Tag Archives: Bernanke

FT: Time for comrade Paulson to pull the plug on the Fannie and Freddie charade

Posted on by


[Skip to the end]

Totally misguided regarding public purpose.

For one thing, the shareholders of the agencies are still there for ‘market discipline’ – all that’s been done for them is eliminated liquidity issues, not solvency issues.

At the end of the day a lot of houses were built for a lot of people who live there.

These are real assets and real standards of living that have been supported.

Is anyone arguing it’s a waste of real resources? That’s the real issue.

Also, fiscal policy is all about demand management, not a ‘pretty’ balance sheet by some arbitrary standard.

And, of course, without the fundamental understanding that the funds to pay taxes and buy government securities comes from government spending policy is likely to be suboptimal at best.

Also, note the bias towards ‘inflation’ that’s built into the political process.

This all supports prices and GDP.

There are no supply side constraints on government spending and/or lending with floating fx, unlike the gold standard of 1907/1930, and other fixed fx regimes, past and present.

Time for comrade Paulson to pull the plug on the Fannie and Freddie charade

by Willem Buiter

Are Fannie Mae and Freddie Mac adequately capitalised, as asserted recently by US Treasury Secretary Hank Paulson, Federal Reserve Board Chairman Ben Bernanke and their regulator Office of Federal Housing Enterprise Oversight Director James B. Lockhart III? The answer is: obviously not, if these two government-sponsored enterprises of the US federal government had to make a living on normal private commercial terms. Obviously not if they were subject to the market discipline preached by Paulson and Bernanke, but not practiced when it comes to large financial institutions perceived as systemically important (too large or too interconnected to fail) or too politically sensitive to fail.


[top]

Share

Bernanke’s July 07 speech and today’s inflation issue

Posted on by


[Skip to the end]

From Chairman Bernanke’s July 07 speech:

As you know, the control of inflation is central to good monetary policy. Price stability, which is one leg of the Federal Reserve’s dual mandate from the Congress, is a good thing in itself, for reasons that economists understand much better today than they did a few decades ago. Inflation injects noise into the price system, makes long-term financial planning more complex, and interacts in perverse ways with imperfectly indexed tax and accounting rules. In the short-to-medium term, the maintenance of price stability helps avoid the pattern of stop-go monetary policies that were the source of much instability in output and employment in the past. More fundamentally, experience suggests that high and persistent inflation undermines public confidence in the economy and in the management of economic policy generally, with potentially adverse effects on risk-taking, investment, and other productive activities that are sensitive to the public’s assessments of the prospects for future economic stability. In the long term, low inflation promotes growth, efficiency, and stability–which, all else being equal, support maximum sustainable employment, the other leg of the mandate given to the Federal Reserve by the Congress.

Note that the current anti-‘inflation’ argument within the FOMC is that the high prices for imports take discretionary income from consumers that reduces domestic demand and reduces the ability to service domestic debt. There was no thought or mention of that reason for ‘inflation’ being a ‘bad thing’ a year ago.

I suppose one could argue that this problem is due to there not being inflation, as with wages ‘well-anchored’ there is only a relative value story. If we did have ‘real inflation’ with rising wages, we wouldn’t have the problem of insufficient consumer income to support domestic demand, but we would have the traditional negatives from inflation.

But Bernanke’s response to Congress was that exports are replacing domestic consumption and that is a ‘good thing’ as it brings the US trade back to ‘balance’ and restores ‘national savings’ – the old mercantilist, gold standard imperatives. But it does leave weak domestic demand and rising prices. That brings us back to the tail end of Bernanke’s statement:

Admittedly, measuring the long-term relationship between growth or productivity and inflation is difficult. For example, it may be that low inflation has accompanied good economic performance in part because countries that maintain low inflation tend to pursue other sound economic policies as well. Still, I think we can agree that, at a minimum, the opposite proposition–that inflationary policies promote employment growth in the long run–has been entirely discredited and, indeed, that policies based on this proposition have led to very bad outcomes whenever they have been applied.

Seems that either way you look at it, rising prices (whether you call it inflation or not) lead to ‘bad’ outcomes.

And it sure looks to the dissenters in the FOMC that this is exactly what is happening. Only time will tell, but all Fed speakers now agree the risk of inflation is elevated substantially, and we will soon see if they still agree the cost of letting the inflation cat out of the bag is far higher than letting a near-term recession run its course and (hopefully) contain prices and keep a relative value story from turning into an inflation story.

Also, not how the Fed continues to use ‘other tools’ for market functioning as Bernanke just now indicates they will keep lending directly to their primary dealers.


[top]

Share

Re: Mainstream sounding off on inflation

Posted on by


[Skip to the end]

(an email exchange)

On Thu, Jun 26, 2008 at 2:25 PM, Tom wrote:
>
>
>

 

Where’s Bernanke’s Inner Volcker?

by Larry Kudlow

(NRO) On the day after an unusually important Fed policy meeting both gold and stocks severely rebuked the central bank’s decision to take no action in support of the weak dollar or to curb rapidly growing inflation. Gold spiked $30, a clear message that Bernanke & Co. won’t stop inflation. Stocks plunged over 200 points, an equally clear message that the Fed’s cheap-dollar inflation is damaging economic growth.

These market warnings are two sides of the same coin. Inflation, which is caused by excess dollar creation, is the cruelest tax of all. It is a tax on consumer and family purchasing power. It is a tax on corporate profits. It is a tax on the value of stocks, homes, and other assets. Crucially, the capital-gains tax — the most important levy on all wealth-creating assets — is un-indexed for inflation. Hence, long before Barack Obama or Congress can legislatively raise the capital-gains tax rate, rising inflation is increasing the effective tax rate on real capital gains. That’s an economy-wide problem.

By doing nothing at the June 25 meeting the Fed turned its back on the very inflation-tax problem it helped create. The spanking it received from the markets was well deserved.

Former Fed chairman Paul Volcker, who is advising Sen. Obama’s presidential campaign, issued a stern warning at the New York Economics Club a few months back. He said inflation is real and the dollar is in crisis. Soon after, Fed head Ben Bernanke changed his tune in public speeches, pledging greater vigilance on inflation and hinting at a defense of the dollar. Treasury man Henry Paulson and President Bush also stepped up their rhetoric regarding a stronger greenback.

But words were no substitute for actions this week.

It is an interesting historical footnote that Paul Volcker is still highly regarded as the greatest inflation fighter of our time. Working with Ronald Reagan, it was Volcker who slew the inflation dragon in the 1980s. Indeed, the combination of tighter monetary control from the Fed and abundant new tax incentives from Reagan launched an unprecedented twenty-five-year prosperity boom characterized by strong growth and rock-bottom inflation. At the center of the boom was a remarkable 12-fold rise in stock market values, a symbol of the renaissance of American capitalism. But that was then and this is now.

Talk of major new tax hikes is in the air today, while the inflationary decline of the American dollar is plain fact. It’s as though our economic memory is being erased, both in tax and monetary terms. Staunchly optimistic supply-siders Arthur Laffer and Steve Moore are even finishing a book on the subject. Called The Gathering Economic Storm, its concluding chapter is titled: “The Death of Economic Sanity.”

The Volcker anti-inflation model presumably handed down to Alan Greenspan and Ben Bernanke always argued that price stability is the cornerstone of economic growth. Yet it appears that today’s Fed has reverted to a 1970s-style Phillips-curve mentality that argues for a trade-off between unemployment and inflation, rather than the primacy of price stability.

History teaches us otherwise. It states that since rising inflation corrodes economic growth, inflation and unemployment move together — not inversely. Even in the last 18 months this is proving true. Inflation bottomed around 1 percent in late 2006. Unemployment bottomed at 4.4 percent about 6 months later. Today, the CPI inflation rate has climbed to over 4 percent, wholesale prices have jumped to 7 percent, and import prices have spiked to 18 percent. Unemployment, meanwhile, has moved up to 5.5 percent.

Over the past five years the greenback has lost 40 percent of its value. Oil is close to $140 a barrel. And gold, now trading above $900 an ounce, is warning that if the Fed fails to stop creating excess dollars, inflation could rise to 6 or 7 percent.

I had hoped Ben Bernanke would reveal his inner Volcker at Wednesday’s meeting. He didn’t. While the Fed acknowledged that “the upside risks to inflation and inflation expectations have increased,” it took no action taken to raise the fed funds target rate, which now stands at 2 percent and is actually minus-2 percent adjusted for inflation. Even a quarter-point rate hike — merely taking back the last easing move in April — would have been a shot heard ’round the world in defense of the beleaguered dollar. It didn’t happen.

Only Richard Fisher, president of the regional Dallas Fed, dissented in favor of a higher target rate. That leaves the hard-money Fisher as the lone remaining protégé of Paul Volcker.

Of course, if Fed policymakers reconvene immediately to right their wrongheaded mistake, the value of our money could be quickly restored. The next scheduled Open Market meeting is August 5, but they needn’t wait that long.

Let’s hope they come to their senses.

>
>
>

Good, thanks, as expected, this is where the mainstream (no pun intended) is going, though Kudlow is of course not ‘center’ mainstream.

Good luck to us!


[top]

Share

Bloomberg: Mainstream criticism of FOMC

Posted on by


[Skip to the end]

As mainstream economists, the Fed knows it took a very large risk when it cut aggressively, hoping its forecasts for ‘moderating inflation’ would play out, and knowing the following would happen if ‘inflation’ accelerated.

Bernanke May Regret Interest-Rate Cuts, Lawson Says

by Kim-Mai Cutler

(Bloomberg) Former U.K. Chancellor of the Exchequer Nigel Lawson said Federal Reserve Chairman Ben S. Bernanke may be “regretting” the fastest pace of U.S. interest-rate cuts since 1984 as global inflation accelerates.

The Fed reduced its benchmark rate by 3.25 percentage points to 2 percent between September and April 30 to stave off a recession following the collapse of the U.S. subprime-mortgage market. The Bank of England, also facing a slowdown, cut its key rate by 0.75 percentage point to 5 percent. The European Central Bank left rates unchanged at 4 percent for a year and signaled this month it may raise them in July.

“The Bank of England has been very cautious and careful and it has been much closer to the views of the European Central Bank,” Lawson, 76, who was finance minister from 1983 to 1989 under former Prime Minister Margaret Thatcher, said in a telephone interview. “It has not gone conspicuously the way of the Fed, where I suspect that Mr. Bernanke’s now regretting it.”

U.S. consumer prices rose 0.6 percent in May, the most since November, the Labor Department said June 13. Inflation in the euro area accelerated last month to a 3.7 percent annual rate, the fastest since June 1992, the European Union reported June 16.

Inflation caused by rising commodity prices is the biggest threat to the world economy, eclipsing concern about the seizure in the credit markets, finance ministers from the Group of Eight nations said June 14. The World Bank said on June 10 that global economic growth will probably slow to 2.7 percent this year from 3.7 percent in 2007.

Oil ‘Bubble’
Rising food prices and a “speculative bubble” in oil markets will prompt central banks to lift rates, leading to a “growth recession” where the rate of expansion is lower than historical trends, Lawson said in the interview.

Crude oil rose 95 percent from a year ago and traded at an all-time high of $139.89 a barrel in New York June 16. Corn for December delivery also traded at a record $7.915 in Chicago.

“Most of the central banks are very, very clear on just how dangerous it is to let inflationary expectations get out of hand,” he said.

Traders see a 48 percent chance the Fed will raise its target rate for overnight bank loans from 2 percent as early as August, up from 4.1 percent odds a month ago, futures contracts on the Chicago Board of Trade show. The chances of an increase in October are 99 percent, the contracts show.

Michelle Smith, a Fed spokeswoman in Washington, declined to comment on Lawson’s remarks.

‘Shallow’ Recession
The slowdown in the U.K. is going to last “longer than most people expect,” while remaining “shallow,” Lawson said. The economy, the second-largest in Europe, grew 0.4 percent in the first quarter, its weakest pace since 2005, as higher credit costs hurt construction and business services slowed, according to the Office for National Statistics.

“This is the hangover after the binge,” Lawson said. “It’s going to be very, very difficult for the next two to three years for the global economy.”

The U.K. won’t adopt the euro in place of the pound as a global slowdown heightens tensions between members of the 27- nation European Union, Lawson said. Ireland vetoed the bloc’s new government treaty June 13, sinking an agreement that needed ratification by all EU countries.

“There are going to be considerable strains within the euro area,” Lawson said. “There are going to be a number of countries that found the single currency satisfactory during the benign period, that are now going to hurt much more under these difficult conditions.”


[top]

Share

Bloomberg: Poole jumps in

Posted on by



[Skip to the end]

The Fed’s mission is to not let a relative value story turn into an inflation story.

When food/fuel prices rise, consumers have less to spend on other things; so, they should moderate to keep it all a relative value story.

But even though core CPI hasn’t gone up as fast as headline (YET), it has gone up to 2.3%. Rather than stay the same or go down; so, the relative value story is slowing turning into an inflation story.

And my guess is that most of Congress isn’t going to like the idea that the Fed’s job is to keep wages ‘behaving’ (suppressed) when food/fuel goes up, as Poole states below:

Poole Says Fed Needs to Help Prevent Wage Increase

by Kathleen Hays and Timothy R. Homan

(Bloomberg) The Federal Reserve needs to prevent the public’s expectation that inflation will accelerate from spurring demands for higher wages, William Poole, former St. Louis Fed President, said today.

“You want to keep wages behaving,” Poole said in an interview on Bloomberg Television. Once the public’s anticipation of rising prices begins to stoke demands for higher wages, “the jig is up” and inflation becomes harder to eradicate.

The public’s outlook for annual inflation over five years stood at 3.4 percent in June, up from 2.9 percent the same month last year, according to the Reuters/University of Michigan Survey.

Comments by Fed Chairman Ben S. Bernanke and other policy makers this month have compelled traders to increase bets the central bank will start to lift the main lending rate later this year to keep rising food and energy costs from influencing labor agreements and other prices.

“We should be moving sooner rather than later,” Poole said, referring to an interest-rate increase.


[top]

Share

Re: Mishkin signal?

Posted on by


[Skip to the end]

(an email exchange)

>
>   On Tue, Jun 10, 2008 at 8:12 AM, anonymous wrote:
>

>   Fisher’s remark induces one to wonder if Ambrose Evans-Pritchard is
>   correct in stating that Fed policy is now being concocted from Dallas.
>
>   The recent spate of criticism directed at Bernanke and Fed doves by
>   various current and past Fed officials, including Paul Volcker, implies
>   that there has been a revolt within the Fed. Mishkin’s resignation
>   supports the view that the hawks have won.
>
>

Agreed. I’ve been calling it a ‘palace revolt’.

Bernanke’s limit was inflation expectations as anticipated back in August, but he let it go a lot further than I thought he would.

The dallas crew is confused on a lot of things as well, but inflation expectations are the unifying force of the FOMC right now. When Yellen cried uncle, that was my signal.


[top]

Share

June 9 Bernanke speech

Posted on by


[Skip to the end]

Outstanding Issues in the Analysis of Inflation

Nonetheless, much remains to be learned about both inflation forecasting and inflation control. In the spirit of this conference, my remarks this evening will highlight some key areas where additional research could help to provide a still-firmer foundation for monetary policymaking.

Good start!

Before turning to those issues, however, I would like to provide a brief update on the outlook for the economy and policy, beginning with the prospects for growth. Despite the unwelcome rise in the unemployment rate that was reported last week, the recent incoming data, taken as a whole, have affected the outlook for economic activity and employment only modestly. Indeed, although activity during the current quarter is likely to be weak, the risk that the economy has entered a substantial downturn appears to have diminished over the past month or so. Over the remainder of 2008, the effects of monetary and fiscal stimulus, a gradual ebbing of the drag from residential construction, further progress in the repair of financial and credit markets, and still-solid demand from abroad should provide some offset to the headwinds that still face the economy. However, the ongoing contraction in the housing market and continuing increases in energy prices suggest that growth risks remain to the downside.

Downside risks diminished, but still remain.

One of the most effective means by which the Federal Reserve can help to restore moderate growth over time and to reduce the associated downside risks is by supporting the return of financial markets to more-normal functioning. We have taken a number of actions to promote financial stability and remain strongly committed to that objective.

Technical market functioning action vs. interest rate cuts.

Inflation has remained high, largely reflecting sharp increases in the prices of globally traded commodities. Thus far, the pass-through of high raw materials costs to the prices of most other products and to domestic labor costs has been limited, in part because of softening domestic demand. However, the continuation of this pattern is not guaranteed and future developments in this regard will bear close attention. Moreover, the latest round of increases in energy prices has added to the upside risks to inflation and inflation expectations. The Federal Open Market Committee will strongly resist an erosion of longer-term inflation expectations, as an unanchoring of those expectations would be destabilizing for growth as well as for inflation.

Upside risks to inflation and inflation expectations have increased as the downside risks to growth have diminished.

Turning now to the principal topic of my remarks, I will briefly touch on four topics of particular interest for policymakers: commodity prices and inflation, the role of labor costs in the price-setting process, issues arising from the necessity of making policy in real time, and the determinants and effects of changes in inflation expectations.

Commodity Prices and Inflation

Rapidly rising prices for globally traded commodities have been the major source of the relatively high rates of inflation we have experienced in recent years, underscoring the importance for policy of both forecasting commodity price changes and understanding the factors that drive those changes.

Policymakers and other analysts have often relied on quotes from commodity futures markets to derive forecasts of the prices of key commodities. However, as you know, futures markets quotes have underpredicted commodity price increases in recent years, leading to corresponding underpredictions of overall inflation. The poor recent record of commodity futures markets in forecasting the course of prices raises the question of whether policymakers should continue to use this source of information and, if so, how.

It’s worse – they have been reading the market information incorrectly, confusing the difference between perishable from non-perishable commodities in regards to the term structures of futures contracts.

Despite this recent record, I do not think it is reasonable, when forecasting commodity prices, to ignore the substantial amounts of information about supply and demand conditions that are aggregated by futures markets. Indeed, the use of some simple alternatives–such as extrapolating recent commodity price trends–would require us to assume that investors in commodity futures can expect to earn supernormal risk-adjusted returns, inconsistent with principles of financial arbitrage. However, it does seem reasonable–and consistent with the wide distributions of commodity price expectations implied by options prices–to treat the forecasts of commodity prices obtained from futures markets, and consequently the forecasts of aggregate price inflation, as highly uncertain.

Futures markets for non-perishables express inventory conditions, not price expectations per se.

These considerations raise several questions for researchers: First, is it possible to improve our forecasts of commodity prices, using information from futures markets but possibly other information as well? For example, the markets for longer-dated futures contracts are often quite illiquid, suggesting that the associated futures prices may not effectively aggregate all available information. Second, what are the implications for the conduct of monetary policy of the high degree of uncertainty that attends forecasts of commodity prices? Although theoretical analyses often focus on the case in which policymakers care only about expected economic outcomes and not the uncertainty surrounding those outcomes, in practice policymakers are concerned about the risks to their projections as well as the projections themselves. How should those concerns affect the setting of policy in this context?

They need to understand what futures markets for non-perishables express.

Empirical work on inflation, including much of the classic work on Phillips curves, has generally treated changes in commodity prices as an exogenous influence on the inflation process, driven by market-specific factors such as weather conditions or geopolitical developments.

Or imperfect competition? Like the Saudis and/or Russians and/or Iranians setting price?

By contrast, some analysts emphasize the endogeneity of commodity prices to broad macroeconomic and monetary developments such as expected growth, expected inflation, interest rates, and currency movements. Of course, in reality, commodity prices are influenced by both market-specific and aggregate factors. Market-specific influences are evident in the significant differences in price behavior across individual commodities, which often can be traced to idiosyncratic supply and demand factors. Aggregate influences are suggested by the fact that the prices of several major classes of commodities, including energy, metals, and grains, have all shown broad-based gains in recent years. In particular, it seems clear that commodity prices have been importantly influenced by secular global trends affecting the conditions of demand and supply for raw materials.

And at least some influence from pension funds engaging in passive commodity strategies?

We have seen rapid growth in the worldwide demand for raw materials, which in turn is largely the result of sustained global growth–particularly resources-intensive growth in emerging market economies. And factors including inadequate investment, long lags in the development of new capacity, and underlying resource constraints have caused the supplies of a number of important commodity classes, including energy and metals, to lag global demand. These problems have been exacerbated to some extent by a systematic underprediction of demand and overprediction of productive capacity for a number of key commodities, notably oil. Further analysis of the range of aggregate and idiosyncratic determinants of commodity prices would be fruitful.

And biofuels converting our food supply to energy, thus linking the price of the two?

I have only mentioned a few of the issues raised by commodity price behavior for inflation and monetary policy. Here are a few other questions that researchers could usefully address: First, how should monetary policy deal with increases in commodity prices that are not only large but potentially persistent?

Attempt to add to demand with aggressive rate cuts like the FOMC has done?

Second, does the link between global growth and commodity prices imply a role for global slack, along with domestic slack, in the Phillips curve? Finally, what information about the broader economy is contained in commodity prices? For example, what signal should we take from recent changes in commodity prices about the strength of global demand or about expectations of future growth and inflation?

Or the emergence of imperfect competition and price setters as excess capacity dwindles?

The Role of Labor Costs in Price Setting

Basic microeconomics tells us that marginal cost should play a central role in firms’ pricing decisions.

More precisely, they have been assuming pricing where marginal cost and marginal revenue curves cross, not cost plus pricing.

And, notwithstanding the effects of changes in commodity prices on the cost of production, for the economy as a whole, by far the most important cost is the cost of labor.

Yes, and the cost of labor is also closely tied to the share of the output that goes to labor.

Over the past decade, formal work in the modeling of inflation has treated marginal cost, particularly the marginal cost of labor, as central to the determination of inflation.2 However, the empirical evidence for this linkage is less definitive than we would like.

‘Like’??? Yes, they blamed labor unions for the 1970s inflation, and now they would ‘like’ support for that presumption?

This mixed evidence is one reason that much Phillips curve analysis has centered on price-price equations with no explicit role for wages.

Problems in the measurement of labor costs may help explain the absence of a clearer empirical relationship between labor costs and prices. Compensation per hour in the nonfarm business sector, a commonly used measure of labor cost, displays substantial volatility from quarter to quarter and year to year, is often revised significantly, and includes compensation that is largely unrelated to marginal costs–for example, exercises (as opposed to grants) of stock options. These and other problems carry through to the published estimates of labor’s share in the nonfarm business sector–the proxy for real marginal cost that is typically used in empirical work. A second commonly used measure of aggregate hourly labor compensation, the employment cost index, has its own set of drawbacks as a measure of marginal cost. Indeed, these two compensation measures not infrequently generate conflicting signals of trends in labor costs and thus differing implications for inflation.

The interpretation of changes in labor productivity also affects the measurement of marginal cost. As economists have recognized for half a century, labor productivity tends to be procyclical, in contrast to the theoretical prediction that movements along a stable, conventional production function should generate countercyclical productivity behavior. Many explanations for procyclical productivity have been advanced, ranging from labor hoarding in downturns to procyclical technological progress. A better understanding of the observed procyclicality of productivity would help us to interpret cyclical movements in unit labor costs and to better measure marginal cost.

The relationship between marginal cost, properly measured, and prices also depends on the markups that firms can impose.

Right, this assumes they attempt to price where marginal cost curves cross with marginal revenue curves.

One important open question is the degree to which variation over time in average markups may be obscuring the empirical link between prices and labor costs. Considerable work has also been done on the role of time-varying markups in the inflation process, but a consensus on the role of changing markups on the inflation process remains elusive. More research in this area, particularly with an empirical orientation, would be welcome.

Real-Time Policymaking

The measurement issues I just raised point to another important concern of policymakers, namely, the necessity of making decisions in “real time,” under conditions of great uncertainty–including uncertainty about the underlying state of the economy–and without the benefit of hindsight.

In the context of Phillips curve analysis, a number of researchers have highlighted the difficulty of assessing the output gap–the difference between actual and potential output–in real time. An inability to measure the output gap in real time obviously limits the usefulness of the concept in practical policymaking. On the other hand, to argue that output gaps are very difficult to measure in real time is not the same as arguing that economic slack does not influence inflation; indeed, the bulk of the evidence suggests that there is a relationship, albeit one that may be less pronounced than in the past.

That’s a big issue. They suspect the Phillips Curve is very flat, which means large changes in the output gap are needed to change the price level.

These observations suggest two useful directions for research: First, more obviously, there is scope to continue the search for measures or indicators of output gaps that provide useful information in real time. Second, we need to continue to think through the decision procedures that policymakers should use under conditions of substantial uncertainty about the state of the economy and underlying economic relationships. For example, even if the output gap is poorly measured, by taking appropriate account of measurement uncertainties and combining information about the output gap with information from other sources, we may be able to achieve better policy outcomes than would be possible if we simply ignored noisy output gap measures. Of course, similar considerations apply to other types of real-time economic information.

This is particularly problematic as ultimately they see their role as altering the output gap to control inflation expectations.

Inflation itself can pose real-time measurement challenges. We have multiple measures of inflation, each of which reflects different coverage, methods of construction, and seasonality, and each of which is subject to statistical noise arising from sampling, imputation of certain prices, and temporary or special factors affecting certain markets. From these measures and other information, policymakers attempt to infer the “true” underlying rate of inflation. In other words, policymakers must read the incoming data in real time to judge which changes in inflation are likely to be transitory and which may prove more persistent.

Seems more important for the FOMC should be to determine what measure of inflation, if held stable, optimizes long-term growth and employment? Without that, what do they have under mainstream theory?

Getting this distinction right has first-order implications for monetary policy: Because monetary policy works with a lag, policy should be calibrated based on forecasts of medium-term inflation, which may differ from the current inflation rate. The need to distinguish changes in the inflation trend from temporary movements around that trend has motivated attention to various measures of “core,” or underlying, inflation, including measures that exclude certain prices (such as those of food and energy), “trimmed mean” measures, and others, but other approaches are certainly worth consideration.8 Further work on the problem of filtering the incoming data so as to obtain better measures of the underlying inflation trend could be of great value to policymakers.

I’m sure they are troubled about cutting rates into a triple negative supply shock based on forecasts of lower inflation that didn’t materialize.

The necessity of making policy in real time highlights the importance of maintaining and improving the economic data infrastructure and, in particular, working to make economic data timelier and more accurate. I noted earlier the problems in interpreting existing measures of labor compensation. Significant scope exists to improve the quality of price data as well–for example, by using the wealth of information available from checkout scanners or finding better ways to adjust for quality change. I encourage researchers to become more familiar with the strengths and shortcomings of the data that they routinely use. Besides leading to better analysis, attention to data quality issues by researchers often leads to better data in the longer term, both because of the insights generated by research and because researchers are important and influential clients of data collection agencies.

Implying that ‘if only they had better data they might not have made the same decisions’.

Inflation Expectations

Finally, I will say a few words on inflation expectations, which most economists see as central to inflation dynamics.

All mainstream economists. As Vice Chairman Kohn stated a few years ago, ‘the entire success of the US economy over the last twenty years can be attributed to successfully controlling inflation expectations’.

But there is much we do not understand about inflation expectations, their determination, and their implications. I will divide my list of questions into three categories.

First, we need to understand better the factors that determine the public’s inflation expectations. As I discussed in some detail in a talk at the National Bureau of Economic Research last summer, much evidence suggests that expectations have become better anchored than they were a few decades ago, but that they nonetheless remain imperfectly anchored. It would be quite useful for policymakers to know more about how inflation expectations are influenced by monetary policy actions, monetary policy communication, and other economic developments such as oil price shocks.

The growing literature on learning in macroeconomic models appears to be a useful vehicle to address many of these issues.10 In a traditional model with rational expectations, a fixed economic structure, and stable policy objectives, there is no role for learning by the public. In such a model, there is generally a unique long-run equilibrium inflation rate which is fully anticipated; in particular, the public makes no inferences based on central bankers’ words or deeds. But in fact, the public has only incomplete information about both the economy and policymakers’ objectives, which themselves may change over time. Allowing for the possibility of learning by the public is more realistic and tends to generate more reasonable conclusions about how inflation expectations change and, in particular, about how they can be influenced by monetary policy actions and communications.

Yes, the mainstream does consider that a serious topic of discussion!

The second category of questions involves the channels through which inflation expectations affect actual inflation. Is the primary linkage from inflation expectations to wage bargains, or are other channels important? One somewhat puzzling finding comes from a survey of business pricing decisions conducted by Blinder, Canetti, Lebow, and Rudd, in which only a small share of respondents claimed that expected aggregate inflation affected their pricing at all. How do we reconcile this result with our strong presumption that expectations are of central importance for explaining inflation?

Easy – they don’t matter at all. But then they are left with no theory of the price level, apart from the relative prices; so, they MUST matter.

Perhaps expectations affect actual inflation through some channel that is relatively indirect. The growing literature on disaggregated price setting may be able to shed some light on this question.

Good luck.

Finally, a large set of questions revolve around how the central bank can best monitor the public’s inflation expectations. Many measures of expected inflation exist, including expectations taken from surveys of households, forecasts by professional economists, and information extracted from markets for inflation-indexed securities. Unfortunately, only very limited information is available on expectations of price-setters themselves, namely businesses. Which of these agents’ expectations are most important for inflation dynamics, and how can central bankers best extract the relevant information from the various available measures?

Someday they will realize the currency itself is a simple public monopoly, and the price level is necessarily a function of prices paid by government. But that someday is nowhere in site; so, keep your eye on what they consider inflation expectations for clues to their next move.

Conclusion

This evening I have touched on only a few of the questions that confront policymakers as we deal with the challenges we face. The contributions of economic researchers in helping us to address these and other important questions have been and will continue to be invaluable. I will conclude by offering my best wishes for an interesting and productive conference.


[top]

Share

Bloomberg: Jason Furman now top dog for Obama

Posted on by


[Skip to the end]

Obama Names Rubin Ally Furman to Economic Policy Post

by Kim Chipman and Matthew Benjamin

(Bloomberg) Barack Obama’s presidential campaign today named Jason Furman, who worked closely with former Treasury Secretary Robert Rubin, as economic policy director.

Not a good sign – Ruben has the fundamental accounting identity of national income accounting- government deficit = non-government surplus – completely confused. He thinks deficits take away from savings when they add to savings.

Furman, 37, most recently worked as an economist and budget expert at the Brookings Institution in Washington, where he headed the Hamilton Project, an economic policy research group aligned with the Democratic Party that was founded by Rubin, now chairman of Citigroup Inc.’s executive committee.

A bunch of deficit terrorists.

Obama today begins a two-week tour of tightly contested states including Missouri and Florida to tout his plan for jumpstarting a slowing economy. The Illinois senator says he, not Republican rival John McCain, is best suited to create jobs, provide tax relief and revive the middle class. Obama, who has struggled to attract lower-income workers, seeks to link McCain to what he deems the failed policies of President George W. Bush.

All he’s going to do is link himself to higher taxes and link McCain to tax cuts. Not a good strategy!

Hamilton Project

Furman’s appointment allies Obama’s campaign with leading economic centrists in the Democratic Party, foremost among them is Rubin, 69, who helped found the Hamilton Project in 2006 and is on the group’s advisory council. Furman is a former adviser to 2004 Democratic presidential nominee John Kerry.

Rubin orchestrated President Bill Clinton’s economic policy of promoting free trade and reducing the federal budget deficit.

Clinton caught the tail wind of the 5% GDP deficits of the early 90’s that pumped in income and savings, and allowed the economy to expand until the surpluses generated by the countercyclical tax structure destroyed almost $1 trillion in net financial equity and caused the economy to collapse in 2000.

Obama says he favors free-trade pacts as long as they include stronger protections for workers and the environment. He also advocates budgeting rules that require new spending proposals or tax changes be paid for by cuts to other government programs or new revenue-generating sources.

Pay Go – he’s all about ‘fiscal responsibility’ which is the road to high unemployment, slow growth, and expanded inequality.

Furman and Austan Goolsbee, a University of Chicago economist who until recently was Obama’s top economic adviser, told reporters today that Obama’s “pay-as-you-go” position contrasts with McCain’s. They claim that the Republican senator from Arizona doesn’t provide details about how he would pay for his economic proposals.

McCain has it backwards and is anti-deficit as well, as he wants to cut taxes now to bring deficits down later. But while that strategy is confused, at least it will initially add to demand, employment, and growth. And inflation…

Consequence of Bush Policies

They also criticized McCain, 71, for what they say are proposals that would increase the federal budget deficit and fail to provide short-term stimulus to the economy

Most any increase in the deficit will add aggregate demand and help support GDP.

and tied him to Bush policies they said were responsible for the current economic slowdown.

He let the deficit get too small as it tailed off after the 2003 fiscal package.

Note they never mention inflation, and McCain probably doesn’t either. When you believe the Fed alone is responsible for inflation, you can run any deficit you want without worrying about it. And it was Bernanke who ran to Congress urging them to add to the deficit not long ago, indicating he also believes inflation is solely up to the Fed.

“We did not arrive at the doorstep of our current economic crisis by some accident of history,” Obama said today. “This was not an inevitable part of the business cycle that was beyond our power to avoid. It was the logical conclusion of a tired and misguided philosophy that has dominated Washington for far too long.”

Right – fiscal responsibility is the enemy, and both parties push it.

McCain’s campaign responded today, saying that Obama’s proposals will lead to higher taxes, further weaken the economy and hurt job creation.

Why is Obama taking the initiative of branding himself as the symbol of higher taxes?

“While hardworking families are hurting and employers are vulnerable, Barack Obama has promised higher income taxes, Social Security taxes, capital gains taxes, dividend taxes, and tax hikes on job creating businesses,” McCain spokesman Tucker Bounds said in a statement.

Obama opens the door to damaging counter-punches with every economic initiative.

Neither party has any obvious economic initiative to ‘fix’ things, so they are both better off allowing the other to lead and then get shot down by the press. Obama seems to be falling into this trap more than McCain.

McCain Fundraiser

McCain today attended a fund raiser in Richmond, Virginia, raising $800,000 for his campaign and other Republicans.

Obama today repeated his calls for a middle-class tax cut, an overhaul of energy policy, the rebuilding of the country’s infrastructure, protection of Social Security and making college more affordable.

And, as per ‘Pay Go’ higher taxes elsewhere to pay for it.

He also singled out Exxon Mobil Corp., the world’s biggest oil refiner. Obama said he would seek to tax oil companies such as Irving, Texas-based Exxon on their record profits.

First, these wouldn’t be nearly enough. Second, he opens himself to all kinds of destructive criticism he can’t respond to about the presumed failures of this in the past, effects on investment and equity prices in general if government can target specific companies for extra taxes, etc. Also, about 75% of Americans are shareholders, and want their stock to do better.

“We’ll use the money to help families pay for their skyrocketing energy costs and other bills,” Obama said today.

The critics will say that directing more money to help pay for energy will only encourage more consumption, even higher prices, and inflation, as well as promote all kinds of environmental damage.

Obama says that McCain’s tax proposals would result in almost $2 trillion in breaks for companies, including $1.2 billion for Exxon alone.

You hear this with every election, and with subsequent examination of the details, it always seems to evaporate.

The Congress is in Democratic hands, and Obama was a senator, so why didn’t he/doesn’t he propose this kind of legislation?

Furman said in an interview that the Obama campaign’s economic goal is based on “broadly shared, bottom-up growth,” similar to the views espoused by groups such as the Hamilton Project and the Economic Policy Institute, a Washington research group funded partly by labor unions.

Not a source of broad based support.

‘Empower People’

“You need to empower people to make the economy work for them,” Furman said.

Sounds like Reagan?

As Obama’s economic policy director, Furman said his priority would be to expand the range of advice and proposals flowing to the presumptive Democratic nominee by reaching out to a wider group of economists.

???

“My key mandate, which came directly from the senator, is to bring him a diverse set of voices and ideas, because that’s the kind of debate he likes to hear to make up his mind about his economic agenda,” Furman said. He named Rubin, former Treasury Secretary Lawrence Summers and former Federal Reserve Vice Chairman Alan Blinder as advisers the campaign would turn to.

Bringing back both Rubin and Summers- Letting the foxes back into the chicken coop.

Furman also named Jared Bernstein of the Economic Policy Institute and James Galbraith, a University of Texas economist and son of economist John Kenneth Galbraith, who was an adviser to President John F. Kennedy.

Galbraith and Ruben on the same team? What’s next, Mitt Romney as Obama’s VP?

Furman attended Harvard University in Cambridge, Massachusetts and the London School of Economics and received a doctorate in economics from Harvard. He worked as an economist in the Clinton administration and at the World Bank.

Goolsbee will continue to play a leading role in the campaign, Furman said.

Why not?!


[top]

Share

Bernanke on inflation expectations

Posted on by


[Skip to the end]

Elevated inflation expectations are unacceptable to a mainstream Central Banker, and Bernanke seems to be clearly telling us we’ve reached his limits.

To get ahead of the ‘inflation curve’ will mean interest rates of at least the 5.25% level of last August, when the FOMC didn’t cut because inflation was deemed too high.

While GDP growth is lower now, inflation is a lot higher now. And while GDP was higher then, their forecast for growth had been deteriorating through year end, and now it’s both above expectations and improving.

“The latest round of increases in energy prices has added to the upside risks to inflation and inflation expectations,” Bernanke said in remarks prepared for delivery to a conference organized by the Boston Federal Reserve in Chatham, Mass.

“The Federal Open Market Committee will strongly resist an erosion of longer-term inflation expectations, as an unanchoring of those expectations would be destabilizing for growth as well as for inflation,” Bernanke said.


[top]

Share

Bernanke comments

Posted on by


[Skip to the end]

The FOMC can’t possibly believe that a 2% Fed Funds rate is the ‘right’ rate given current CPI of about 4%, core at about 2.5%, GPD moving back up towards 2%, unemployment ‘only’ about 5%, and inflation expectations showing signs of elevating.

The 2% Fed Funds rate is only appropriate if their forecasts show as sufficiently high probability of economic deterioration and increased ‘slack’.

As Fisher and other have put it, they all believe low and stable inflation is a necessary condition for optimal growth and employment.

The Lehman issue will pass with a lot less drama than the Bear Stearns issue.

Q2 GDP forecasts are being revised up as most numbers are coming in better than expected.

Inflation continues to move higher.

The ‘Mike Masters sell-off’ in commodities will run its course, with commodities subject to competitive markets underperforming, and crude moving higher (when the smoke clears – they try not to make their position too obvious as with the Goldman sell off of August 2006) as Saudis continue as price setter.

2008-06-04 Crude Sell Off in 2006

2006 Crude Sell Off

I expect the sell off to be less than the approximate three month sell off from the Goldman index change in 2006.

Obama is looking strong, but it has been historically problematic to propose tax hikes and win the election.

News reports of Bernanke’s speech:

“Some indicators of longer-term inflation expectations have risen in recent months, which is a significant concern for the Federal Reserve,” Bernanke said in a speech to graduating students at Harvard University.

Yes. To the point. They are concerned their own actions might indicate a higher tolerance for inflation and thereby elevate inflation expectations.

“We will need to monitor that situation closely,” he said, but added there was little sign a “1970s-style wage-price spiral, in which wages and prices chased each other ever upward,” might be starting.

The 1970s were all about oil prices working through the cost side of the economy, just as they are today. And there are still many nations with weak domestic demand, weak currencies, and continuously high levels of inflation.

He said the impact of soaring oil prices has been “relatively muted” because the amount of energy used to produce a given amount of output — a gauge known as energy intensity — has fallen markedly since the 1970s.

This only extends the delay between food/energy prices and core CPI.

He also said policy-makers learned a lesson in the 1970s, in particular that they must keep long-term inflation expectations anchored to achieve low and stable inflation.

Yes, the FOMC and the mainstream truly believes this. In fact, it’s all they have regarding ‘inflation’ vs. relative value changes in their models.

“If people expect an increase in inflation to be temporary and do not build it into their long-term plans for setting wages and prices, then the inflation created by a shock to oil prices will tend to fade relatively quickly,” he said.

Again, they all do truly believe this. They see inflation as a ‘monetary phenomena’, where somehow ‘too much money chases too few goods’. That makes ‘inflation’ a demand-side issue. Price pressures on the supply-side are only ‘relative value stories’ until ‘inflation expectations’ shape ‘long-term plans for setting wages and prices’.


[top]

Share