Tag Archives: Inflation Expectations

FOMC

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Karim Basta:

  1. Further cut to gwth outlook
  2. Financial conditions tighter and housing getting worse
  3. Inflation receives greater concern than prior statement
  4. Conclusion: downside risks predominant and ‘timely’ means another intermeeting cut on the table.

Agreed, further comments below:

Release Date: March 18, 2008

For immediate release

The Federal Open Market Committee decided today to lower its target for the federal funds rate 75 basis points to 2-1/4 percent.

Could have been 100 as anticipated by the markets. Fed shaded its cut to the low side of the priced in expectations.

Recent information indicates that the outlook for economic activity has weakened further. Growth in consumer spending has slowed

Implies there is still some growth, not negative yet.

and labor markets have softened.

Looking unrevised February payroll number, not the lower unemployment rate. In January they looked at the higher unemployment rate. Unemployment has subsequently gone from 5.0% to 4.9% to 4.8% (rounded).

Financial markets remain under considerable stress,

They went a long way to relieve stress over the weekend.

and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters.

Housing starts were revised up, and other indicators indicate it may have bottomed.

Inflation has been elevated, and some indicators of inflation expectations have risen.

This was noted in several Fed intermeeting speeches.

The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization.

They continue to make this projection even after being completely wrong for many meetings.

Still, uncertainty about the inflation outlook has increased.

That’s why – their forecasts have proven unreliable, and crude/food continues to rise as the USD continues to fall.

It will be necessary to continue to monitor inflation developments carefully.

Only ‘monitor’? No action planned.

Today’s policy action, combined with those taken earlier, including measures to foster market liquidity, should help to promote moderate growth over time and to mitigate the risks to economic activity. However, downside risks to growth remain. The Committee will act in a timely manner as needed to promote sustainable economic growth and price stability.

Intermeeting action is on the table, for both growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Gary H. Stern; and Kevin M. Warsh. Voting against were Richard W. Fisher and Charles I. Plosser, who preferred less aggressive action at this meeting.

Wonder how much less aggressive?

In a related action, the Board of Governors unanimously approved a 75-basis-point decrease in the discount rate to 2-1/2 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, and San Francisco.

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Mishkin speech

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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

Okay.

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.

Conclusion
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.

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Bloomberg: Trichet may not cut rates in 2008

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Trichet May Not Cut Rates in 2008, Say Merrill, ABN

by Simon Kennedy
(SNIP)
(Bloomberg)Erik Nielsen, Goldman Sachs’s chief European economist, disagrees. He said the ECB’s primary mandate is to preserve price stability, so it has no room to follow the Federal Reserve and the Bank of England, even as economic growth weakens. The Fed slashed its main rate by 1.25 percentage points last month, and the Bank of England cut its benchmark by a quarter point Feb. 7 for the second time in three months.

‘Hurdle’
“Inflation and expectations for it are a hurdle for a cut,” Nielsen said. “Inflation is very stubborn” in Europe.

The annual pace of consumer-price increases in the euro region accelerated to a 14-year high of 3.2 percent in January, pushed above the ECB’s 2 percent limit for a fifth month by food and energy costs. Inflation in France, the euro-area’s second largest economy, accelerated in January to the fastest pace in at least 12 years, according to data released today.

US CPI is up nearly 4.5% year over year with no let up in sight, and core measures are above FOMC comfort zones and picking up steam as well.

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Mishkin’s speech

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From today’s speech:

A central bank must always be concerned with inflation as well as growth. As I have emphasized in an earlier speech about inflation dynamics, the behavior of inflation is significantly influenced by the public’s expectations about where inflation is likely to head in the long run (Mishkin, 2007a). Therefore, preemptive actions of the sort I have described here would be counterproductive if these actions caused an increase in inflation expectations and in the underlying rate of inflation; in other words, the flexibility to act preemptively against a financial disruption presumes that inflation expectations are firmly anchored and unlikely to rise during a period of temporary monetary easing.

There have been recent signs of inflation expectations rising, including today’s jump in the one year Michigan expectation to 3.7%.

Indeed, as I have argued elsewhere, a commitment to a strong nominal anchor is crucial for both aspects of the dual mandate, that is, for achieving maximum employment as well as for keeping inflation low and stable (Mishkin, 2007b). Policymakers therefore need to closely monitor information about underlying inflation and longer-run inflation expectations, and the central bank must be ready to hold steady or even raise the policy rate if the evidence clearly indicates a significant rise in inflation expectations.

Says here he will vote to hike if expectations elevate.

♥

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Another Yellen speech

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Prospects for the U.S. Economy in 2008

(intro remarks snipped)

Today I’d like to talk about developments in the economy and in monetary policy, two items that have definitely been making the news lately. On January 22, the Federal Open Market Committee cut its main policy rate—the federal funds rate—by three-quarters of a percentage point. Then, on January 30, at the scheduled meeting, the Committee voted to cut the policy rate again, this time by half a percentage point to 3 percent. Taking these actions together with those that began last September, the Committee has cut that rate by a total of 2¼ percentage points.

The purpose of these actions is to stimulate demand in the face of the combined impact of the severe contraction in housing and the related financial market disruptions.

The purpose has gone from restoring market functioning to stimulating demand.

While housing construction has been weak for more than two years, its effects did not spill over to most other sectors until fairly recently. That’s why we used to talk about a “dual economy,” with housing notably weak, but other sectors doing well. However, financial markets became disrupted in the middle of last year, which has not only intensified the housing slump, but also has tightened credit conditions for some households and businesses. The combined impact has led to slowing more broadly through the economy. It is this broader slowdown that has elicited Federal Reserve actions in recent months.

Now attention is turned to increasing demand to a fight a slowdown.

(SNIP)

Financial markets

I’d like to begin with a discussion of the disruptions in U.S. and global financial markets, because they influence not only the economy’s most likely course but also the risks that could alter that course. In my view, these disruptions are likely to continue for some time. In other words, I think they have laid bare some fundamental issues with the structure of the financial system that will require significant adjustments.

The financial disruptions are centered in the markets for asset-backed securities.

(SNIP DESCRIPTION OF ABS, RATINGS AGENCIES HISTORY, RISKS)

The bottom line is that, in recent years, the financial system has gone through a significant restructuring that made evaluating and pricing risk difficult. The reverberations of the resulting financial disruption are still with us. I’d like to describe some of them now.

However, the potential stimulatory effects of this drop in risk-free Treasury rates have been offset in many cases by another key feature of the financial turmoil, namely, a sharp rise in interest rate risk spreads, as riskier borrowers have had to pay higher premiums to compensate lenders for a perceived increase in the probability of default or losses in that event. On the corporate side, prime borrowers have actually experienced some net decline in interest rates since the shock first hit—that is, even though risk spreads are higher, they have been more than offset by lower Treasury rates. However, issuers of low-grade corporate bonds with greater credit risk, in contrast, face notably higher interest rates.

Risk has been repriced, and low grade borrowers are still paying more, even after Fed cuts.

The mortgage market has been the epicenter of the shock, and, not surprisingly, greater aversion to risk has been particularly apparent there, with spreads above Treasuries increasing for mortgages of all types. Although borrowing rates for low-risk conforming mortgages are now lower than they were before the financial shock hit, fixed rates on jumbo mortgages are higher on net. Subprime mortgages remain difficult to get at any rate. Moreover, many markets for securitized assets, especially non-agency mortgage-backed securities, continue to experience severe illiquidity; in other words, the markets are not functioning efficiently, or may not be functioning much at all.

She does not think markets are functioning efficiently.

The turmoil is reverberating in depository institutions as well.1 One problem is an unanticipated buildup of mortgages as well as LBO-related loans on their balance sheets.

(SNIP LBO DESCRIPTION)

Furthermore, as investors have pulled back from the markets for asset-backed securities, the value of these securities and CDOs has fallen dramatically, so banks and other financial institutions have had to write down their values, which has shrunk their capital and driven their stock prices down.


Another problem for bank balance sheets is that credit losses have been edging up.

The latest reverberation involves monoline financial guarantors.

(SNIP DESCRIPTION)

Fortunately, the banking system entered this difficult period in a strong position. Most institutions were extremely well capitalized. However, the combination of unanticipated growth in assets and in write-downs has put increased pressure on banks’ capital positions. Given their concerns about capital adequacy and their increased caution in managing liquidity, it is not surprising that they are tightening credit terms and restricting availability. At first, the focus was mostly on mortgages, but now it has spread to other kinds of loans, including home equity lines of credit, credit cards, and other consumer credit, as well as business loans. The tightening of credit is also a response to a now noticeable deterioration in credit quality, particularly for subprime mortgages; the losses in other parts of the consumer loan portfolio remain at relatively low levels from an historical perspective, but they, too, have edged up.

Worries here about the supply side of credit.

Finally, equity markets have hardly been immune to recent financial turbulence. Broad U.S. equity indices have been very volatile, and, on the whole, have declined since August, representing a restraint on spending. More recently, some of these declines have occurred as profits have come in below market expectations for some financial firms due to write-downs of the value of mortgage-backed securities.

My overall assessment is that the turbulence in financial markets is due to some fundamental problems that are not likely to be resolved quickly. The effects of these problems have now made credit conditions tighter throughout most of the economy’s private sector, and this will restrain spending going forward.

That is the actual risk – will spending be credit constrained going forward, and, if so, whether exports and/or government (deficit) spending will pick up the slack and support growth and employment.

The impact hit economic activity mainly in the fourth quarter, and so far, it has been starkly negative. After robust performance in the second and third quarters of last year, growth slowed significantly in the fourth quarter—to a pace of only ½ percent.

Subject to revision. They said much the same about Q3 until it was revised up sharply. And Q4 reported inventory draw-downs of 1.4%; so, demand wasn’t that bad. And it is not unusual for GDP to puring a relatively low number after a very strong quarter like Q3 of 4.9%

This brings me to the outlook for the economy.

Economic outlook

Current indicators point to continued anemic growth for at least the first half of this year as well as significant downside risks even to those weak expectations. As I mentioned at the outset, though the prolonged slump in housing construction did not spill over significantly to the rest of the economy during 2006 and much of 2007, when combined with the recent financial market turmoil, it has been central to the emergence of today’s slow-growth environment. And the course of its resolution will be a key factor in the economic outlook.

The main indicators are the payroll number and the ISM, which are both subject to revision/reversal in a few weeks, and the December trade numbers out later this week that may alter Q4 GDP forecasts.

Not to mention that the current environment has sufficient demand to generate inflation numbers above her comfort zone.

Forward-looking indicators of housing activity strongly suggest that the downward cycle may be with us a while longer.

Agreed, but may have bottomed and not be subtracting materially from GDP going forward.

Despite the subprime and jumbo mortgage challenges, home prices were largely stable in the Bay Area during the first three quarters of 2007. It remains to be seen, of course, how they will do as further market adjustments occur.

On the national level, housing construction probably will continue to contract through the end of this year.

That’s doubtful, but possible.

It is true that the residential construction sector is a fairly small piece of the overall economy and is unlikely to cause significant overall weakness in and of itself.

Right.

But the fallout from the housing cycle has many dimensions, and in the fourth quarter there were signs of spillovers to other sectors of the economy, most worrisomely, to consumer spending. This sector is a huge part of the economy—about 70 percent—and its growth slowed to a rate that is somewhat below its long-run trend in the face of spillovers from the housing market and rising energy and food prices.

A minor slowdown for one quarter, maybe, so far. And the question remains whether exports and government deficit spending will pick up the slack.

Looking ahead, developments related to housing are likely to continue to put a strain on consumers. For example, house prices have fallen noticeably and the declines have intensified. Moreover, futures markets for house prices indicate further—and even larger—declines in a number of metropolitan areas this year.

Future prices? Pretty think market to direct policy.

With house prices falling, homeowners’ total wealth is declining, and that could lead to a pullback in spending.

Maybe, but the Fed economists have no evidence of that.

At the same time, the fall in house prices may constrain consumer spending by lowering the value of mortgage equity; less equity reduces the quantity of funds available for credit-constrained consumers to borrow through home equity loans or to withdraw through refinancing.

Same, no evidence of that yet.

Indeed, it would not be surprising to see even more moderation over the next year or so, as consumers face additional constraints due to the declines in the stock market, the tightening of lending terms at depository institutions, and the lagged effects of previous increases in energy prices.

Spending is predominately a function of income, which has held up so far.

National surveys show that consumer confidence has plummeted. And I have been hearing comments and stories from my business contacts in the retail industry that are also downbeat. The rise in delinquency rates across the spectrum of consumer loans is strongly indicative of the growing strains on households.

Finally, another negative factor for consumption is that labor markets have softened. In recent months, growth in employment from a survey of business establishments slowed sharply, actually falling in January, and many other indicators point in the same direction. Slower job growth will have a negative impact on the disposable income available to households and therefore will provide an additional restraint on consumer spending.

If January is revised up, does the Fed change its tune? They said the same about December employment when it was reported as being low, and then a month later when it was revised to a decent positive number there was no comment. Same when August reported negative then revised to a respectable number a month later.

With the domestic consumer likely to be pretty hobbled, it is tempting to look at consumers beyond our own borders to be a source of strength for economic activity. Foreign real GDP has advanced robustly over the past three years. With the dollar falling well below its level of a year ago, U.S. exports have done very well; partly for this reason, U.S. net exports—exports minus imports—which consistently held growth down from 2000 to 2005, actually gave it a lift over the past couple of years. I expect net exports to remain a source of strength. But some countries—especially in Europe—are experiencing direct negative impacts from the ongoing turmoil in financial markets. Others are likely to suffer indirect impacts from any slowdown in the U.S. A slowdown here could well produce ripple effects lowering growth there through trade linkages, and recently this factor has been reinforced by a worldwide drop in stock prices.

Yes, exports could fall. But they are being driven by an attempt to exit $US financial assets and that means spending them here rather than accumulating them there.

The US has taken strong measures to keep foreigners from accumulating $US financial assets – calling CB’s currency manipulators if they add to their $US reserves, the Fed’s actions making it clear it doesn’t care about inflation, and geopolitical policy driving unfriendly oil producers from accumulating their savings in $US.

This could easily increase US exports and asset sales by $500 billion per year from current levels.

Economic policies are another important factor in gauging the economic outlook. As I have noted, the FOMC has eased the stance of monetary policy substantially in the past five months. Moreover, Congress has now passed a fiscal stimulus package to help the economy and it could provide notable stimulus in the latter half of this year.

Yes, good sized demand add there.

Even with such policy stimulus, the overall economy is still likely to turn in a very sluggish performance this year, expanding by a rate well below potential and creating more slack in labor markets. At 4.9 percent, the unemployment rate is already slightly above my estimate of its sustainable level.

Slightly? That confirms that even the most dovish Fed president thinks about 4.75% is the minimum non-inflationary unemployment rate.

Slow growth this year would most likely push unemployment even higher.

How high does it have to go to keep inflation from rising? To then bring it down to her comfort zone? She would have to say a lot, based on the apparent insensitivity of inflation to unemployment in recent years.

To sum it up, for the next few quarters, I see economic activity as weighed down by the housing slump and the negative factors now impacting consumer spending. It remains particularly vulnerable to the continuing turmoil in financial markets. My comments haven’t even touched on possible slowdowns in business investment in equipment and software and buildings. I see the growth risks as skewed to the downside for the near term.

Right, and agreed, demand has been weakening since Q2 2006 when the budget deficit became too small to support a strong enough credit expansion for full-employment. But exports picked up the slack when the subprime home buyers were the first to fall by the wayside.

In circumstances like these, we can’t rule out the possibility of getting into an adverse feedback loop—that is, the slowing economy weakens financial markets, which induces greater caution by lenders, households, and firms, and which feeds back to even more weakness in economic activity and more caution. Indeed, an important objective of Fed policy is to mitigate the possibility that such a negative feedback loop could develop and take hold.

The countercyclical tax structure limits this. Just like th early 1990s when the slowdown drove the budget deficit to 5% of GDP (equal to about a $750 billion deficit today) and added that much net financial equity to trigger and support the boom of the second half of the 1990s.

With a gold standard, this does not happen. The government run that kind of deficit without losing reserves and defaulting. Like the US did in 1934 when it went off the gold standard.

Now let me turn to inflation. The recent news has been disappointing. Over the past three months, the personal consumption expenditures price index excluding food and energy, or the core PCE price index—one of the key measures included in the FOMC’s quarterly forecasts—has increased by 2.7 percent, bringing the increase over the past twelve months to 2.2 percent. This rate is somewhat above what I consider to be price stability.

Yes, even as demand is slowing.

I expect core inflation to moderate over the next few years, edging down to around 1¾ percent under appropriate monetary policy.

What does that mean? She said the Fed has been cutting rates to add to demand. How does adding to demand bring down inflation?

Such an outcome is broadly consistent with my interpretation of the Fed’s price stability mandate. Moreover, I believe the risks on the upside and downside are roughly balanced. First, it appears that core inflation has been pushed up somewhat by the pass-through of higher energy and food prices and by the drop in the dollar. However, recently, energy prices have turned down in response to concerns that a slowdown in the U.S. will weaken economic growth around the world, and thereby lower the demand for energy.

Hardly! Oil is still trending higher, as it bounced off of $86 got through $94 yesterday. And January 2008 gasoline consumption was 1.4% over January 2007 – during the ‘slowdown’ emphasized above. Not to mention grain prices and the CRB in general. And anecdotal earnings reports showing trending cost push inflation taking hold both internationally and domestically.

Another factor that could restrain inflationary pressures is the slowdown in the U.S. economy.

Hasn’t yet. In fact, seems to be getting worse if anything.

This can be expected to create more slack in labor and goods markets, a development that typically has been associated with reduced inflation in the past.

Not in the 1970s. Not with ‘imported’ cost push inflation, and now with biofuels liking food to fuel and with a couple of billion up-and-coming consumers in India and China competing for resources.

And not to mention our own pension funds increasing their allocations to passive commodity strategies – pure, inflationary hoarding.

A key factor for inflation going forward is inflation expectations. These appear to have become well-anchored over the past decade or so as the Fed’s inflation resolve has gained credibility. Very recently, far-dated inflation compensation—a measure derived from various Treasury yields—has risen, but it’s not clear whether this rise is due to higher inflation expectations or to changes in the liquidity of those Treasury instruments or inflation risk. Going forward, we will need to monitor inflation expectations carefully to ensure that they do indeed remain well anchored.

Right, as if monitoring will keep them anchored.

Actions now speak louder than words. The Fed’s actions are telling us loud and clear that at least so far they have been willing to step hard on what the believe is the inflation pedal to soften a slowdown, with unemployment still very near what they consider full-employment.

The question is: how sever does inflation have to get for the Fed to address it with action rather than ‘monitoring’?

Monetary policy

Now let me turn to monetary policy. The federal funds rate has been cut by 2¼ percentage points since September and now stands at 3 percent. With near-term expected inflation of just above 2 percent, the real—inflation adjusted—funds rate is around 1 percent or slightly lower, which represents an accommodative posture.

OK, they do consider the current FF rate accommodative.

And as core creeps up, the Fed sees it as more accommodative.

I believe that accommodation is appropriate because the financial shock and the housing cycle have significantly restrained economic growth.

But not inflation, at least not yet.

While growth seems likely to be sluggish this year, the Fed’s policy actions should help to promote a pickup in growth over time. I consider it most probable that the U.S. economy will experience slow growth, and not outright recession, in coming quarters. At the same time, core consumer inflation seems likely to decline gradually to somewhat below 2 percent over the next couple of years, a level that is consistent with price stability.

Why is it likely to decline? Don’t see any support for what that position apart from it used to decline when unemployment went up. But even then, it took a lot more unemployment to decline the way they are expecting it to.

However, economic prospects are unusually uncertain. And downside risks to economic growth remain.

And that means a downside risk to inflation as they must be assuming inflation is a function of growth? If so, why not say it?

This implies that, going forward, the Committee must carefully monitor and assess the effects of ongoing financial and economic developments on the outlook and be prepared to act in a timely manner to address developments that alter the forecast or the risks to it.

My guess is the Fed’s forecast has not been revised down since the last meeting, but the inflation forecast may be revised up and appropriate monetary policy might be implying higher rates down the road.

I expect she would vote for a rate cut at the next meeting if conditions remain the same, if she was still a voting member.

Now, I’d be glad to take your questions.

Endnotes

In recent months, and particularly toward year-end, strains were evident in the term interbank funding markets; in these markets, banks borrow from and lend to each other, with loans maturing in a number of weeks, months, or even a year. The problem has been that banks that would normally lend their excess funds to other banks that need them became reluctant to do so. This may reflect banks’ recognition of the need to preserve liquidity to meet unexpected credit demands, greater uncertainty about the creditworthiness of counterparties and concerns relating to capital positions, on top of typical, year-end balance sheet considerations. A heightened focus on liquidity is logical when the markets for securitized assets held by banks have become highly illiquid and when the potential exists for some customers—such as struggling mortgage companies and others—to draw on unsecured credit lines. These markets have improved since the end of last year, perhaps in part because of the Fed’s introduction of the Term Auction Facility, which gives banks another route besides the discount window to tap into the Fed’s lending function. (Banks had not used the discount window very much despite their need for liquidity because they were concerned that doing so might erroneously signal to other financial institutions that they were in bad straits. The plan for the TFA, which the Fed created in cooperation with the European Central Bank and the National Bank of Switzerland, was announced on December 12.)

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Yellen on inflation

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SF Fed president Yellen on inflation, from yesterday’s speech in Hawaii:

Now let me turn to inflation. The recent news has been disappointing. Over the past three months, the personal consumption expenditures price index excluding food and energy, or the core PCE price index—one of the key measures included in the FOMC’s quarterly forecasts—has increased by 2.7 percent, bringing the increase over the past 12 months to 2.2 percent. This rate is somewhat above what I consider to be price stability.

Yellen is the most dovish Fed president and not currently a voting member. Notable that 2.2% core PCE is clearly above her comfort zone.

I expect core inflation to moderate over the next few years, edging down to around 1¾ percent under appropriate monetary policy.

Appropriate monetary policy is a requirement to bring inflation down.

Such an outcome is broadly consistent with my interpretation of the Fed’s price stability mandate. Moreover, I believe the risks on the upside and downside are roughly balanced. First, it appears that core inflation has been pushed up somewhat by the pass-through

Up until now, the Fed has taken comfort that ‘pass through’ was not happening. This is what brings core up to headline, something the Fed has previously believed was not happening.

of higher energy and food prices and by the drop in the dollar. However, recently, energy prices have turned down in response to concerns that a slowdown in the U.S. will weaken economic growth around the world, and thereby lower the demand for energy.

Meaning an upturn in energy prices will do the reverse. Seems inflation is now a function of energy prices. This is a change from energy prices weakening demand and causing deflation. Now, it is passing through and causing core inflation.

Another factor that could restrain inflationary pressures is the slowdown in the U.S. economy. This can be expected to create more slack in labor and goods markets, a development that typically has been associated with reduced inflation in the past.

Yes. This is the remaining dove position. Previous speeches this week by the hawks have expressed concerns that economic weakness and slack in the labor markets will not bring down core inflation.

This is the problem of the trade-off between unemployment and inflation. Seems that the applicable historical data now shows that it takes ever larger moves in unemployment to move the inflation needle in either direction.

A key factor for inflation going forward is inflation expectations. These appear to have become well-anchored over the past decade or so as the Fed’s inflation resolve has gained credibility. Very recently, far-dated inflation compensation—a measure derived from various Treasury yields—has risen, but it’s not clear whether this rise is due to higher inflation expectations or to changes in the liquidity of those Treasury instruments or inflation risk. Going forward, we will need to monitor inflation expectations carefully to ensure that they do indeed remain well anchored.

All speeches have now stated that there are signs inflation expectations may be elevating.

There are two schools of thought on this at the Fed. The majority will state that when expectations begin to rise, it is too late. The minority say you can let them rise a ‘little bit’, but then they must take decisive action.

Since August, the Fed forecasts have been projecting that economic weakness will bring down prices. With both hawks and doves now acknowledging that this my not be the case, it could be the official Fed forecasts have elevated their near- and medium-term inflation forecasts.

The long-term Fed inflation forecast will remain the same, as it indicates what their long-term inflation target is. But also in the forecasts is what Yellen called the ‘appropriate monetary policy’ to achieve that target.

This could mean the official forecasts now have higher interest rates built into their forecasting model.

And more so now that Congress passed the fiscal package today. Private forecasts are saying it will add maybe 1% of GDP by Q2 and may double that in Q3. At a minimum, this will help support domestic gasoline demand. (And raising the mortgage cap won’t hurt either.)

My twin themes that began in Q2 2006 remain:

  1. Weakening domestic demand due to the government deficit being too small, but supported by strong exports due to non-residents’ reduced desire to accumulate $US financial assets and now some additional support to demand from today’s fiscal package.
  1. Rising prices are due to Saudis/Russians acting as swing producer and setting price at ever higher levels until demand falls below their pain thresholds.

For the last five months, I have been underestimating the Fed’s inflation tolerance. They all firmly believe that price stability is a necessary condition for optimal long-term growth and employment.

And they all do not want a relative-value story to turn into an inflation story as happened in the 1970s.

The Fed is data dependent; the question is which data.

At some point, it becomes the inflation data, and at that point, the Fed is way behind the inflation curve.

For example, rates are up to 7.25% in Australia and their inflation is 1% lower than ours.

Bernanke spends next week. The fixed exchange rate types of deflationary risks he has feared have not materialized.

It is looking more like the 1970s than the 1930s.

If Bernanke confirms inflation expectations have been elevating, the easing cycle may be over.

No matter how weak the economy may get in the near term.

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Claims, ECI

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From Karim:

  • True to the past 5yrs pattern, claims seem to be reverting to trend after the first few weeks of January.

Right, good call!

  • IJC climbed from 306k to 375k; the trend before the January drop was around 340-350k; this number was for MLK holiday week, so an adjustment issue here as well; bottom line is I think trend is still around 350k.
  • Continuing claims rose from 2685k to 2716k.
  • ECI (both headline and wage component) up 0.8% q/q

Data below is for Dec, so was largely known in yday’s GDP number.

  • Personal income up 0.5%, with wage and salary component up 0.4%
  • Core PCE up 0.2% m/m (2.2% y/y)

Most meaningful data here was continuing claims (little to no hiring taking place) and ECI (wage gwth still tame).

And Fed still looking at this as an indication of ‘inflation expectations’.

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Why I expect US exports to continue to be very strong..

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The desire to accumulate $US financial assets has been diminished for at least the following reasons:

  1. Treasury policy – Paulson is actively pushing both a strong yuan and threatening any other CB that buys $US with the label of ‘currency manipulator.’ CB’s had been perhaps the largest source of $US financial assets accumulation and are now limited to compounding of interest.
  2. US foreign policy is probably driving CB’s in less than friendly nations to diversify their reserves away from $US financial assets.
  3. Fed policy has the appearance of a ‘beggar thy neighbor’/’inflate your way out of debt’ policy, as the Fed aggressively cuts rates in the face of inflation not seen in 25 years.

This all sets in motion a downward pricing of the $US as non residents sell them to each other at lower and lower prices in this effort to lower their rate of accumulation of $US financial assets. But these financial assets can only ‘go away’ when they get spent or invested in the US, when US prices are low enough to cause this to happen. The rapid rise in exports and accelerated non resident buying of US real estate and other assets is anecdotal evidence this is taking place as theory predicts.

This is a very large cyclical force that should continue to drive rapidly rising exports for perhaps a year or more. Weak foreign economies should have little effect on this process, as that weakness doesn’t reduce the desire of portfolio managers to shift out of $US financial assets.

This is also highly inflationary for the US. This buying by non residents both drives down the $US and drives up the prices of US exports, now rising at a 7% clip last I checked.

The desired shift is probably well over $1 trillion which means exports will increase by a good part of that to facilitate this transfer.

This can sustain US GDP in the face of falling domestic demand, which will stay relatively low until housing picks up. Employment will remain reasonably good, but standards of living fall as we produce as much, but export more and consume less. We get paid to work but can buy less due to high prices, with our remaining production exported to those wishing to reduce their accumulated $US financial assets.

We’ve been talking about this possibility about a long time, but seems our trade negotiators have finally got their wish.

Meanwhile, Saudis continue to act the swing producer. In fact, they told Bush today they have 2 million bpd capacity in reserve, and that markets are well supplied. At their price, of course.

Probably have been some year end allocations out of crude by pension funds as with the price hikes they would need to sell some to keep the same ‘weight’ in their portfolios. That should be ending soon.

And I agree with Karim, the Fed is not likely to act on inflation until core starts to rise or their measures of inflation expectations start to rise, despite the fact that mainstream theory clearly says if any of that happens it’s too late. Seems to me the senior FOMC members are putting their jobs on the line by taking that kind of systemic risk, which their own theory tells them is far higher than the risk of any lost output from a .

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