a voice for those who have piles) came out with an IRS stat that 11M tax deductions were made on unique (give me a break) individual paychecks that were not American residents...and so the reported 12M "illegal aliens" is like a slap on the back for catching 92% of them...see?
It's not enough that 8% of the work force is undocumented...the economist's pencil is diamond, not lead, and stops at nothing...right off the page, up the other arm and into the ear...short circuiting something, I make it, you?

Posted by: calmo | July 08, 2007 at 12:41 AM

Of those 12,000 construction jobs created last month, 26,000 came from the BLS Birth/Death model. B/D model may be overestimating the job creation at the beginning of downturns (and underestimating it at the upturns).

Posted by: Anon | July 09, 2007 at 09:18 AM


Ever read a paper about "Superstar Cities"? Its by J. Gyourko, C. Mayer and T. Sinai.

Here's the link:


I think it will add a bit more to your thinking. I have always been intrigued by how prices were so expensive in CA. I don't think their paper is a complete answer, but is part of the answer.

Posted by: Nathan | July 09, 2007 at 12:23 PM

Nathan. THX,I printed it (duplex)& it's in the queue. I'll let you know.

Posted by: bailey | July 09, 2007 at 03:13 PM

I think that on the surface, Bailey is correct. However, in 1997, what percentage of people owned more than one home? In 2007?

I also wonder about foreign home ownership in the US in 97 vs 07.

Both percentages has probably jumped exponentially.
Just a gut read, not backed up with numbers.

For sure, there are significant problems in the mortgage market. But I suspect that they are confined. The market for risk, and the ability to spread it around has changed substantially since 1997.

Posted by: jeff | July 09, 2007 at 03:51 PM

Here's another piece alluding to the harsh Economic reality one Bubble State will face when the utter & shameless immoral lending practices do end:


Posted by: bailey | July 10, 2007 at 03:34 PM

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July 05, 2007

Roubini On The Symmetry Of Exchange Rate Misalignment

This post is a bit geeky, but I've been mulling over some comments Nouriel Roubini offered a few days back in an email to RGE Monitor subscribers:

Today we look at how Asian Financial Crisis changed Asia and the world...

Policy makers throughout Asia clearly are determined not to return to the IMF.  In Stephen Jen's words the Asian Financial Crisis taught Asian central banks to never be caught without enough foreign exchange reserves...

Asia's crisis generated an international consensus that emerging economies need to hold sufficient reserves to cover their short-term debt.  No comparable consensus emerged, though, over the right exchange rate regime.   The G-7 and the IMF argued that Asia's crisis showed the risks of currency pegs, at least those currency pegs not backed up by an institutional commitment like a currency board.   But it isn't clear that Asian policy makers drew the same lesson many seem to have concluded the real problem was not pegs, but an over-valued currency.

In a simple cut at the issue, there is a distinction between pegging an exchange rate below its freely-floating value -- the case of an under-valued currency -- and pegging the exchange rate above its freely-floating value -- the case of an over-valued currency.  In the case of an over-valued currency, the central bank has to trade from its holdings of foreign currency reserves to "soak up" the excess supply of its own currency.  The ability to do this is obviously limited by its reserves, which can become seriously depleted in the event of a persistent misalignment between the pegged value and where the market would take the exchange rate in the absence of the peg.  And if market participants get a sniff of the possibility that the government lacks sufficient reserves to support the peg, a speculative run is all but guaranteed.

The situation is a bit different when the currency is under-valued.  In this case a central bank would react to upward pressure on the exchange rate by expanding its own money supply to buy foreign currencies, thus eliminating the excess supply of those currencies.  Since there are no inherent resource restrictions in creating fiat money, there is no obvious limit to the government's ability to play the game.  Money supply expansion may eventually be inflationary, but that would itself tend to drive down the freely-floating value of the currency.  But therein, according to Nouriel, lies the problem:

... reserves are not an unmitigated blessing. Sterilizing the region's huge reserve growth poses growing difficulties.  In some countries - notably China - strong money and credit growth has fueled inflationary pressures, stock market bubbles and housing bubbles.  Nouriel Roubini argues that current Asian exchange rate and financial policies have left Asia vulnerable to new kinds of crises. See "Have Asia's Sterilization and Reserve Accumulation Policies Shielded It From Another Crisis Or Have Led To Increased Vulnerabilities?"

I confess that I have been used to thinking like the Asian policy makers in assuming that the impact of pegging an exchange at too low a level is more benign than pegging at too a high level.  Because inflation reduces the value of a currency relative to others, there is a sense in which the actions of a central bank attempting to damp currency appreciation are consistent with moving the exchange rate closer to the unfettered equilibrium value. 

The same argument, however, ought to hold for a currency that is over-valued.  When a central bank buys back its own currency with foreign reserves it is contracting the domestic money supply.  That in turn should reduce the domestic rate of inflation and result in a nominal appreciation, moving the exchange rate's fundamental value toward the peg.  If there are problems, then, they must arise because the necessary price adjustments are too slow when the pressure on the currency is persistent.

But if prices are slow to adjust, why not on the upside as well as the downside?  And though depleting reserves are no problem in the case of an under-valued exchange rate, the misallocation of resources associated with excessive monetary creation could be, which I believe is exactly Nouriel's point.  I'm still not sure that such misallocations have as sharp a destabilizing potential as running out of reserves and losing the capacity to intervene all together, but I'm convinced Nouriel's argument is worth thinking about.

July 5, 2007 in Exchange Rates and the Dollar | Permalink


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Dr. Altig -- I wouldn't assume that every RGE email is written by Nouriel himself. If the email comes directly from Dr. Roubini, it probably was. But a lot of different people contribute to the biweekly note. That particular passage was written by Christian Menegatti and myself, though in part we were summarizing an argument Dr. Roubini made.

Posted by: bsetser | July 07, 2007 at 08:55 PM

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July 03, 2007

The World According To Goldman Sachs (And Almost Everyone Else)

From my email, "A Tale of Two Tail Risks," from Goldman Sachs' Michael Vaknin:

  • Sub-prime mortgage woes still hold centre-stage as housing fundamentals deteriorate further.
  • A full-blown spillover from credit markets to other asset classes is unlikely as corporate sector and global macro fundamentals remain strong.
  • Rather, credit market will feature less leverage, more convents, elevated volatility and gradual supply absorption.
  • Upward risks to global inflation also remain high on the list of what investors worry about currently.
  • On our baseline case, prudent monetary policy should limit a build-up of inflationary pressures.

Some details:

From a fundamental standpoint, there are two conflicting forces to consider. First, the ongoing deterioration in the residential housing market will continue to weigh on the mortgage market. Recent housing market data point to further inventory accumulation, while price indicators suggest the deceleration in house prices has gained more traction recently. The Case-Shiller 10- and 20-city composite indexes have declined sharply in April (7?% on annualized basis). The resulting decline in housing equity, along with the recent widening of mortgage rates and tightening of contractual mortgage conditions are all likely to keep credit investors on high alert.

On the bright side, corporate fundamentals remain fairly robust. Corporate default fundamentals are in good health, and from a macro perspective, corporate earnings are still supported by broadly favourable global demand conditions. While measures of industrial activity (including our Global Leading Indicator) have been somewhat softer than expected recently, from a level perspective the global manufacturing cycle remains comparatively strong, and a more broad-based weakness in the data is needed to shift this perception. Today's US ISM and the upcoming US payroll data are highly important in this respect.

That ISM report was, of course, a good one, although today's news on pending home sales failed to break the string of lousy housing data and factory orders for May were primarily lauded for being less bad than expected.  But put it together and the consensus seems to be that it all adds up to the Goldman Sachs story.  That's what came through in yesterday's round-up of forecasts from the Wall Street Journal, and the story that we're sticking to appeared again today in Bloomberg's coverage of the housing sales and orders reports:

Economists and the Federal Reserve predict growth will accelerate from its first quarter pace, the weakest since 2002, even as housing remains a burden. Fed Chairman Ben S. Bernanke said last month there was no sign of "major spillovers'' from the housing slide. Industry reports for June show manufacturers are raising production as businesses spend on investment.

"The second half is coming together almost perfectly according to the Fed's plan,'' said Mark Vitner, senior economist at Wachovia Corp. in Charlotte, North Carolina. "Housing is going to be a drag but if we get some strength in business spending then the economy will be able to handle it.''

Though some of the forecasters in that Wall Street Journal survey -- about 20 percent --- put inflationary risks at the top of their wish-not list, GS's Vaknin wants to ease their minds:

As global activity continues to grow at an above-trend rate and commodity prices remain elevated, a re-acceleration in consumer price inflation, particularly in the major markets, remains a clear risk to the outlook for financial asset returns. Consider that, on a year-on-year basis, headline inflation in advanced economies has accelerated from 1.7% in Q4:06 to around 2.0% currently, driven largely by higher food and energy prices. Such acceleration comes on the back of extended tightness in production capacity: According to the OECD, the output gap in this group of countries is about to move into a positive territory by year-end after hovering in negative levels since mid-2001.

Despite these seemingly worrying observations, we that think inflation, particularly in the G-7, should accelerate only moderately before stabilizing at benign levels early next year. Granted, elevated food and energy prices may keep headline inflation above core measures for a bit longer. But this should be seen in the context of two important developments: (1) US core inflation is on a genuine deceleration path, and (2) Monetary policy stance remains prudent in other major economies where upside inflation risks are clearly higher.

The "monetary policy stance" is key, and it probably explains why so many commentators are taking their predictions of a policy-rate cut off the table for the time being.

July 3, 2007 in Forecasts, Housing, Interest Rates | Permalink


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» June auto sales from Econbrowser
Not a good month for the domestic automakers. [Read More]

Tracked on Jul 4, 2007 10:53:11 AM


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