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Archive for February, 2008

2008-02-29 US Economic Releases

Posted by Sada Mosler on 29th February 2008

2008-02-29 Personal Income YoY

Personal Income YoY (Jan)

Survey n/a
Actual 4.9
Prior 5.6
Revised n/a

Falling off some. Interest rates are partially responsible, as last I checked households are still net savers and have net interest income.

This is one reason I lean towards the view that lower interest rates tend to slow nominal growth, while higher interest rates support nominal growth.

2008-02-29 Personal Consumption Expense Nom$ YoY

Personal Expenditures Nominal$ YoY (Jan)

Survey n/a
Actual 5.5%
Prior 5.8%
Revised n/a

Nominal spending holding up. With our ‘new’ export economy, real spending gives way to exports, and GDP muddles through.

2008-02-29 Personal Consumption Expenditures Chain YoY

Personal Expenditures Chain YoY (Jan)

Survey n/a
Actual 1.8%
Prior 2.1%
Revised n/a

2008-02-29 Personal Consumption Expenditures Price YoY

Personal Expenditure Price YoY (Jan)

Survey n/a
Actual 3.7%
Prior 3.6%
Revised n/a

This is problematic for the Fed.

2008-02-29 Personal Consumption Expenditures Core YoY

Personal Expenditure Core YoY (Jan)

Survey n/a
Actual 2.2%
Prior 2.2%
Revised n/a

This is not easy for the Fed to watch, as they worked long and hard to bring it below 2% and back to their comfort zone of 1-2%. Now the concern is how hard it will be to bring down from even higher expected levels if they keep cutting rates.

2008-02-29 Personal Consumption Market Based YoY

Personal Consumption Market Based YoY (Jan)

Survey n/a
Actual 3.7%
Prior 3.6%
Revised n/a

As above, this is way too high for comfort.

2008-02-29 Personal Consumption Expendatures Market Based Core YoY

Personal Consumption Market Based Core YoY (Jan)

Survey n/a
Actual 1.9%
Prior 2.0%
Revised n/a

Also as above. Ok, but threatening to move higher and be very costly to bring back down.

2008-02-29 PCE Core YoY

PCE Core YoY (Jan)

Survey 2.2%
Actual 2.2%
Prior 2.2%
Revised n/a

As above.

2008-02-29 Chicago Purchasing Manager

Chicago Purchasing Manager (Feb)

Survey 49.5
Actual 44.5
Prior 51.5
Revised n/a

2008-02-29 Chicago Purchasing Manager TABLE

Chicago Purchasing Manager TABLE

Definitely not good, but like ISM, a survey that gets subjective responses, and price components remain high.

New orders up as well.

2008-02-29 U. of Michigan Confidence

U. of Michigan Confidence (Feb F)

Survey 70.0
Actual 70.8
Prior 69.6
Revised n/a

2008-02-29 U of Michigan Confidence TABLE

U. of Michigan Confidence TABLE

While better than expected, does not look good.

And one year inflation expectations are up to 3.6%.

2008-02-29 NAPM Milwaukee

NAPM-Milwaukee (Feb)

Survey n/a
Actual 53.0
Prior 58.0
Revised n/a

Below expectations, but positive. Probably won’t get reported anywhere else..

Posted in Daily | No Comments »

Re: GDP/claims

Posted by Sada Mosler on 28th February 2008

(an interoffice email)

On Thu, Feb 28, 2008 at 9:38 AM, Karim wrote:


  • Housing and business capex weaker than originally estimated; exports stronger
  • All above offset to leave gwth at 0.6% annualized in Q4

Yes, nominal growth falls to 3.3% from 6.0% in Q3 as well.


  • More important news is claims, which corroborate recent weak survey data (Conf Board, ISM)
    • Initial now at 373k (prior revised from 349k to 354k)
    • Continuing up 21k on week to a new cycle high of 2807k
    • Higher continuing claims reflect lack of hiring, higher initial claims reflect new layoffs

Yes, up in a new range. Q1 looking near zero as widely anticipated. Exports may be strong enough to keep the economy out of recession, but not much more without a March recovery.

Crude back over $100, $ down some, commodities up some, etc.

Weakness and inflation continue.

Posted in Email | No Comments »

Bloomberg: Calpers to Increase Commodity Assets to as Much as $7.2 Billion

Posted by Sada Mosler on 28th February 2008

And 3% of assets is on the low side. I think most were targeting 4% allocations, and now I’m hearing some are moving north of 10%, which should keep the commodities going for quite a while.

Calpers to Increase Commodity Assets to as Much as $7.2 Bil

by Saijel Kishan

(Bloomberg) The California Public Employees’ Retirement System, the largest U.S. pension fund, will increase investment in commodities to as much as $7.2 billion in the next two years as raw materials prices surge to records.

Calpers, which has $240 billion in assets, agreed at a Feb. 19 board meeting to invest between 0.5 percent and 3 percent of its assets in commodities through 2010, said Clark McKinley, a spokesman for the Sacremento, California-based fund.

“We plan on ramping up the program by hiring additional staff,” he said by phone yesterday. “We are excited about commodities, which have performed exceptionally well for us.”

The fund in March invested $450 million in commodities, its first such investment, by tracking the Standard & Poor’s GSCI index of 24 commodities. The index has returned 10 percent so far this year, adding to a 33 percent gain in 2007, as oil rose above $100 a barrel and wheat breached $13 a bushel for the first time. Gold and platinum also climbed to all-time highs.

Calpers, which covers the benefits of more than 1.5 million California state and local government employees, will set the proportion of assets invested in commodities “depending on market opportunities,” McKinley said.

The fund plans to allow its staff to actively manage some of its commodity investments this year, he added.

Posted in Articles | No Comments »

TIPS 5yr 5yr fwd

Posted by Sada Mosler on 28th February 2008

One of the Fed’s favorite inflation expectation indicators continues to look to be breaking out.

All pre/post ‘July 2006 pause’ progress has been reversed.

2008-02-28 TIPS 5yr 5yr fwd

TIPS 5yr 5yr fwd

Posted in Inflation | No Comments »

Re: Bernanke/data

Posted by Sada Mosler on 28th February 2008

(an interoffice email)

Yes, and he reaffirmed that he’s using the futures prices to predict where prices are going.  He pointed to crude being at $95 in the back months and stated that translates to a forecast for prices to come down from current levels.

Also indicated the lower dollar is useful for bringing down the trade deficit.  This ‘works’ for as long as US labor costs are ‘well anchored’.  Congress didn’t grasp this part, as it no doubt would have evoked quite an outcry if they had understood it.

Bernanke plainly stated he considered export growth a desired outcome versus domestic consumption.

Initial claims telling today.  Other numbers point to surprises on the upside.  This could be partially tempered by Q4 GDP being revised up.

FF futures already discounting cuts to below 2% over the next six months.

While crude inventories are up, markets are saying it’s ‘desired’ inventory as the term structure is still backwardated and WTI is still higher than Brent.

On Wed, Feb 27, 2008 at 12:32 PM, Karim wrote:
All you need to know about BB’s testimony courtesy of the Xinhua news agency:

WASHINGTON, Feb 27, 2008 (Xinhua via COMTEX) — Federal Reserve Chairman Ben

Bernanke told Congress on Wednesday the central bank will again lower interest

rates to boost U.S. economy.


Other highlights:


Commenting on new Fed forecasts from last week:

The risks to this outlook remain to the downside.  The risks include the possibilities that the housing market or labor market may deteriorate more than is currently anticipated and that credit conditions may tighten substantially further.


… financial markets continue to be under considerable stress


Important comment on the time frame over which policy should aim to attain objective inflation rates

The inflation projections submitted by FOMC participants for 2010–which ranged from 1.5 percent to 2.0 percent for overall PCE inflation–were importantly influenced by participants’ judgments about the measured rates of inflation consistent with the Federal Reserve’s dual mandate and about the time frame over which policy should aim to attain those rates.


Concluding comments highlight downside risks to growth and inflation pressures but when addressing ACTION, only mentions supporting growth and providing insurance against downside risks.

A critical task for the Federal Reserve over the course of this year will be to assess whether the stance of monetary policy is properly calibrated to foster our mandated objectives of maximum employment and price stability in an environment of downside risks to growth, stressed financial conditions, and inflation pressures.  In particular, the FOMC will need to judge whether the policy actions taken thus far are having their intended effects.  Monetary policy works with a lag.  Therefore, our policy stance must be determined in light of the medium-term forecast for real activity and inflation as well as the risks to that forecast.  Although the FOMC participants’ economic projections envision an improving economic picture, it is important to recognize that downside risks to growth remain.  The FOMC will be carefully evaluating incoming information bearing on the economic outlook and will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks.


Data-wise, more of the same:

  • Durable goods orders down 5.3% after 4.4% rise last month. Core component down 1.4% after 5.2% rise. Capex too small a part of economy and potential rates of change too little to have much bearing on end growth at this stage.
  • New home sales down another 2.8% in January and mths supply makes a new high, rising from 9.5 to 9.9; Y/Y median price drops to -15.1% from -7.8%

Posted in Email, Fed, Inflation, Interest Rates, Oil | No Comments »

New home sales

Posted by Sada Mosler on 28th February 2008

Weak winter sales, but the absolute number of homes in inventory did go down again and is well off the highs.

A modest pickup in the sales rate will now translate into a larger drop in the number of months of inventory.

The median price is more a function of which category of houses are selling.

The first quarter is looking weak domestically. Whether GDP goes negative or not will be a function of export strength.

New Home Sales Take Biggest Fall in Nearly 13 Years

(Reuters) New U.S. single-family home sales fell 2.8 percent in January to the lowest rate in nearly 13 years while the median sales price slipped and the housing overstock shrank, according to a government report on Wednesday that delivered more grim news for the ailing housing sector.

New home sales fell to an annual rate of 588,000 from an upwardly revised rate of 605,000 in December, the Commerce Department said.

Economists polled by Reuters were expecting January sales to fall to an annual rate of 600,000 from the December previously reported rate of 604,000.

In January, the median sales price for a new home fell 15.1 percent $216,000 from $254,400 a year ago.

Posted in Articles, Housing | No Comments »

Bernanke testimony

Posted by Sada Mosler on 27th February 2008

Mercantilism is alive and well

Most telling statement when asked about what he wanted for the economy-

moderate domestic consumption, more investment, and more exports to eliminate the trade deficit.
(I’m looking for the transcript now to get the exact quotes.)

This fits with the policy of a lower interest rates, lower $, lower domestic real consumption due to higher import prices, and higher exports to sustain demand (at the ‘expense’ of the country you are exporting to who ‘loses’ demand for its products). This can be done for as long as nominal domestic wages remain ‘well anchored’ thereby reducing real wages, particularly vs our intended markets.

This is the old ‘beggar thy neighbor’ policy last seen in the 1930′s. The purpose was to accumulate the world’s gold supply, and increase ‘national savings.’ The policy was called mercantilism. It’s the logical end that follows from being on a gold standard.
A trade surplus tended to increase gold reserves, while a trade deficit tended to drain gold reserves.

Today we have non convertible currency, so government accumulation of its own currency per se is meaningless. However, we have retained some of the gold standard accounting nomenclature, such as ‘national savings’ which still features govt. accumulation of it’s own currency (as well as foreign exchange, which at least does represent value).

Fed Chairman Bernanke, the student of the great depression of the 30′s, sees the tail risk as that of gold standard deflationary collapses, and is cutting interest rates to bring the $ down and increase exports. He deems trade deficits ‘bad’ and ‘unsustainable,’ trade surpluses ‘good’ and ‘wealth enhancing,’ and increasing ‘national savings’ the mark of success.

(Mainstream economics, with all its shortcomings, does recognize the differences between convertible and non convertible currency regimes that Bernanke seems to be missing.)

Additionally Chairman Bernanke made it clear today that he sees lower futures prices for crude oil, a non perishable commodity, as indicative of market expectations for future prices, and is making decisions on that basis.

Ironically, the backwardated crude market is the result of the Saudis/Russians acting as swing producer setting price and letting quantity adjust (imperfect competition), which is functionally an engineered spot ‘shortage’ that supports price.

This brings us back to the present condition of the US economy-

Weak domestic real demand due to ‘well anchored nominal wages’ and falling real wages,

GDP muddling through with the support of booming export demand and a falling trade deficit,

And cost push inflation accelerating.


Based on today’s testimony, the FOMC seems fine with the lower $ and the associated rising costs of imports, as the weak $ supports export growth.

It will get concerned about inflation when it sees signs unit labor costs are accelerating.

Posted in Fed | 6 Comments »

2008-02-27 US Economic Releases

Posted by Sada Mosler on 27th February 2008

2008-02-27 MBAVPRCH

MBAVPRCH Index (Feb 22)

Survey n/a
Actual 358.2
Prior 357.6
Revised n/a

While still winter numbers, this is nonetheless looking very weak.

No way to tell if it’s more than loss of market share to banks, but other winter housing numbers are also weak.

2008-02-27 MBAVREFI

MBAVREFI Index (Feb 22)

Survey n/a
Actual 2458.9
Prior 3533.8
Revised n/a


2008-02-27 Durable Goods Orders

Durable Goods Orders (Jan)

Survey -4/0%
Actual -5.3%
Prior 5.2%
Revised 4.4%


2008-02-27 Durable Goods Orders

Durable Goods YoY (Jan)

Survey n/a
Actual 3.0%
Prior 4.2%
Revised n/a


2008-02-27 Durables Ex Transporation

Durables Ex Transportation (Jan)

Survey -1.4%
Actual -1.6%
Prior 2.6%
Revised 2.0%


2008-02-27 New Home Sales

New Home Sales (Jan)

Survey 600K
Actual 588K
Prior 604K
Revised 605K


2008-02-27 New Home Sales MoM

New Home Sales MoM (Jan)

Survey -0.7%
Actual -2.8%
Prior -4.7%
Revised -4.0%


 Gives less reason to think January payrolls will be reversed very much higher.

Posted in Daily | No Comments »

Two quick comments on inflation

Posted by Sada Mosler on 27th February 2008

  1. Bernanke may be reminded of the reason the dual mandate includes inflation – voters don’t like inflation even more than they don’t like unemployment.
  1. As inflation rates rises into the March 18 meeting, with the FF rate at 3% the real rate falls, which the FOMC sees as ‘easier’ policy.

    Posted in Fed, Inflation | No Comments »

    Additions to yesterday’s review

    Posted by Sada Mosler on 27th February 2008

    Forgot to include the influence of the 8,000 lb gorilla I’ve been advancing for the last few years!

    Supporting GDP

    1. Pension funds adding to allocations for passive commodity strategies

    Sources of inflation

    1. Pension funds adding to allocations for passive commodity strategies
    2. Pension funds contributing to the $ decline by allocating funds away from domestic equities to foreign equities
    3. Sovereign wealth funds allocating to passive commodity strategies

    Errors made by the Fed

    1. Failure to recognize the influence of pension funds on inflation and aggregate demand
    2. Failed to understand reserve accounting and liquidity issues
      1. Thought open market operations altered functional quantitative measures, not just interest rates
      2. Delayed implementing the TAF for several months to accept additional bank assets as collateral
      3. Failed to recognize that the liability side of Fed member banks is not an appropriate source of market discipline

    Posted in Fed, Inflation | No Comments »

    Re: update

    Posted by Sada Mosler on 27th February 2008

    Dear Philip,

    Seems there’s a break between Mishkin and Kohn that previously wasn’t there.
    Markets are thinking Kohn supports a 50 cut and that he and Bernanke are alligned.

    Today Bernanke may show whether he leans towards Mishkin, the co academic, or Kohn, more the practitioner.

    Meanwhile, another ‘inflation day’ with oil and commodities up, $ down, and headlines like ‘Honda says no recession in US.’

    All the best,

    On 27 Feb 2008 09:09:43 +0000, Prof. P. Arestis

    > Dear Warren,
    > Many thanks.
    > > Do you think Kohn’s speech indicates he’s ready to cut another half point
    > > on Mar 18?
    > I think the simple answer to the question is probably no with a question
    > mark. I say this in the sense that before March 18 we will probably hear
    > more about Kohn’s views, which may be clearer in terms of whether he is
    > ready for another half point reduction. However, in terms of the analysis
    > he offered in the piece you kindly sent me I did not see anything that
    > suggested half point cut, although there is plenty in the piece to suggest
    > that he is in favour of more cuts. I say this in that although he sees
    > problems with the real economy he is also mindful of inflation, but he is
    > not an ‘inflation nutter’ as some others are. So at this stage I believe he
    > will go for a cut but not as much as half point.
    > What do you think?
    > Best wishes, Philip

    Posted in Email, Fed | No Comments »

    Inflation, growth, and Fed policy

    Posted by Sada Mosler on 26th February 2008

    Stocks up big, oil up big, dollar down big, and interest rates lower. How does this happen?


    Twin themes remain

    • weakness
    • inflation

    Sources of weakness

    1. Shrinking gov budget deficit caused the financial obligations ratio to get too high by Q2 2006 to support the private sector credit growth needed to sustain previous levels of aggregate demand.
    2. Subprime business plan failed (mainly due to lender fraud) and removed that bid from the housing market.
    3. Lower interest rates reduce personal/household income.

    Supporting GDP

    1. Exports booming due to a reduced desire of non residents to accumulate $US financial assets. (This drives the $US down to levels where non residents are spending them on US goods and services.)
      1. Paulson branding any country that buys $ a ‘currency manipulator’
      2. Apparent lack of Fed concern about inflation discouraging holders of $US financial assets
      3. Bush policies discouraging ‘less then friendly’ oil producers from accumulating $US financial assets
    2. Govt. spending moved forward from 07 to 08 now kicking in.
    3. Fiscal package begins to distribute funds in May.
    4. Pension funds adding to allocations for passive commodity strategies

    Sources of Inflation

    1. Sufficient demand for Saudis/Russians to act as swing producers and set crude prices as high as they want to
    2. Biofuels linking energy prices to food prices as we burn up the world’s food supply for fuel
    3. Govt. payrolls and transfer payments indexed to CPI
    4. Weak $US policies driving higher import and export prices
    5. Pension funds adding to allocations for passive commodity strategies
    6. Pension funds contributing to the $ decline by allocating funds away from domestic equities to foreign equities
    7. Sovereign wealth funds allocating to passive commodity strategies

    An export economy looks like this

    1. Weak domestic demand and domestic consumption
    2. Exports strong enough to sustain reasonable levels of employment (but generally not full employment)
    3. Employment and output stays reasonably high.
    4. Domestic prices are high enough relative to domestic wages to subdue domestic consumption.
    5. Foreigners ‘outbid’ domestics for the remaining output that thereby gets exported.
    6. The domestic economy works more and consumes less (lower standard of living), with the difference accounted for as ‘rising savings.’

    Mainstream history (not mine) will show the following errors made by the Fed

    1. They ‘paused’ a couple of years ago as the great commodity boom was hitting it’s stride, monetizing (whatever that is) the price increases, and allowing a relative value story to turn into an inflation story.
    2. They cut aggressively into a triple negative supply shock exacerbating the monetization (whatever that is) process due to the following fundamental errors of judgement:
      1. They read futures prices in food and energy as ‘expectations’ of lower prices in the future, rather than as indicators of current inventory conditions.
      2. They assumed gold standard tail risks to a non convertible currency regime.
      3. They failed to recognize the source of rising crude prices was foreign monopoly pricing.
      4. They delayed introducing the TAF for several months.
      5. They pushed the President and Congress into increasing the budget deficit with an inflationary cash give handout.
    3. Failure to recognize the influence of pension funds on inflation and aggregate demand
    4. Failed to understand reserve accounting and liquidity issues
      1. Thought open market operations altered functional quantitative measures, not just interest rates
      2. Delayed implementing the TAF for several months to accept additional bank assets as collateral
      3. Failed to recognize that the liability side of Fed member banks is not an appropriate source of market discipline

    Back to the present

    • Stocks are up as financial risks ease with the monolines sorting things out, and energy and export businesses boom.
    • Stocks are up as markets believe the Fed doesn’t care about inflation and will leave rates low for an extended period of time.
    • Crude is up as Saudis/Russians continue to hike prices.
    • The falling dollar results in higher import prices including gold, silver, copper, and most everything else.

    Interest rates are down as markets read the Kohn speech as saying the Fed expects inflation to come down so there’s no need to be concerned or take action. And inflation is a lagging indicator that historically comes down after the Fed cuts rates when the economy weakens.

    Posted in Fed, Inflation, Interest Rates, USA | No Comments »

    Kohn speech

    Posted by Sada Mosler on 26th February 2008

    After the speech, crude up $1.61 and back over $100.
    Yields down on fixed income as markets anticipate Fed won’t respond to inflation anytime soon:

    February 26, 2008

    The U.S. Economy and Monetary Policy


    Several major developments are shaping current economic performance, the outlook, and the conduct of monetary policy. The most prominent of these developments is the contraction in the housing market that began in early 2006. Both the prices and pace of construction of new homes rose to unsustainable levels in the preceding few years. For a time, the resulting correction was largely confined to the housing market, but the consequences of that correction have spread to other sectors of the economy.

    The financial markets are playing a key role in the transmission of the housing downturn to the rest of the economy.


    The result has been a substantial tightening in credit availability for many firms and households.

    At the same time, continued sizable increases in the prices of food, energy, and other commodities have raised inflation. To some extent, those increases have resulted from strong demand in rapidly growing emerging-market economies, like China and India. But the increases likely also reflect conditions such as adverse weather in some parts of the world, the use of agricultural commodities to produce energy, and geopolitical developments that threaten supplies in some petroleum-producing centers. The higher prices have eroded the purchasing power of household income, adding to restraint on spending.


    Recent Economic and Financial Developments

    The pace of real economic activity stepped down sharply toward the end of last year and has remained sluggish in recent months. Real gross domestic product (GDP) is estimated to have risen only slightly in the fourth quarter. The contraction in the housing market continues to drag down economic growth. Declines in real residential investment subtracted nearly 1 percentage point from the overall increase in real GDP in 2007. Even so, the inventory of unsold new homes remains unusually high, because the demand for housing has fallen about as rapidly as the supply. Problems in the subprime market have virtually cut off financing in this sector. Prime jumbo mortgages are being made, but the lack of a secondary market has caused the spread between rates on these mortgages and on those that have been eligible for purchase by Fannie Mae and Freddie Mac to widen substantially. Even the standards for conforming mortgages have been tightened of late. Weak demand, in turn, is leading to widespread declines in the actual and expected prices of houses, further discouraging buyers. Starts of new single-family homes continued to fall in January, dropping to fewer than 750,000 units–a level of activity more than 1 million units below the peak in early 2006. Judging from the further decline in permits last month, additional cutbacks in construction are likely. It appears that the correction in the housing market has further to go.

    For the better part of the past two years, the trouble in the housing market was contained; however, over the past several months, the weakness appears to have spread to other sectors of the economy. Tighter credit, reductions in housing and equity wealth, higher energy prices, and uncertainty about economic prospects seem to be weighing on business and household spending. Labor demand has softened in recent months. Private nonfarm payrolls were little changed in January, and the unemployment rate moved up to 4.9 percent, on average, during December and January, after remaining around 4-1/2 percent from late 2006 through most of 2007. The higher level of weekly claims for unemployment insurance suggests continued softness in employment this month.

    Agreed, the economy has hit the ‘soft spot’ previously forecast by the Fed and private economists.

    Apart from the labor market, the hard data on economic activity in the first quarter are limited, but, on the whole, the data suggest economic activity has remained very sluggish. Retail sales were up moderately in nominal terms in January, but after adjusting for the rise in prices of consumer goods, real spending on non-auto goods appears to have been little changed last month. In addition, unit sales of new motor vehicles weakened. Total industrial production rose just 0.1 percent in January for a second consecutive month, and manufacturing output was unchanged. Much of the other information about the current quarter has come in the form of surveys of business and consumers–and most all of it has been downbeat. That said, I can still see a few bright spots. One is that the level of business inventories does not appear worrisome at present. Another is that international trade continued to be a solid source of support for the economy through the end of last year. The worsening financial conditions and slower growth in the United States have had some effect on the rest of the world, but the prospects for foreign growth remain favorable.

    Agreed, weak domestic demand supported by rising exports.

    The most recent news on inflation–the January report on the consumer price index (CPI)–was disappointing. Once again, total or headline CPI was boosted by a jump in energy prices and relatively large increases in food prices; last month’s rise left the twelve-month change in the overall CPI at 4.3 percent–twice the pace a year ago. In addition, the January increase of 0.3 percent in the CPI excluding food and energy was slightly higher than the average monthly rate in 2007. Nonetheless, the twelve-month change in this measure of core inflation, at 2-1/2 percent, was still slightly below the rate one year earlier. The recent readings on core inflation suggest that the higher costs of energy, a pickup in prices of imported goods, and, perhaps, the persistent upward price pressures in commodity markets may be passing through a bit to core consumer prices.

    Headline passing through to core – not good.

    The Implications of Financial Stress for the Economic Outlook


    The pressures from the financial turmoil have been most intense for those financial intermediaries that have been exposed to losses on mortgages and other credits that are repricing, as well as for those institutions now required to bring onto their balance sheets loans that previously would have been sold into securities markets. As those intermediaries take steps to protect themselves from further losses and conserve capital, and as investors more broadly have responded to the evolving risks, spreads on household and business debt in securities markets have widened, the availability of bank credit has decreased, and equity prices have weakened.

    In addition to the drying up of large portions of mortgage finance that I referred to previously, conditions have firmed on loans for a variety of other purposes. Responses to our Senior Loan Officer Opinion Survey in January showed that banks have tightened terms and standards for household and commercial mortgages, commercial and industrial loans, and consumer loans.

    The Fed puts a lot of weight on this and reads it differently than I do. Yes, they have tightened standards, but that doesn’t mean those who had previously qualified no longer qualified under the new standards. For example, requiring a larger down payment is considered tightening, and there’s no evidence yet that would be borrowers don’t simply put more money down. Same with other ‘tightening standards’ issues.

    In corporate bond markets, spreads have been widening on both investment- and speculative-grade issues. Lenders are demanding much higher risk premiums for commercial real estate loans. And equity prices have fallen substantially over the past seven months, reducing household wealth and increasing the cost of raising equity capital for businesses.

    All true, but part of the great repricing of risk. Arguably spreads were unsustainably narrow a year ago.

    To be sure, the easing of monetary policy that I will be discussing in a minute has, quite deliberately, been intended to offset the effect of this tightening, resulting in some borrowers seeing lower interest rates. But financing costs have risen, on balance, for riskier credits, and almost all borrowers are dealing with more cautious lenders who have adopted more stringent standards. Those financial market developments are, in many respects, a healthy correction to previous excesses.

    Yes, agreed with that.

    But, in some cases, they may represent an overreaction, or at least positioning for the small probability of very adverse economic conditions. In any case, they have the potential to adversely affect household and business spending.

    Yes, they have that potential. And regulatory over reach is also a problem he doesn’t address, as the OCC is unnecessarily making things more difficult for small banks to function ‘normally’.

    The recovery in financial markets is likely to be a prolonged process. The length of the recuperation will depend importantly on the course of the economy, particularly on developments in the housing market. If the deterioration in the housing market were greater than expected in coming months, the losses borne by financial institutions would be even greater, and lenders might further reduce credit availability. More widespread macroeconomic weakness could make lenders more cautious and could cause the financial problems to spread further. The recent problems of financial guarantors, with possible implications for municipal bond markets as well as for bank balance sheets, are an indication that the financial sector remains vulnerable.

    Agreed that parts of the financial sector remains vulnerable, while others are doing exceptionally well.

    Even in a more favorable economic environment, some time is likely to be required to restore the functioning and liquidity of a number of markets.


    The Monetary Policy Response


    As the deterioration in financial markets increasingly has threatened to hold down spending and employment, the FOMC has eased monetary policy, reducing the federal funds rate target by 2-1/4 percentage points since the turmoil erupted in August. Those actions have been intended to counteract the effects on the overall economy of tighter terms and conditions in credit markets, the drop in equity and housing wealth, and the steep decline in housing activity. Our objective has been to promote sustainable growth and maximum employment over time.


    What policy can do is attempt to limit the fallout on the economy from this adjustment.

    Lower interest rates should support aggregate demand over time, even in the face of widespread contraction in the supply of credit.

    Among other things, lower rates should facilitate the refinancing of mortgage loans, and they will hold down the cost of capital to business.

    Easier policy should also support asset prices–or at least cushion declines that otherwise would have occurred.

    And expected policy easing likely contributed to the drop in the foreign exchange value of the dollar, which is bolstering our exports.

    Yes, the ‘inflate your way out of debt’ approach. Highly unusual for a central bank to aggressively do this. Harks back to the ‘beggar thy neighbor’ policies of the 1930s.

    The extent of the financial adjustment, as I mentioned previously, is itself highly dependent on how housing and the economy evolve. Part of the rise in risk spreads, reduction in credit availability, and the declines in stock prices in the past few months reflect investor efforts to protect themselves against the potential for very adverse economic outcomes–that is, the exposures and losses that would accompany a persistent steep decline in house prices and a significant recession. Of course, these actions–reducing exposures, tightening credit standards, demanding extra compensation for taking risk–themselves make these “tail risk” scenarios even more likely. In circumstances like these, the decisions of policymakers must take account of not only the most likely course of the economy, but also the possibility of very unfavorable developments.

    Not including inflation?

    Doing so should reduce the odds on an especially adverse outcome not only by having policy a little easier than otherwise, but also by reassuring lenders and spenders that the central bank recognizes such a possibility in its policy deliberations. Whether the Federal Reserve has done enough in this regard is a question this policymaker will be weighing carefully over coming months.

    Even as we respond to forces currently weighing on real activity, we must also set policy to resist any tendency for inflation to increase on a sustained basis. Allowing elevated rates of inflation to become entrenched in inflation expectations would be costly to reverse, constrain our ability to cushion further downward shocks to spending, and result over time in lower and less stable economic expansion. Inflation expectations generally have appeared reasonably well anchored, giving the FOMC room to focus on supporting economic growth. Moreover, as I will explain below, for a variety of reasons, I do not expect the recent elevated inflation rates to persist. In my view, the adverse dynamics of the financial markets and the economy have presented the greater threat to economic welfare in the United States. But the recent information on prices underlines the need to continue to monitor the inflation situation very carefully.

    The Outlook for Economic Activity and Inflation

    How long the adjustment in financial markets will take and the consequences of that adjustment for economic activity are subject to considerable uncertainty. In my view, the most likely scenario is one in which the economy experiences a period of sluggish growth in demand and production in the near term that is accompanied by some further increase in joblessness.

    New building activity will continue to decline until the overhang of inventories of unsold homes has been substantially reduced, and the demand side of the market is not likely to revive appreciably until buyers sense that price declines are abating and financing conditions for mortgages are improving. Consumer spending will be damped by the effects on real incomes of a weak labor market and rising energy prices and by the effects of declines in the stock market and home prices on household wealth. Business spending on capital equipment should be held down by slower sales and production and by caution in a very uncertain economic environment. Nonresidential construction is likely to lose some momentum in the wake of both weak growth in overall economic activity and tighter credit. Some modest offset to these areas of weakness should come from export demand, which should be boosted by the lagged effects of recent declines in the dollar and supported by still-solid growth abroad.

    Seems he doesn’t realize export demand is part of the cause of higher prices, as non-residents compete with residents to buy the US output of goods and services. That’s what an export economy looks like, and this will continue for as long as non-resident desires to accumulate $US financial assets continues to fall.

    By midyear, economic activity should begin to benefit from several factors. One is the fiscal stimulus package that the Congress recently enacted. The rebates that households are scheduled to begin to receive in May should provide a temporary boost to consumption. Although the timing and the magnitude of the spending response is uncertain, economic studies of the previous experience suggest that a noticeable proportion of households are quite sensitive to temporary cash flow. The potential effects of the business incentives are perhaps more uncertain. Although economic theory suggests that they should bring forward some capital spending, past experience has been mixed.

    Second, the decline in residential investment should begin to abate later this year as the overhang of unsold homes is worked off, reducing what has been a significant drag on economic growth over the past two years. Finally, the declines in interest rates that began last summer should be supporting activity over coming quarters, and their effects should show through more clearly to improvements in economic activity as the stress in financial markets dissipates.

    Although a firming in the growth of economic activity after midyear now appears the most likely scenario, the outlook is subject to a number of important risks. Further substantial declines in house prices could cut more deeply into household wealth and intensify the problems in mortgage markets and for those intermediaries holding mortgage loans. Financial markets could remain quite fragile, delaying the restoration of more normal credit flows. As observed in the minutes of its most recent meeting, the FOMC has expressed a broad concern about the possibility of adverse interactions among weaker economic activity, stress in financial markets, and credit constraints.

    I expect the run-up in headline inflation to be reversed and core inflation to edge lower over the next few years. This projection assumes that energy and other commodity prices will level out, as suggested by the futures markets.

    No other reasons? Not much to bet the ranch on? And futures prices for non perishables are not about expectations, but about inventory conditions. Contango indicates a surplus of desired spot inventories and backwardation a shortage of desired spot inventories.

    The current backwardated term structure of oil and other futures is indicating shortages, which, if anything, tell me the risk is more to the upside than the downside, as well as support my position that the Saudis/Russians are acting as swing producers and setting price.

    Moreover, greater slack in the economy should reduce pressure on prices and wages.

    Maybe, but also a risky stance.

    Rising import prices are in fact rising real wages for US, as many imports have high labor contents.

    And given rising import prices of labor intensive goods and services due to the weak $, lower US domestic real wages shift production back to domestic firms, who support US nominal wages and keep employment firmer than otherwise.

    Despite high resource utilization over the past couple of years and periods of elevated headline inflation, labor cost increases have remained quite moderate, and inflation expectations remain reasonably well anchored.

    As above, rising import prices represent rising labor costs, and inflation expectations have dropped to only ‘reasonably’ well anchored.

    Nonetheless, policymakers must remain very attentive to the outlook for inflation. As I mentioned earlier, the recent uptick in core inflation may reflect some spillover of the higher costs of food, energy, and imports into core prices.

    To the mainstream economists, this is a serious development.

    And the prices of crude oil and other commodities have moved up further in recent weeks. A related concern is that inflation expectations might drift higher if the current rapid rates of headline inflation persist for longer than anticipated or if the recent easing in monetary policy is misinterpreted as reflecting less resolve among Committee members to maintain low and stable inflation over the medium run. Persistent elevated inflation would undermine the performance of the economy over time.

    Worse, to a mainstream economist, including Governor Kohn, it’s a necessary condition for optimal growth and employment.


    These have been difficult times for the U.S. economy. The correction of excesses in sectors of the economy and financial markets has spilled over more broadly. Growth has slowed, and unemployment has increased; both borrowers and lenders are facing problems, and the functioning of the financial markets has been disrupted. At the same time, inflation has risen.

    Yes, weakness and higher prices.

    I believe we will see a return to stronger growth, lower unemployment, lower inflation and improved flows in financial markets, but it probably will take a little while.

    This ‘belief’ is at best scantily supported in this speech. Lower inflation because futures are lower? Lower employment/output gap and bringing inflation down to comfort zone at the same time?

    And adverse risks to this most likely scenario abound: Uncertainty could trigger an even greater withdrawal from risk-taking by households, businesses, and investors, resulting in more pronounced and prolonged economic weakness; events beyond our borders could continue to put upward pressure on inflation rates.


    But we should not lose sight of some fundamental strengths of our economy. Our markets have proven to be flexible and resilient, able to absorb shocks, and quick to adapt to changing circumstances. Those markets reward entrepreneurship and risk-taking, and many people are looking for opportunities to buy distressed assets and restructure and strengthen businesses to take advantage of the economic rebound that will occur. Monetary policy has proven itself, under a wide variety of circumstances, very effective in recent decades in damping inflation when needed

    Yes, but only by hiking rates. There is no other policy option for bringing down inflation.

    and in stimulating demand and activity when that has been appropriate. Our job at the Federal Reserve is to put in place those policies that will promote both price stability and growth over time. We have the tools.

    They have one tool – setting the interbank interest rates and other rates as desired.

    They have no way of directly increasing or decreasing aggregate demand. That requires direct buying or selling of actual goods and services, not just financial assets.

    Treasury spending/taxing directly add/removes demand.

    As Chairman Bernanke often emphasizes: We will do what is needed.

    Yes, to the best of their knowledge and ability.

    This is a relatively neutral speech with more inflation talk than in previous, dovish speeches.

    High February CPI numbers before the next meeting will make it very difficult for the FOMC to vote on a cut without a more than anticipated decline of economic activity.

    Posted in Fed | No Comments »

    2008-02-26 US Economic Releases

    Posted by Sada Mosler on 26th February 2008

    2008-02-26 Producer Price Index MoM

    Producer Price Index MoM (Jan)

    Survey 0.4%
    Actual 1.0%
    Prior -0.1%
    Revised -0.3%

    2008-02-26 PPI Ex Food & Energy MoM

    PPI Ex Food & Energy MoM (Jan)

    Survey 0.2%
    Actual 0.4%
    Prior 0.2%
    Revised n/a

    2008-02-26 Producer Price Index YoY

    Producer Price Index YoY (Jan)

    Survey 7.3%
    Actual 7.4%
    Prior 6.3%
    Revised n/a

    2008-02-26 PPI Ex Food & Energy YoY

    PPI Ex Food & Energy YoY (Jan)

    Survey 2.2%
    Actual 2.3%
    Prior 2.0%
    Revised n/a

    To high for the Fed and looking higher. Kohn speaking next today.

    In the early 70′s inflation kept going up, even after crude flattened out for several years after a fivefold+ jump,

    2008-02-26 S&P-CaseShiller Home Price Index

    S&P/CaseShiller Home Price Index (Dec)

    Survey n/a
    Actual 184.9
    Prior 188.8
    Revised 188.9

    2008-02-26 S&P-CS Composite-20 YoY

    S&P/CS Composite-20 YoY (Dec)

    Survey -9.7%
    Actual -9.1%
    Prior -7.7%
    Revised n/a

    2008-02-26 S&P-CS US HPI

    S&P/Case-Shiller US HPI (4Q)

    Survey n/a
    Actual 170.6
    Prior 180.5
    Revised 180.3

    2008-02-26 S&P-CS US HPI YoY%

    S&P/Case-Shiller US HPI YoY% (4Q)

    Survey n/a
    Actual -8.9%
    Prior -4.5%
    Revised -4.6%

    2008-02-26 Consumer Confidence

    Consumer Confidence (Feb)

    Survey 82.0
    Actual 75.0
    Prior 87.9
    Revised 87.3

    2008-02-26 Richmond Fed Manufact. Index

    Richmond Fed Manufact. Index (Feb)

    Survey -12
    Actual -5
    Prior -8
    Revised n/a

    2008-02-26 Housing Price Index QoQ

    House Price Index QoQ (4Q)

    Survey -1.0%
    Actual 0.1%
    Prior -0.4%
    Revised -0.2%

    Not released yet..

    ABC Consumer Confidence (Feb 24)

    Survey -
    Actual -
    Prior -37
    Revised -


    Posted in Daily | No Comments »

    Mishkin speech

    Posted by Sada Mosler on 25th February 2008

    Not a quick read, but telling – inflation risks seem to be overtaking concerns with the economy:

    Does Stabilizing Inflation Contribute to Stabilizing Economic Activity?

    (Interesting that this is a question)

    The ultimate purpose of a central bank should be to promote the public good through policies that foster economic prosperity. Research in monetary economics describes this purpose by specifying monetary policy objectives in terms of stabilizing both inflation and economic activity. Indeed, this specification of monetary policy objectives is exactly what is suggested by the dual mandate that the Congress has given to the Federal Reserve to promote both price stability and maximum employment.1

    Yes, just as the mainstream says, and FOMC voting member Fisher restate recently: price stability is a necessary condition for optimal long-term employment and growth.

    We might worry that, under some circumstances, the objectives of stabilizing inflation and economic activity could conflict, particularly in the short run. However, economic research over the past three decades suggests that such conflicts may not, in fact, be that serious. Indeed, stabilizing inflation and stabilizing economic activity are mutually reinforcing not only in the long run, but in the short run as well. In my remarks today, I would like to outline how economic researchers came to that conclusion, and in so doing, explain why it is so important to achieve and maintain price stability.2

    Seems the emphasis is now on price stability. The question remains whether talk will translate to action.

    The Long Run
    Both economic theory and empirical evidence indicate that the stabilization of inflation promotes stronger economic activity in the long run.3

    (I don’t agree, but that’s another story. Congressmen do, however, need low inflation to stay in office, hence the dual mandate.)

    Two principles underlie that conclusion. The first principle is that low inflation is beneficial for economic welfare. Rates of inflation significantly above the low levels of recent years can have serious adverse effects on economic efficiency and hence on output in the long run. The distortions from a moderate to high level of long-run inflation are many. High inflation can cause confusion among households and firms, thereby distorting savings and investment decisions (Lucas, 1972; Briault, 1995; Shafir, Diamond, and Tversky, 1997).

    (I don’t agree that these ‘distortions’, if any, are qualitatively less supportive of public purpose.)

    The interaction of inflation and the tax code, which is often applied to nominal income, can have adverse effects, especially on the incentive of firms to invest in productive capital (Feldstein, 1997).

    (If so, that’s a reason to adjust the tax code, rather than a ‘problem’ with inflation per se?)

    Infrequent nominal price adjustment implies that high inflation results in distorted relative prices, thereby leading to an inefficient allocation of resources (Woodford, 2003).

    (Versus our current allocation of real resources??? But yes, these are the mainstream pillars.)

    And high inflation distorts the financial sector as firms and households demand greater protection from inflation’s erosion of the value of cash holdings (English, 1999).

    As above. It’s already hard to pin down any real value added to most, if not all our financial sector…

    The second principle is the lack of a long-run tradeoff between unemployment and the inflation rate. Rather, the long-run Phillips curve is vertical, implying that the economy gravitates to some natural rate of unemployment in the long run no matter what the rate of inflation is (Friedman, 1968; Phelps, 1968).4

    And the mainstream also adds ‘no matter what the fiscal balance’.

    The natural rate, in turn, is determined by the structure of labor and product markets, including elements such as the ease with which people who lose their jobs can find new employment and the pace at which technological progress creates new industries and occupations while shrinking or eliminating others. Importantly, those structural features of the economy are outside the control of monetary policy. As a result, any attempt by a central bank to keep unemployment below the natural rate would prove fruitless. Such a strategy would only lead to higher inflation that, as the first principle suggests, would lower economic activity and household welfare in the long run.

    Yes, the mainstream believes this, and the general assumption is that 4.75% is currently the natural rate of unemployment. January unemployment was reported at 4.9%; so, this implies we are already very near full employment, and therefore lowering rates to help the economy may only generate more inflation, and not more output.

    Empirical evidence has starkly demonstrated the adverse effects of high inflation (e.g., see the surveys in Fischer, 1993, and Anderson and Gruen, 1995). In most industrialized countries, the late 1960s to early 1980s was a period during which inflation rose to high levels while economic activity stagnated. While many factors contributed to the improved economic performance of recent decades, policymakers’ focus on low and stable inflation was likely an important factor.5

    Correct, only ‘likely’. I attribute other factors to the real performance, but, again, that’s another story.

    The Short Run
    Although there is no long-run tradeoff between unemployment and inflation, in the short run, expansionary monetary policy that raises inflation can lower unemployment and raise employment. That is, the short-run Phillips curve is not vertical.

    (This is also theoretically and empirically subject to much recent debate.)

    That fact would seem to suggest that achieving the dual goals of price stability and maximum sustainable employment might at times conflict. However, several lines of research provide support for the view that stabilization of inflation and economic activity can be complementary rather than in conflict.

    Economists have long recognized that some sources of economic fluctuations imply that output stability and inflation stability are mutually reinforcing. Consider a negative shock to aggregate demand (such as a decline in consumer confidence) that causes households to cut spending. The drop in demand leads, in turn, to a decline in actual output relative to its potential–that is, the level of output that the economy can produce at the maximum sustainable level of employment. As a result of increased slack in the economy, future inflation will fall below levels consistent with price stability, and the central bank will pursue an expansionary policy to keep inflation from falling.

    Yes, the FOMC has believed increased slack would bring down the level of inflation. And, they further believed that there was some risk of a total financial collapse, which would result in a massive 1930s style deflation. Not sure if they still do.

    The expansionary policy will then result in an increase in demand that boosts output toward its potential to return inflation to a level consistent with price stability. Stabilizing output thus stabilizes inflation and vice versa under these conditions.

    For example, the Federal Reserve reduced its target for the federal funds rate a total of 5-1/2 percentage points during the 2001 recession; that stimulus not only contributed to economic recovery but also helped to avoid an unwelcome decline in inflation below its already low level.

    The international context was deflationary, as import prices were falling and putting downward pressure on domestic prices. (Also, the Fed economists trace the recovery to the ‘fiscal impulses’ rather than the lower interest rates.)

    At other times, a tightening of the stance of monetary policy has prevented the economy from overheating and generating a boom-bust cycle in the level of employment as well as an undesirable upward spurt of inflation.

    This is also difficult to separate from the fiscal cycle, but, again, it is the mainstream view.

    One critical precondition for effective central-bank easing in response to adverse demand shocks is anchored long-run inflation expectations. Otherwise, lowering short-term interest rates could raise inflation expectations, which might lead to higher, rather than lower, long-term interest rates, thereby depriving monetary policy of one of its key transmission channels for stimulating the economy.

    Yes, the mainstream considers inflation expectations as the critical determinant of the price level.

    The role of expectations illustrates two additional basic principles of monetary policy that help explain why stabilizing inflation helps stabilize economic activity: First, expectations of future policy actions and accompanying economic conditions play a crucial role in determining the effects of current policy actions on the economy. Second, monetary policy is most effective when the central bank is firmly committed, through its actions and statements, to a “nominal anchor”–such as to keeping inflation low and stable. A strong commitment to stabilizing inflation helps anchor inflation expectations so that a central bank will not have to worry that expansionary policy to counter a negative demand shock will lead to a sharp rise in expected inflation–a so-called inflation scare (Goodfriend, 1993, 2005). Such a scare would not only blunt the effects of lower short-term interest rates on real activity but would also push up actual inflation in the future. Thus, a strong commitment to a nominal anchor enables a central bank to react more aggressively to negative demand shocks and, therefore, to prevent rapid declines in employment or output.

    The last few weeks have seen an elevated use of this kind of definitive, hawkish language, even from some of the Fed doves.

    Unlike demand shocks, which drive inflation and economic activity in the same direction and thus present policymakers with a clear signal for how to adjust policy, supply shocks, such as the increases in the price of energy that we have been experiencing lately, drive inflation and output in opposite directions. In this case, because tightening monetary policy to reduce inflation can lead to lower output, the goal of stabilizing inflation might conflict with the goal of stabilizing economic activity.

    Yes, that is what they see developing as the current set of options.

    Here again, a strong, previously established commitment to stabilizing inflation can help stabilize economic activity, because supply shocks, such as a rise in relative energy prices, are likely to have only a temporary effect on inflation in such circumstances. When inflation expectations are well anchored, the central bank does not necessarily need to raise interest rates aggressively to keep inflation under control following an aggregate supply shock. Hence, the commitment to price stability can help avoid imposing unnecessary hardship on workers and the economy more broadly.

    The Fed has to manage expectations at all times.

    The experience of recent decades supports the view that a substantial conflict between stabilizing inflation and stabilizing output in response to supply shocks does not arise if inflation expectations are well anchored. The oil shocks in the 1970s caused large increases in inflation not only through their direct effects on household energy prices but also through their “second round” effects on the prices of other goods that reflected, in part, expectations of higher future inflation.

    Yes, that’s the mainstream theory.

    Sharp economic downturns followed, driven partly by restrictive monetary policy actions taken in response to the inflation outbreaks. In contrast, the run-up in energy prices since 2003 has had only modest effects on inflation for other goods;

    (Seems to me it took about three years this time, about the same as back then?)

    as a result, monetary policy has been able to avoid responding precipitously to higher oil prices. More generally, the period from the mid-1960s to the early 1980s was one of relatively high and volatile inflation; at the same time, real activity was very volatile. Since the early 1980s, central banks have put greater weight on achieving low and stable inflation, while during the same period, real activity stabilized appreciably.

    (Energy and commodity prices also fell with excess supply and then stabilized for almost two decades, bringing down and stabilizing core inflation and stabilizing real activity.)

    Many factors were likely at work, but this experience suggests that inflation stabilization does not have to come at the cost of greater volatility of real activity; in fact, it suggests that, by anchoring inflation expectations, low and stable inflation is an important precondition for macroeconomic stability.

    Research over the past decade using so-called New Keynesian models has added further support to the proposition that inflation stabilization may contribute to stabilizing employment and output at their maximum sustainable levels. This research has also led to a deeper understanding of the benefits of price stability and the setting of monetary policy in response to changes in economic activity and inflation.

    Repeating the need for price stability as a necessary condition for optimal employment and growth.

    In particular, research has emphasized the interaction between stabilizing inflation and economic activity and has found that price stability can contribute to overall economic stability in a range of circumstances. The intuition


    that leads to the conclusion that stabilizing inflation promotes maximum sustainable output and employment is simple, and it holds in a range of economic models whose policy prescriptions have been dubbed the New Neoclassical Synthesis. To begin, the prices of many goods and services adjust infrequently. Accordingly, under general price inflation, the prices of some goods and services are changing while other prices do not, thus distorting relative prices between different goods and services. As a consequence, the profitability of producing the various goods and services no longer reflects the relative social costs of producing them, which in turn yields an inefficient allocation of resources.

    (Only if there was efficiency in the first place, where many if not most prices are ‘cost plus’ and institutional structure determines many others, such as health care prices, tax laws, corporate law, etc.)

    A policy of price stability minimizes those inefficiencies (Goodfriend and King, 1997; Rotemberg and Woodford, 1997; Woodford, 2003).

    There are several subtleties here. First, in some circumstance, relative prices should change. For example, the rapid technological advances in the production of information-technology goods witnessed over the past decades mean that the prices of these goods relative to other goods and services should decline, because fewer economic resources are required for their production. Conversely, shifts in the balance between global demand for, and supply of, oil require that relative prices change to achieve an appropriate reallocation of resources–in this case, the reduced use of expensive energy.

    (Makes me wonder how does a financial package designed to help people pay their energy and food bills fits in?)

    Thus, the policy prescription refers to stability of the price level as a whole, not to the stability of each individual price.

    Second, the New Neoclassical Synthesis suggests that only those prices that move sluggishly, referred to as sticky prices, should be stabilized. Indeed, these models indicate that monetary policy should try to get the economy to operate at the same level that would prevail if all prices were flexible–that is, at the so-called natural rate of output or employment. Stabilizing sticky prices helps the economy get close to the theoretical flexible-price equilibrium because it keeps sticky prices from moving away from their appropriate relative level while flexible prices are adjusting to their own appropriate relative level. The New Neoclassical Synthesis, therefore, does not suggest that headline inflation, in which the weight on flexible prices is larger, should be stabilized. For example, to the extent that households directly consume energy goods with flexible prices, such as gasoline, headline inflation should be allowed to increase in response to an oil price shock. At the same time, insofar as energy enters as an input in the production of goods whose prices are sticky, stabilizing the level of sticky prices would require that the increase in energy-intensive goods prices be offset by declines in the prices of other goods.

    Yes – AKA, ‘Don’t let a relative value story turn into an inflation story.’

    That reasoning suggests that monetary policy should focus on stabilizing a measure of “core” inflation, which is made up mostly of sticky prices. Simulations with FRB/US, the model of the U.S. economy created and maintained by the staff of the Federal Reserve Board (Mishkin, 2007b), illustrate this point. To keep the simulations as simple as possible, I have assumed that the economy begins at full employment with both headline and core inflation at desired levels. The economy is then assumed to experience a shock that raises the world price of oil about $30 per barrel over two years;

    (It actually went up more than that.)

    the shock is assumed to slowly dissipate thereafter.

    (It hasn’t yet, hence the problem of core converging to headline when headline trends.)

    In each of two scenarios, a Taylor rule is assumed to govern the response of the federal funds rate; the only difference between the two scenarios is that in one, the federal funds rate responds to core personal consumption expenditures (PCE) inflation, whereas in the other, it responds to headline PCE inflation.6 Figure 1 illustrates the results of those two scenarios. The federal funds rate jumps higher and faster when the central bank responds to headline inflation rather than to core inflation, as would be expected (top-left panel). Likewise, responding to headline inflation pushes the unemployment rate markedly higher than otherwise in the early going (top-right panel),

    Maybe. This function has not held true in recent history.

    and produces an inflation rate that is slightly lower than otherwise,

    As above.

    whether measured by core or headline indexes (bottom panels). More important, even for a shock as persistent as this one, the policy response under headline inflation has to be unwound in the sense that the federal funds rate must drop substantially below baseline once the first-round effects of the shock drop out of the inflation data.7

    The basic point from these simulations is that monetary policy that responds to headline inflation rather than to core inflation in response to an oil price shock pushes unemployment markedly higher than monetary policy that responds to core inflation. In addition, because this policy has larger swings in the federal funds rate that must be reversed, it leads to more pronounced swings in unemployment. On the other hand, monetary policy that responds to core inflation does not lead to appreciably worse performance on stabilizing inflation than does monetary policy that responds to headline inflation. Stabilizing core inflation, therefore, leads to better economic outcomes than stabilizing headline inflation.

    Yes, they firmly believe that.

    Although the simplest sticky-price models imply that stabilizing sticky-price inflation and economic activity are two sides of the same coin, the presence of other frictions besides sticky prices can lead to instances in which completely stabilizing sticky-price inflation would not imply stabilizing employment (or output) around their natural rates. For example, in response to an increase in productivity (a positive technology shock), the real wage has to rise to reflect the higher marginal product of labor inputs, which requires either prices to fall or nominal wages to rise for employment to reach its natural rate. If both nominal wages and prices are sticky, a policy of completely stabilizing prices will force the necessary real wage adjustment to occur entirely through nominal wage adjustment, thereby impeding the adjustment of employment to its efficient level (Blanchard, 1997; Erceg, Henderson, and Levin, 2000). Indeed, if wages are much stickier than prices, the best strategy is to stabilize nominal wage inflation rather than price inflation, thereby allowing price inflation to decline to achieve the required increase in real wages.

    Makes sense under mainstream assumptions.

    Fluctuations in inflation and economic activity induced by variation over time in sources of economic inefficiency, such as changes in the markups in goods and labor markets or inefficiencies in labor market search, could also drive a wedge between the goals of stabilizing inflation and economic activity (Blanchard and Galí, 2006; Galí, Gertler, and López-Salido, 2007). For example, in sectors of the economy subject to little competitive pressure, prices that firms set tend to be higher and output lower than would prevail under greater competition. Monetary policy is, of course, unable to offset permanently high markups because of the principle, mentioned earlier, that the long-run Phillips curve is vertical. However, a temporary increase in monopoly power that raises markups would exert upward pressure on prices without, at the same time, reducing the productive potential of the economy. That would, indeed, be a case of a tradeoff between stabilizing inflation and stabilizing output.

    How about a non-resident monopolist at the margin, like the Saudis?

    These examples narrow the degree to which the recent findings of congruence between stabilizing inflation and economic activity apply in all cases, but they do not necessarily overturn the findings. The example of sticky wages would not invalidate the view that stabilizing inflation stabilizes economic activity if wages are sticky, for example, because they are held constant in order to operate as an “insurance” contract between employers and workers (Goodfriend and King, 2001). And for many of the inefficient shocks that drive a wedge between the sustainable level of output and the level of output associated with price stability, monetary policy may be the wrong tool to offset their effects (Blanchard, 2005).

    Of course, central banks at times will still face difficult decisions regarding the short-run tradeoff between stabilizing inflation and output. For example, judging from the fit of New Keynesian Phillips curves, a substantial fraction of overall inflation variability seems related to supply-type shocks

    (Rather than a ‘monetary phenomena’ as they say, inflation can be a supply shock phenomena?)

    that create a tradeoff between inflation and output-gap stabilization (Kiley, 2007b). But the key insight from recent research–that the interaction between inflation fluctuations and relative price distortions should lead to a focus on the stability of nominal prices that adjust sluggishly–will likely prove to have important practical implications that can help contribute to inflation and employment stabilization.

    Stabilizing Inflation as a Robust Policy in the Presence of Uncertainty
    The discussion so far has been based on the premise that the central bank knows the efficient, or natural, rate of output or employment. However, the natural rates of employment and output cannot be directly observed and are subject to considerable uncertainty–particularly in real time. Indeed, economists do not even agree on the economic theory or econometric methods that should be used to measure those rates.

    (And I can give you some good reasons there is no natural rate of unemployment as well.)

    These concerns are perhaps even more severe in the most recent models, where fluctuations in natural rates of output or employment can be very substantial (for example, Rotemberg and Woodford, 1997; Edge, Kiley, and Laforte, forthcoming). Furthermore, because the natural rates in the most recent models are defined as the counterfactual levels of output and employment that would be obtained if prices and wages were completely flexible, the estimated fluctuations in natural rates generated by the research are very sensitive to model specification.

    If a central bank errs in measuring the natural rates of output and employment, its attempts to stabilize economic activity at those mismeasured natural rates can lead to very poor outcomes. For example, most economists now agree that the natural unemployment rate shifted up for many years starting in the late 1960s and that the growth of potential output shifted down for a considerable time after 1970. However, perhaps because those shifts were not generally recognized until much later (Orphanides and van Norden, 2002; Orphanides, 2003), monetary policy in the 1970s seems to have been aimed at achieving unsustainable levels of output and employment. Hence, policymakers may have unwittingly contributed to accelerating inflation that reached double digits by the end of the decade as well as undesirable swings in unemployment. And although subsequent monetary policy tightening was successful in regaining control of inflation, the toll was a severe recession in 1981-82, which pushed up the unemployment rate to around 10 percent.

    How about the tight fiscal policy from the interaction of inflation and the tax structure (described by Governor Mishkin above) that drove the budget to a small surplus in 1979, along with oil gapping from $20 to $40 as the Saudis hiked price and accumulated $US financial assets rather than spending their income, which drained aggregate demand from the US economy.

    Uncertainty about the natural rates of economic activity implies that less weight may need to be put on stabilizing output or employment around what is likely to be a mismeasured natural rate (Orphanides and Williams, 2002). Furthermore, research with New Keynesian models has found that overall economic performance may be most efficiently achieved by policies with a heavy focus on stabilizing inflation (for example, Schmitt-Grohé and Uribe, 2007).

    Back to stabilizing inflation, the main theme of the speech.

    Because monetary policy has not one but two objectives, stabilizing inflation and stabilizing economic activity, it might seem obvious that those objectives would usually, if not always, conflict. As so often occurs with the “obvious,” however, the impression turns out to be incorrect. The economic research that I have discussed today demonstrates, rather, that the objectives of price stability and stabilizing economic activity are often likely to be mutually reinforcing. Thus, the answer to the title of this speech–”Does stabilizing inflation contribute to stabilizing economic activity?”–is, for the most part, yes.

    Price stability is a necessary condition for optimal employment and growth.

    A key policy recommendation from the past three decades of research in monetary economics is that monetary policy makers must always keep their eye on inflation and emphasize the importance of price stability in their actions and communications.

    First time I’ve seen the word ‘action’ regarding inflation, and it’s placed first.

    Doing so does not mean that monetary policy makers are less concerned about stabilizing economic activity. Rather, by appropriately focusing on stabilizing inflation along the lines I have outlined here, monetary policy is more likely to better stabilize economic activity.

    A speech can’t get any more hawkish than that.

    Lots of data between now and March 18th.

    I still expect weakness and rising inflation.

    Posted in Fed | No Comments »

    2008-02-25 US Economic Releases

    Posted by Sada Mosler on 25th February 2008

    2008-02-25 Existing Home Sales

    Existing Home Sales (Jan)

    Survey 4.80M
    Actual 4.89M
    Prior 4.89M
    Revised 4.91M

    2008-02-25 Existing Home Sales MoM

    Existing Home Sales MoM (Jan)

    Survey -1.8%
    Actual -0.4
    Prior -2.2%
    Revised n/a

    A little better than expected.  A glimmer of hope here as well.

    Posted in Daily | No Comments »

    PBOC to stick to ‘tight’ stance

    Posted by Sada Mosler on 25th February 2008

    PBOC to stick to ‘tight’ stance
    Goldman Sachs raises China’s 2008 inflation forecast to 6.8%

    To the extent ‘actual inflation’ (whatever that actually is- I realize the difficulties in that statement) is higher ‘actual real growth’ (same qualifications) is lower.

    Might partially explain high sustained rates of ‘real’ growth?

    Posted in China | 2 Comments »

    The Schroders Economic Viewpoint – Feb 2008

    Posted by Sada Mosler on 25th February 2008

    Interesting in that it totally ignores inflation when predicting CB moves.
    Maybe not only the Fed but the rest of the world’s CB’s don’t care about inflation:

    Into the valley

    One of the characteristics of a recession is a sudden drop off in activity, the point at which a slowdown turns into something more serious. Economists term this a discontinuity or a break in the data and it is this pattern which makes recessions so difficult to spot from simply tracking the daily data releases. There is evidence that we have hit such a point in the US with several indicators taking a tumble over the past month.

    True, but these indicators aren’t yet sufficient:

    For example, the service sector ISM fell to its lowest level since the last recession in 2001,

    The first move of this indicator is very unreliable, and these types of drops have a recent history of getting reversed. The next update will be more meaningful.

    consumer confidence reached a 16 year low

    Yes, but again, this is not a reliable indicator

    and we saw the first fall in payrolls for 4 years as firms trimmed jobs in construction and manufacturing.

    Yes, but how quickly they forget the same was said when the August number came out negative, only to be revised to a very respectable positive number a month later.

    And the December number was also revised up to a reasonable number from a weak initial report. The February number and revised January number will be out a week from Friday.

    Meanwhile, activity in the housing sector remained weak and consumer spending has levelled off. The economy lost momentum at the end of last year with GDP rising just 0.6% at an annualised rate in the fourth quarter.

    This could also be revised up soon as exports were higher than anticipated.

    It is quite possible that this tipped over into a negative quarter in Q1 this year.

    Yes, it’s possible, but this is biased analysis that simply cherry picked the worst possible data.

    The Fed has not been slow to respond and cut rates by a further 50 basis points to 3% at its last meeting to bring the cumulative easing to 225 bps in this cycle. Fed chairman Ben Bernanke has shown that he will adopt an activist stance in the face of downside risks to activity, a departure from the gradualist approach of his predecessor Alan Greenspan. Bernanke is a student of the Great Depression in the US

    Yes, and he has also expressed risks that existed only due to the gold standard of the time and don’t apply to current floating fx policy.

    and so is well aware of the dangers of allowing confidence to slide and the economy falling into a liquidity trap. Sometimes described as pushing on a string, this was also the situation in Japan during the 1990s, where lower interest rates failed to stimulate activity.

    Yes, that can happen due to tight fiscal policy. The difference between now/Japan and the gold standard days is that now there are no quantitative supply side constraints on lending. In the US today as with Japan credit is infinitely available to credit worthy borrowers. Today’s constraints come with bank perceptions of credit worthiness, as well as ‘regulatory over reach’ where bank regulators restrict lending. And, for another example, today the treasury can issue unlimited numbers of treasury securities (as did Japan) as rates at or below the CB’s target rates. On a gold standard, treasury borrowing drives up rates as it competes for funds with the private sector, and those funds are limited by the gold standard.

    The current situation is not as severe as in these episodes, but does share the essential characteristic that the transmission mechanism from central bank rate cuts to the real economy is impaired and not functioning normally.

    Confused as above.

    This, of course, is the credit crunch where banks are tightening or withdrawing credit from the economy even as interest rates fall. Evidence of this is found in the continued tightening of lending conditions apparent in the Fed’s senior loan officer survey despite the fall in policy rates (see chart on front page).

    Again, very different from gold standard constraints and easily overcome if understood, where the gold standard constraints are only overcome by going off it, as the US did domestically in 1934.

    True, however, that employment, growth, and inflation are not functions of interest rates, as is nearly always the case.

    It is this headwind which policy makers not just in the US, but also in the Eurozone and UK need to overcome. The problem extends into the markets for securitised debt which have in many cases dried up. In response to this and the weaker near term performance of the economy, we have reduced our forecast for the Fed funds target rate to 2% by May (previously 2.5%).

    Regardless of inflation!

    These inflation concerns have weighted more heavily in Europe than the US where the Bank of England and ECB continue to voice concern about second round effects from higher commodity prices into wages. Nonetheless, we still see scope for a further easing of policy from both central banks along with the Federal Reserve in coming months as activity weakens (see below for more on the UK and Eurozone).

    More generally, our baseline view remains one where global growth slows in 2008 and quells inflation fears in the second half of the year. Our forecasts will be reviewed next month and although we already have a weak profile for US GDP growth we will trim our baseline projections. It is more than likely that the US is now in recession. However, we will still look for a modest recovery in the second half of the year as the housing market stabilises and the economy begins to experience some of the effects of looser fiscal and monetary policy. Nonetheless, growth is expected to remain below trend throughout 2008, so it will feel more like a stabilisation than a recovery. More of an “L” shaped recovery than a “V”.

    Posted in Articles, Inflation, Interest Rates | 2 Comments »

    Reuters: Oil Falls Below $98 on Swelling US Crude Supplies

    Posted by Sada Mosler on 22nd February 2008

    Supplies probably aren’t ‘excessive’ or US companies wouldn’t import so much and futures spreads would be in contango instead of backwardation, and WTI now trading above Brent is another sign inventories are back towards the tight side.

    Oil Falls Below $98 on Swelling US Crude Supplies

    Oil held steady around $98 a barrel on Friday, off its recent record above $101 as rising U.S. crude and gasoline stockpiles added to evidence of slowing demand in the world’s largest consumer.

    Posted in Articles, Oil | 4 Comments »

    Bloomberg: Fed Sees Rate Low `for a Time’ Then Possible Reversal

    Posted by Sada Mosler on 22nd February 2008

    Fed Sees Rate Low `for a Time’ Then Possible Reversal (Update1)

    by Scott Lanman

    Enlarge Image/Details

    (Bloomberg) Federal Reserve officials signaled they are prepared to quickly reverse last month’s interest-rate cuts after concluding that borrowing costs need to be kept low for now.

    Policy makers cut their 2008 growth forecasts and said that rates should be held down “for a time,” minutes of their Jan. 29-30 meeting showed yesterday. They also called inflation “disappointing,” and some foresaw raising rates, possibly at a “rapid” pace once the economy recovers.

    The threat goes beyond remarks by Chairman Ben S. Bernanke, who last week warned that policy will have to be “calibrated” over the next year to meet both inflation and growth objectives.

    Yes, the issue is they believe an output gap greater than ‘zero’ is required to bring down inflation over time; so, they can’t afford to let the economy fully recover and grow at an inflationary pace.

    So while they don’t want to allow a massive collapse, they also don’t want the output gap to be too narrow to bring down inflation.

    This could mean, for example, a GDP growth rate speed limit of between 1% and 2% given current data points of GDP growth and coincident inflation.

    That would mean achieving ‘stability’ at current GDP and employment levels rather than a ‘recovery’ to lower unemployment and 2.5%+ GDP.

    With inflation expectations considered to be on the verge of elevating, the FOMC now faces elevating risks of both inflation and recession.

    Posted in Articles, Fed, Inflation | 8 Comments »