April 2005 Archives

Continued from the last post.

Question #5: Would privatization be a free lunch? (See numerous posts at Angry Bear) Economists are trained to be very skeptical of free lunch claims. It's hard to answer yes to that question. However, if it were reworded: are the opportunities for some small efficiency gains? That asks about the same thing but sounds better. (Ok, ok, I'll quit being evasive.) Not much of a free lunch--not to the extent that some claim. Some efficiency gains might be possible, mostly for the very young. This has a lot to do with how people's portfolios will change if there was privatization. It also has to do with Ricardian Equivalence. Here's what I said in January. I was responding to PGL of Angry Bear:

PGL writes that if people already have balanced portfolios, including the bonds implicit in the Trust Fund and their 401(k)s and they suddenly receive the Trust Fund, they will not buy stocks. The implication is that they would buy bonds, effectively replacing the bonds in the Trust Fund and keeping their risk/return ratio the same.

Our logic is pretty much the same. If Social Security was fully funded, I would absolutely 100% agree. But it's not. So I don't. Not 100% anyway. I have to ask myself this question. Suppose the government gave me a $1000 refund on my FICA tax for this year and offered me two options. 1) Give it back to Social Security and forget the whole thing ever happened or 2) buy a $1000 government bond (TIPS, so I don't have to worry about inflation) and keep rolling it over until I retire.

I choose door number 2. In a heartbeat. In other words, I don't think that the bonds implicit in the Trust Fund are the same as a bond in my hand (or my private account). If I did think that they were the same, I wouldn't care--option 1 and option 2 would be equivalent. (UPDATE/CLARIFICATION: It's not by a wide margin that I choose door number 2, but I would choose it. The implication that has for PGL's comment is that while I don't agree 100%, I think he's close. Close enough that there should be more discussion on this point.)

Another reason I'd choose door number 2 that I didn't mention is that I would just like to own the bond myself. Once I own those bonds, would I sell some to buy stocks? I would if my portfolio was previously at a boundary--if I had no stocks and was borrowing constrained. I make the same point in these comments.

No large scale free lunches, but some small scale efficiency gains for mostly young workers. The wealthy and the over-40 set would probably be unaffected. In other words, Ricardian Equivalence would be a good first order approximation. Barro and Becker would be right as a first order approximation.

Question #6: Should private accounts be carved out or added on? I think a carve out would be better if it was done right (sensible assumptions about equity growth, less Draconian cuts). It would also be worse if it was done badly (use your imagination). To have any value, an add-on would have to accomplish something that the present array of 401(k)s and IRAs does not. If it encourages young people to save, it would be better than nothing.

Question #7: What is the significance of 2041? I'll be 69 years old. That's about it.

In other words, the date the trust fund is exhausted is a moving target. (Wasn't it just 2042?) If productivity growth stays healthy and other good things happen, that date will be pushed back. It has been pushed back before. But by the same token, it won't be pushed back to infinity. Since initial benefits are indexed to wage growth, it is harder for productivity gains to push that date back than if initial benefits were indexed to price growth. (See my response to the question on whether or not there is a crisis--it's not a crisis, and 2041 isn't set in stone.)

Final point: The more gradual the change to the Social Security system, the better. The sooner we start, the more gradual we can afford to be.

Closing thoughts: A reasoned debate is still possible. My rationale for these posts is to summarize where I've been and collect my thoughts in one place for my own reference (and yours if you're still listening) as we go into the serious debates on this issue over the summer. If you're still with me after these two posts, you can decide for yourself where I am on the ideological spectrum--I've been called all kinds of things. But I endeavor to be honest. I try to be as consistent as I can be. I love a good discussion of economics, both theory and policy. This has been, and promises to continue to be, both enjoyable and enlightening. As I look back, I haven't changed my position much, but discussions with you, my readers, have refined them.

Thanks to everyone with whom I have discussed these issues through e-mail or blog comments. I look forward to more. Have at it.

It was a pretty interesting week for Social Security blogging. See Angry Bear (pgl), macroblog (David Altig), and Economist's View (Mark Thoma) just to name a few. I figured I'd put down some thoughts--sort of in the form of an interview with myself. Some of it is retrospective. Let's start with the basic question.

Question #1: Is Social Security in crisis? No crisis, but we could do better.Here's what I said in January.

Could the right sort of adjustment/modification/reform of Social Security in the next few years make future retired persons better off? Almost without question, yes.

Is Social Security on the verge of becoming the nation's biggest fiscal problem if it's not fixed in this presidential term of office? Definitely no.

No change in my opinion there.

Question #2: Are the bonds in the trust fund worthless IOUs? No. However, I do not have a claim to those bonds other than through my participation in the Social Security system. The payout I will receive when I retire will be determined by the SSA's formula rather than by the return on those bonds. The bonds represent the government's commitment to fund our retirement based on that formula.

I don't like photo-ops with file cabinets, and I'm not crazy about comments like this from President Bush's press conference:

Now, it's very important for our fellow citizens to understand there is not a bank account here in Washington, D.C., where we take your payroll taxes and hold it for you and then give it back to you when you retire. Our system here is called pay-as-you-go. You pay into the system through your payroll taxes, and the government spends it. It spends the money on the current retirees, and with the money left over, it funds other government programs. And all that's left behind is file cabinets full of IOUs.

The reason I don't like that rhetoric is that it downplays the government's commitment to funding the retirement of the next generation. Some would say that it's tantamount to threatening default. You be the judge of that. I'm pretty sure Bush is not actually threatening default (he'll be long out of office by the time it would happen anyway). It's just not the way I would say it. The political and moral commitment cannot be understated. But a political and moral commitment is not a claim to a specific quantity of bonds.

And here's what I said about it once before. (Feb. 21)

We need to be careful about what we mean when we discuss (or imply the possibility of) default lest we fall into rhetorical traps. The "worthless IOU" argument is itself worthless. There are undoubtedly other cases where it has been used to get the attention of the reader and then been cast aside when it has served its purpose.

That characterizes my current sentiment as well. So far so good.

Question #3: Would privatization solve the solvency problem? Nope. Might privatization make a marginal contribution towards achieving solvency? This depends crucially on the assumptions one makes concerning growth of the stock market and how much the traditional defined-benefits can be reduced as a result. Assume a high enough growth in the stock market and it does contribute towards solvency. I don't buy the upper range of those claims. With reasonable assumptions, the contribution is likely to be small.

However, I don't think that this is a reason to reject partial privatization out of hand. If you want to reject privatization, do so on the merits. Judge privatization by what it would do, not by what it would not do.

See also this post.

Question #4: What about wage vs. price indexing? I can only find one post where I addressed this directly. I am cautiously in favor of the switch, as I was when I wrote that post. My biggest concern is that expectations matter, and I wouldn't want to change the indexing for people who are close to retirement. Maybe for younger workers who have time to plan (and save more--with or without privatization).

Pozen's plan, which the President has embraced, is worth discussing.

Under the current system, the benefits set at retirement are supposed to grow, on average, at the same pace as wages, so that the comparative living standards of retirees, while generally lower than working Americans, do not erode below today's levels.

Mr. Pozen's plan would maintain that schedule only for the bottom 30 percent of the work force - those with average annual earnings up to $25,000.

At the top, those earning more than the taxable limit - expected to be about $113,000 in 2012 when the plan would start, would have future benefits uncoupled from wages and linked instead to inflation, which tends to grow at a pace about 1.1 percentage points slower than wages. In the middle, benefits would be indexed by a mix of prices and wages.

2012 is a little soon for me unless it is phased in slowly, but it's a starting point for negotiation.

I'll continue this in the next post.

The name may not be familiar to you, but the voice should be. You probably know him best for being the voice over of the long running series of "Smuckers" commercials. (With a name like Smuckers, it has to be good.) He did have a number of other roles, including a stint on Lou Grant and more recently The West Wing. Adams was 86 years old. Here is a clip from NPR where you can hear his distinctive voice one more time.

David Altig of macroblog:

I'm not sure I had ever contemplated what the day would look like when 3.1 percent growth was considered bad news, but now I know for sure.

He's got a lot of quotes from a number of sources detailing the good (not much), the bad (quite a bit), and the ugly (well represented), so check it out.

Kash at Angry Bear has a pessimistic, but fair, review of the numbers complete with charts. He concludes with:

That is not a horrible growth rate, but it is a bit disappointing to those who hoped for another year or two of strong economic growth in the US before this phase of the business cycle was over.

Right. Not horrible. Disappointing? A little, but not for the 3.1% number itself. The inventory part is a little troubling since it might indicate weakness in coming quarters. Imports are also a drag on GDP, and those numbers don't appear to be improving quite yet.

So I find myself in a rather odd position. I used to think that anything over 3% is doing well. I always tell people that one statistic doesn't make a trend. Yet, I won't tell you that this is great news either.

I take a little comfort in the fact that the advance estimate has typically been revised upward in the last few quarters. In fact in each of the last 5 quarters, the annual revision (or final estimate for the 3 most recent quarters) has been higher than the advance estimate. (page 5 of this link) I don't think that's a guarantee that the final numbers will be higher, but it keeps me from cashing in all of my chips yet.

Real GDP growth did cool down without causing a recession in 1995. (But then, you knew I was going to say that, right?)

The new information this report give me is that we need to watch things carefully to see if the inventory buildup is a problem. We also need to watch the trade numbers. That will be useful in seeing if this is the beginning of something more. What I hear in everyone's remarks is that this unambiguously lowers the forecast for Q2. Absent a marked fall in the price of oil or a slowdown of import growth, that is probably a correct assessment.

I could have made this an update to an earlier post, but I think the information is sufficient to warrant a separate post.

Remember that I wanted to see the study that the NY Times cites? King at SCSU Scholars has a link to the survey. Again, I quote the New York Times:

The economic literacy of both students and adults has improved since then, but only slightly.

In the report, it is stated that the test was administered to adults differently in 1999 than in 2005, so the results are not directly comparable (page 4 on this link). Ok, so what about students? 14 of the 20 questions were common to both year's exams, so they compared the results of just those questions. Grading on a standard percentage scale (90%=A, etc.) the distribution looked like this in 1999:

A: 5%
B: 6%
C: 14%
D: 11%
F: 63%

And in 2005:

A: 11%
B: 10%
C: 24%
D: 12%
F: 43%

The heading on that page is "Percentage of students scoring an 'A' or 'B' nearly doubled."

"Slightly"????? Did the NY Times writer read the report????

Admittedly there are still too many "F"s, but this is not a "slight" improvement. Read the whole survey. There are pie charts showing the results of each question for adults and students (and bar charts showing improvement on each question common to both years). It's definitely worth 20 minutes of your time, especially if you teach economics.

The survey does not report the results for adults in 1999, so I don't know how the Times writer can say that the results were better for adults (unless there is a copy of those results out there--I will keep looking). If those old results are out there and if the improvement is only slight for adults, I guess that would mean that the Times writer is only guilty of making an invalid comparison.

There is still a lot of room for improvement in questions on macroeconomics and personal finance. Our work is not done.

Ohhh, don't tempt me at this time of year. But seriously, take a look at this: (hat tip: Brad DeLong)

Thousands of exam papers from England will be sent to India later this year as part of the marking process.

Critics in England say the move is the latest example of cost-cutting by outsourcing, and will result in errors in exam marking and delays in results.

...

The Assessment and Qualifications Alliance (AQA) exam board says that under the new system, GCSE exam scripts from England will be scanned into a computer file.

The answers of candidates will then be divided up between questions requiring longer answers and those with just one word answers - usually found in French and maths papers.

The scanned one word answers will be e-mailed to Madras, where Indian workers type them up so that they can be marked by a computer in England.

So let's see... the student writes a one word answer, it gets scanned, e-mailed to India, transcribed and e-mailed back to be marked by a computer in England.

If that saves money, it tells you something about the wage differential between data entry clerks and graders that I would readily believe.

Alas, I don't think this really applies to most of the grading that college professors do. Sounds more like an extension of the multiple choice test. Though I am not familar with the AQA exam in Britain, it sounds a bit like our ACT, SAT, and other alphabet soup tests.

And wasn't there just a big to-do about the essay feature in the new SAT? Tell me who wants to grade that! I guess there were strict requirements on how the graders were to grade the essays. You probably could write a computer program to grade them, but then if that program ever got leaked to the public... just watch the scores go up!

Bottom line: I don't see any huge deal about this. The profession outsourced grading to optical scanning machines a long time ago. That's not much different from having Indians transcribe one word answers.

My students can rest assured that there will be precious few one word answers on their final exams. (Maybe a couple in the principles course--none in the intermediate course.)

Be sure to check out Tyler Cowen's response:

The obvious question is what we really need professors for anyway -- are we simply magnets of personality to keep students interested?

Well, as I have suggested, I don't think that is the obvious question asked by this particular situation. And even so, we professors still program the "grading computer."

As for whether we are magnets of personality... your mileage may vary.

Catharine L. Mann and Katharina Pluck have an interesting op-ed in the NY Times which concludes as follows:

Several factors help explain America's lower pass-through rate. Reduced inflation around the world has made prices less volatile, enabling exporters to ride out currency fluctuations without changing prices. As the United States imports more consumer goods (which have a lower pass-through rate compared with commodities), the overall pass-through rate for American imports has fallen. But perhaps most important, exporters don't want to risk losing market share in the large and competitive American market - even if that means decreasing their own profit margins to keep prices stable in the United States.

Low pass-through means that Americans have not yet lost their purchasing power abroad despite the dollar depreciation, and therefore we can continue to enjoy living beyond our means. Over the long run, though, the enormous trade imbalance is not sustainable. Low pass-through means that it will take a much bigger drop in the dollar to change prices enough to induce switching and correct the trade deficit. In fact, our colleague Ted Truman calculates that between the depreciation of the dollar and the loss in spending power, this adjustment could end up costing every American $2,350. The larger the eventual depreciation, and the longer we wait, the greater our postponed pain promises to be.

I can't find Truman's study on the IIE website, but I wonder if that $2350 is spread out over time (higher prices, etc.). Also, you have to admit that we are benefitting in the current situation. What goes around comes around, right? But it is instructive to remember that things will not stay this way forever. We should be increasing national savings to smooth these fluctuations more than we are. To the extent that they make that point, I agree. But we could use more research on the effects of globalization on pass-through and the prevalence of pricing to market.

Friedman writes:

In sum, Tony Blair has redefined British liberalism. He has made liberalism about embracing, managing and cushioning globalization, about embracing and expanding freedom - through muscular diplomacy where possible and force where necessary - and about embracing fiscal discipline.

Headline (NY Times): Survey Finds Many Have Poor Grasp of Basic Economics

You guessed it. This is not simply a story about the need to improve economics education and basic financial literacy.

Their implied conclusion: Many don't have the skills to cope with an ownership society.

...there was confusion about the purpose of mutual funds, with some students stating that they provided higher returns than individual stocks, and others stating that they guaranteed a steadier income. Only 15 percent of students understood that the purpose of mutual funds was to provide diversification.

Mr. [Alan] Krueger, who contributes a column for the business section of The New York Times, said these findings were disturbing, given the big increase in the number of households that hold stocks and mutual funds.

"Many Americans are potentially open to scams because they don't understand the purpose of the financial markets," he said yesterday.

I agree that's disturbing. But they did not report how adults did on that question (or adult owners of mutual funds). The millions of adults who actually own mutual funds probably understand their purpose a little better than that.

Other analysts said they thought that the findings added to a growing body of evidence that the typical American is poorly equipped to take advantage of what proponents call the ownership society: a future in which individuals are free to invest their own retirement money, rather than having to accept the returns offered by the Social Security program or a group retirement program at work, like a pension plan. Many surveys have shown the public has doubts about the Social Security program, with young people, in particular, confident that they could do better by investing on their own.

Yet even their concern is poorly informed, according to the Employee Benefits Research Institute, a nonpartisan research organization that is financed by companies and labor unions. The institute's own research showed that fewer than 20 percent of workers thought that Social Security would be their primary source of income in retirement, even though Social Security is currently the primary income source for more than two-thirds of retirees.

I don't doubt the validity of these statistics (and I agree that some people are probably deluding themselves), but I do want to give this some additional thought. Is it realistic in the current environment with 401(k) plans, IRAs and so on, to expect that the number of future retirees (current workers in the survey) whose primary income source will be Social Security will equal the portion of current retirees who rely so heavily on Social Security? I don't think so. Now, do I think there will be as massive a shift as the survey implies? Of course not. Would a shift be a good thing? I think so. This story just doesn't give me enough information to say any more than this--it may not be as bad as it seems.

I'll bet I know what people said on this one.

Even though the Social Security Administration sends all participating workers individual annual statements, the institute found that only 18 percent of Americans know at what age they will be eligible to retire with full benefits.

I'm sure a lot of them said 65, but if they are under 44 years old it's 67. As retirement nears, they'll get the message. This question worries me less than some of the others.

The article concludes:

The purpose of the National Council on Economic Education is to raise the public's understanding of the economy. It created a basic standard for high school level financial literacy in 1997 and conducted its first survey in 1999. The economic literacy of both students and adults has improved since then, but only slightly.

Talk about burying the lede. No details on just how much it has improved. I'll try to research that for you and report what I find. We can clearly do better, and I think we also have to remember that if the stakes were higher and a partial privatization ever came to pass, I think we would. After all, if people didn't have to make choices about the allocation of scarce resources because they were all made for us, I (and many of you, my economist readers) would be out of a job.

Our job is to present these concepts and issues in our courses, discuss them on our blogs, and work with the MSM to get the message out.

The fact that so many people do participate in 401(k) plans, contribute to Roth IRAs, and so on, is very encouraging indeed. Rather than wringing our hands, let's redouble our efforts.

N.B. Even if privatization does not happen, I do not shrink from anything I say in this post. Economic and financial literacy is more important than this single issue.

UPDATE: Don at Cafe Hayek has much more.

I'm so far behind... but it's late April on a college campus. That's normal.

Some time ago, macroblog made us aware of Inflation Central from the Cleveland Fed.

Very nice.

In EconLog, Bryan Caplan writes about the proposed repeal of the cell phone ban aboard airplanes:

The important thing is that repealing the existing regulation would give airlines a chance to experiment. If the science behind the cell phone ban is wrong, the current rule can't even hide behind the fig leaf of safety. And who knows, maybe a genius who doesn't write for the Oakton Sun Gazette would figure out a way to make both phoners and non-phoners happy. At risk of giving away a billion-dollar idea for free: How about No-Phoning Sections on planes?

He clearly doesn't mind the idea of cell phones on airplanes. Tyler Cowen, on the other hand, prefers the temple of silence:

Bryan Caplan trots out all the usual arguments, you know the ones I use myself when debating opponents of the market. Start with legal laissez-faire and let airlines weigh conflicting preferences and then implement the profit-maximizing policies.

I still don't want cell phone use on planes, but I'm not going to tell you some fancy-wancy academic story about externalities imposed on infra-marginal consumers. I am still, however, looking for a good argument to use against him. Can I claim that cell phone calls are a socially wasteful means of signaling to your spouse that you care? Can I claim that commercial airplanes are modern (short-term) monasteries, and that markets undersupply such temples of silence?

That the FAA is considering the rule change is not news. It was reported back in December. Though I'm not sure if Caplan or Cowen discussed it back then, I do know that I did. I don't normally do this, but I really liked that post, so here it is again:

The FAA is thinking about allowing cell phone usage on airplanes.

Here's my take on the matter. The only people who would bother me by talking on their cell phone on an airplane are the people seated right next to me. You can't hear a conversation more than a couple rows away because of the noise of the jet engines. It's not going to be that much noisier with people talking on cell phones. One possible glitch with that, however, is that I've never actually heard people talking on cell phones while the engines are running. (Currently they can only be used on the ground when the engines are much quieter if they are running at all.) People trying to talk over the engine noise might have to shout. (Not good.) Someone should do an investigation of this before it goes any further.

For me, it's that total stranger sitting 6 inches from me who would be the trouble. (Think: 3 hours or more sitting in very close quarters with someone complaining about life/love/work/whatever on their cell phone.)

So here's my solution: When ordering your tickets, you should have the opportunity to make a pledge to not use your cell phone. Those making that pledge will only be seated next to others who make a similar pledge, to the extent possible (and if it's not possible, you should be informed before being charged for the ticket). We already have on-line seat selection. This should not be that hard to implement in that system. Those not willing to make the "cell-free" pledge would have no right to complain if they are disturbed. (Note that I don't think a "no-cell section" of the plane would really be necessary. Just try to keep cell users and pledged non-users from sitting next to each other.

And let's see if the market can figure it out. Maybe one smart company will implement my plan (thinking it will get more non-cell phone customers). Others might follow. I hope the government doesn't try to micromanage this.

Any thoughts on my idea? Any other unintended consequences?

I'm not opposed to cell phones on airplanes, but personally, I would like to be seated next to people who (like me) will promise not to use them in flight. Shouldn't be hard to figure out.

On a related matter, the FAA is looking at providing Internet access in the air. It's about time!

I guess my view lies right between Caplan's and Cowen's. I don't need a temple of silence, but I would like a "bubble of silence." My idea is a little more flexible than a "no phone" section and would cope with fluctuating demand better (and thus not constrain the airline's profit maximization problem so much).

Billion dollar idea up for grabs... the cell-free pledge.

Thoughts?

Here's a site for history buffs like me.

Today is the 19th anniversary of the Chernobyl accident and the 16th anniversary of Lucille Ball's death.

Famous people born on this date include Carol Burnett, John James Audubon, Ludwig Wittgenstein, and Charles Richter (yeah, the Richter scale guy).

Who knew?

Just because I might want to check this site every day, I think I'll add a link on this page.

Via Mark Thoma--read here for the whole speech:

But, in the same vein, we should not hesitate to raise interest rates to contain inflation pressures just because it might set off a retrenchment in housing prices, just as we were willing to keep rates unusually low as house prices rose rapidly. Nor should we hesitate to raise rates because higher rates mean higher debt-servicing burdens for the current account, the fiscal authority, or households. In my view, our role is to anticipate as best we can the macroeconomic effects of imbalances and their correction and to respond to unexpected changes in asset prices and spending propensities as they occur. It is through such actions that we aim to achieve our objective of economic stability.

Compare to Sandra Pianalto's comments I reported on yesterday.

A while back I wondered out loud if some folks in the bond market were doubting the Fed's inflation fighting resolve. I'm sleeping better now. The speeches by Fed officials towards the end of the week were probably good words to get on the record.

Given all the talk about soft landings as well as Greenspan's dire warning on the deficit today, I thought this would be a good way to sum up my thoughts at the moment.

Thanks to David Altig for the link. He has some more extensive quotes at his blog. The whole speech by Cleveland Fed President Sandra Pianalto is worth reading, but this really fits my mood concerning the day's discussion.

In the long run, a central bank cannot balance the government's budget, boost national saving, create more energy resources, or solve the many economic problems that we must confront. But a credible monetary policy will help smooth the adjustment to economic circumstances that come our way.

Precisely. Full stop.

WASHINGTON (Reuters) - Federal Reserve Chairman Alan Greenspan warned on Thursday that unless lawmakers come to grips with spiraling U.S. deficits, the economy was at risk of stagnation "or worse."

"Under existing tax rates and reasonable assumptions about other spending ... projections make clear that the federal budget is on an unsustainable path, in which large deficits result in rising interest rates and ever-growing interest payments that augment deficits in future years," Greenspan told the Senate Budget Committee.

He said that while the U.S. economy was "doing well," the danger was that deficits would keep rising as a percentage of total national output.

"Unless that trend is reversed, at some point these deficits would cause the economy to stagnate or worse."

Greenspan's complete prepared remarks are on the Fed's web site. Have at it!

From the NY Times editorial page:

At the heart of this debate is China's policy of linking the value of the yuan to the value of the dollar. That was called sound policy when the dollar was strong. But now that it is weak, Congressional critics call it manipulation because it makes already inexpensive Chinese goods even cheaper the world over. As proof that the yuan is undervalued, the tariff seekers point to the United States' ballooning trade deficit with China, which accounted for about one-fourth of the United States' gargantuan global trade imbalance of $617 billion in 2004.

The trade deficit and the loss of American manufacturing jobs are very serious problems. It would be nice to think that they would self-correct if China would only change its ways. Nice, but wrong. Most of the trade gap with China is caused by Americans' insatiable appetite for Chinese imports, for which there are few domestic substitutes. And even if the yuan's exchange rate is too low - a point on which economists differ - it is a minor contributor to the trade deficit. If China let the yuan appreciate by 20 percent, and most other Asian currencies followed suit, the deficit would probably decline by only about one-fifth over the next year or two. That's not nearly enough to bring the American trade imbalance into a range that is generally considered sustainable.

Tariff-mongering politicians don't necessarily want to believe this. "Many of us feel they're playing this country for a fool," Senator Charles Schumer of New York fumed at a recent hearing. Treasury Secretary John Snow, to his credit, explained at that hearing how a premature yuan revaluation might do more harm than good.

That's just a sample. Read the whole thing. It's right on target.

UPDATE: More on China in today's Times.

PGL examines Bruce Bartlett.

While I agree with his concern, I don’t agree with Bruce’s analogy to the FED tightening during 1999-2000 for two reasons. One is simply that labor markets were tight five years ago and they are not currently. The second reason goes to the discussion at the end of Bruce’s op-ed – that being the “twin deficits” issue. The better analogy would be to compare the current situation to that during 1981 when labor markets were not tight but the FED was concerned with excessive long-term fiscal stimulus.

Absolutely correct on the first part.

On the second part, I differ a bit. 1981 might not be the best comparison either. While the point about the labor market is correct, the current account was in surplus in 1981. The budget was in deficit. In 1999 and 2000, the opposite was true. Today, both are in deficit. That's a pretty big difference right there.

Another difference is that in 1981 the Fed spiked the real funds rate up to almost 10% to wring the last vestiges of the 1970s inflation out of the economy. I really don't see that being in the cards.

I think 1994-95 is a better analogy. (I know, I know, you're not surprised, are you?) The twin deficits had reasserted themselves briefly. The labor market certainly was not tight--unemployment rates were comparable to today's. Employment growth was returning to normal after a jobless recovery (it's unclear that employment growth in the present environment is quite back to normal--it seems to be taking a little longer this time). The strike against inflation by the Fed was preemptive, rather than closing the barn door after the cows got out.

One difference was that tax receipts were trending upwards in prior years (thanks to George H.W. Bush). This has not been the case in the last few years. However, that picture is starting to turn around--not fast enough for some, but turning around nonetheless.

POSTSCRIPT: I forgot to point out that Bartlett finishes his column with:

Hopefully, this can all be managed smoothly and without either a recession or a market break. But it will take great skill and a lot of luck to avoid both.

I couldn't agree more.

UPDATE: PGL and Bartlett spar in the comments at Angry Bear. Worth reading.

I'm not sure why, but it looks like comments have been slow to post. It's also taking more time for me to delete comment spam. Might just be a problem with the server. I'll watch it for a while and see if it gets better or worse and see if I have to do something about it.

When posting a comment, please just submit it once. Even if you refresh the page and it doesn't appear, wait a couple minutes. Refreshing the page usually brings it right up, but perhaps it wasn't today. I would like to know if there are systemic problems. Please feel free to e-mail me at this address, cleverly disguised to confuse spammers (wpolley at bradley dot edu).

Since we're on the subject and have some new readers, now would also be a good time to share my ideas on comments.

1. The purpose of the comments section is to create a dialogue within a community of individuals interested in serious discussion of economics and whatever else I choose to post. The handling of comments will always derive from this guiding principle.

2. Duplicate comments will be deleted. They do not add to the discussion. Same goes for trackbacks.

3. Comment spam will be deleted. This should go without saying. Same goes for trackbacks.

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5. Comments are not edited for spelling or grammar. If I choose to quote your comment in a future post, I may do light editing of spelling and punctuation to make sure we are both understood.

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It's that easy. This blog has picked up a lot of new readers in the last few weeks, and it's important to say "Welcome!" to the newcomers every once in a while. Look around, stay a while, and keep coming back. I am getting to know some of you through comments, e-mails, and your own blogs, and I like the network that is developing. With your support, it will keep getting bigger and better. Thank you!

Enjoy it while you can. The next FOMC meeting is on May 3, two weeks from today. Fed officials observe a "blackout period" beginning one week in advance of the meeting and extending to the Friday after the meeting. You'll probably hear a number of FOMC members get their licks in before next Tuesday.

Today, it was Janet Yellen and William Poole.

San Francisco Fed President Janet Yellen said high energy prices may have created a soft patch by crimping consumer spending, while St. Louis Fed President William Poole said the economy is forging ahead and promises sustained growth.

Interviewed on CNBC, Yellen said "we're hitting something similar" to the conditions seen in the second quarter of 2004, when the pace of economic growth waned.

"We've had some recent readings on trade and retail sales that suggest maybe we had a soft spot in March," Yellen said. High energy prices "draw purchasing power away from a broad range of other goods and services."

Even so, the economy is still growing modestly above its long-term trend pace of 3.25 percent to 3.5 percent, "just enough to reduce labor market slack over time," she said.

Yellen, who leads the largest Federal Reserve district, was the first Fed official to address weak economic data that has jolted market expectations for Fed policy over the past few weeks.

Rate futures dealers, fearful of slower growth, see a chance that the Fed will pause its program of 25 basis point interest rate hikes as soon as August.

The Labor Department on Tuesday said March's core PPI rose 0.1 percent, below Wall Street forecasts. Headline prices jumped 0.7 percent, the biggest advance since October, as gasoline and heating oil prices jumped.

Poole and Yellen. both non-voters on the Federal Open Market Committee this year, said rising headline inflation recently showed a "pass-through" of energy prices but that long-term inflation prospects were sound.

"The outlook for inflation looks quite or very favorable," Poole told reporters after a speech on entrepreneurship. Tame labor costs and growing productivity were helping to keep a lid on inflation, he said.

Yellen said the energy price hikes would most likely also appear in indicators such as the consumer price index, due for release on Wednesday.

All in all, a very fair and even-handed assessment. And yes, tune in tomorrow for the CPI.

By the way, Mark Thoma has a post to St. Louis Fed President Poole's remarks.

"As we get into that (normal) range, policy will become increasingly data dependent," Poole said.

"Last year is the unusual period and you should not expect that as a pattern going forward ... Last year was the exception to normal practice," he said, referring to the predictability of Fed rate hikes after the central bank vowed to remove its policy accommodation "at a pace that was likely to be measured."

Flashback 1994-95: After a few 25 b.p. hikes, the FOMC alternated between doing nothing and raising the funds rate by 50 b.p. or more. In other words, the first few were pretty predictable. The next few, not so much.

I don't see any 50 b.p. increases around the corner, but alternating between doing nothing and 25 b.p. increases is not out of the question.

This assurance was repeated at the last Fed meeting, on March 22, but Fed-watchers expect it to drop the language in the months ahead.

Poole declined to speak directly to the issue of the language in the Fed's interest rate statement but made clear that he felt that all options were open.

As I reported previously, Poole elaborates on this point here.

Spelling it out, Poole said Fed rates could either rise, fall or stay the same, adding: "I want to be quite symmetrical about that" to emphasis that he was giving no more weight to one outcome than either of the others.

That is an interesting way to finish. Personally, I can't see a decrease (see above), but he might be preparing us for the possibility of it later in the summer or even fall.

Mark Thoma's take:

Thus the message is, beginning with the next FOMC meeting, not to expect a straight line path to the target Federal Funds rate.

My take, using my aviation analogy:

We're transitioning from the approach phase to the landing phase. The workload on the pilot just doubled. Fasten your seat belts.

In textbook terms, real GDP is approaching potential GDP from below. Overshooting will cause inflation and too much tightening will kill off the expansion prematurely. Rate movements are going to be very data dependent, much like the 94-95 soft landing. Prediction gets harder. Uncertainty abounds. People hang on every word of every news release, looking for something that will give them a clue of what will happen next. (It's the CPI tomorrow.)

I remember it well from 94-95. I was a first year grad student at the time and following this intensely. While some things are different, I notice a lot of similarities.

And people wonder why I find this stuff fascinating. How can anyone not be fascinated by it?

For more, click here:

VATICAN CITY (CNN) -- Cardinal Joseph Ratzinger of Germany has been selected by the Roman Catholic church as the new pope.

Cardinal Jorge Arturo Medina Estevez of Chile made the announcement to a cheering crowd in St. Peter's Square.

Ratzinger, who took the name Benedict XVI, appeared on the balcony of the Vatican Basilica to greet the people and deliver his first papal blessing.

Dominus tecum, Benedictus.

This time a hard landing of stagflation. A few days ago, he pondered a hard landing caused by a dollar crisis.

So many things to go wrong. In a dollar crisis, interest rates would spike, and that would be a contributing factor in slowing the economy. In stagflation, inflation takes off at the same time unemployment rises and the Fed must decide if it will raise or lower real interest rates (nominal rates will be rising due to inflation). Could a dollar crisis touch off a bout of stagflation? Yes, it could.

Mark plans to write more about hard landings in the coming days. That's good. It's worthy of discussion. I'll throw in my 2 cents from time-to-time.

I don't think I've defined what I think of as a hard/soft landing yet, so here goes.

I am a licensed (but currently inactive) pilot. I have been at the controls of a single engine airplane for many landings, some hard and some soft. Let me tell you, it's every pilot's goal to make the perfect "soft" landing--the one where you don't even feel the wheels touchdown. It's rare, and it takes a lot of skill just to have a chance at a soft landing.

When a new pilot makes a hard landing, it's usually because he or she thought the runway was about a foot higher than it really was. The pilot did a nice job of essentially landing the plane in the air a dozen inches off the surface. The airplane, not knowing any better, figured that its job was done and stopped flying... and began a brief one foot free-fall. Coffee gets spilled, but no lives are lost. Do it a few more feet up an you might bend the landing gear. Do it a hundred feet up and you might not live to tell about it.

Another kind of hard landing is coming in too fast and slamming into the ground. Use your imagination. New pilots do this once in a while too. As long as you correct for it before you hit the runway, you might save the upholstery, but probably not your pride as the folks in the hangar watch you float half a mile down the runway.

Last but not least is the hard landing that just happens. Everything is perfect and then the wind changes. It's like someone suddenly dropped you towards the ground. Been there. It stinks.

What's my point? I remember when the term soft landing started to be used to describe what the Fed did in 1994-95. I liked the term because it seemed to describe in familiar aviation style terms what was happening. The changes in interest rates in 1994-95 were like the corrections that a pilot makes when coming in to land. Too much too soon and you land above the runway and free-fall (choking off the expansion). Too little too late and you either slam into the ground or float half a mile (runaway inflation). Of course, you could do everything right and still spill your coffee when the wind changes at the last minute (oil price spikes).

When things change at the last minute, things can indeed get dicey for both pilots and central bankers. You don't want to use all of your ability to control the situation until you really are safe on the ground. That is Mark's point, and it is a correct one--for pilots and central bankers.

Greenspan did a lot of things right in 94-95, and got lucky besides. The wind didn't shift suddenly on us then, unless you count the Peso crisis, which did make things touch-and-go for a while (aviation pun intended) but was ultimately not much of a factor (for the U.S.) in the soft landing that followed. We had plenty of policy ammunition left to deal with it.

A soft landing is stable inflation and unemployment at sustainable levels in the maturing phase of an expansion. You'll know it when you feel it (or don't feel it, as the case may be).

This story will continue for a while. I imagine Mark and I will be commenting periodically on this until we... uh, land.

Jane Galt questions the value of the Social Security trust fund.

Upon even a moment's reflection, it's obvious that the trust fund does not exist in the way that its proponents are claiming -- as a guarantee of benefits -- because the bonds are not obligations to Social Security beneficiaries. They are obligations to the Social Security Administration. (emphasis in original)

She continues:

Let's say it's 2018, and Congress is running out of money, as the Social Security system stops paying money into the government coffers, and starts taking it out. Congress cuts benefits to the point where Social Security taxes are once again a net contributor to federal revenue. Have we violated the trust fund? Nope. Congress is still paying the interest on those bonds; it's just that the interest they pay is immediately lent back to the federal government. Congress could knock benefits to zero, and keep recording interest payments into the trust fund for all eternity, without violating anything except its constituents expectations.

Now, is this likely? Probably not, because the political cost would be high. But the point is that the continuation of benefits depends on the political cost of offending a highly motivated interest group, not the existance of this trust fund. And the effect on the government of continuing those benefits--forcing it to raise taxes, cut other spending, or borrow money to pay for them--is exactly the same whether or not the payments are recorded on the books as "interest on bonds" or "contribution from general revenue". (emphasis mine)

That last part is what tells me that she understands the concept of the trust fund. I gather, however, that she is just a little less optimistic than I am about the government's willingness and/or ability to make good on their past promises.

But that's ok. That's where the discussion should be focused. In order for any progress to be made on this issue, we all must agree that the generational contract is what is important and that contract has nothing to do with how many bonds are in the SSA's file cabinet. If you happen to interpret the part of my sentence in italics as meaning that the trust fund consists of "worthless IOUs," that is your interpretation. I would, however, say that they are no more or less valuable than the IOUs (T-bills) that the government issues to the public. They are not worthless in that sense. They will be paid to the SSA and not repudiated. But their connection to actual benefits paid is a political, not an accounting, relationship.

To put it another way, those who will retire between 2018 and 2042 should consider this question. How do you think of the government's promise to pay you Social Security benefits?

a) a promise of a stream of income related by a formula taking into account the earnings over my lifetime, indexed by the growth of wages, and once I start earning it, adjusted for increases in the cost of living.

b) a claim to a share of the bonds in the trust fund.

Just because the answer is (a) that doesn't mean that the trust fund is worthless. If we can't agree on that, I don't think we're going to get very far. This sort of thing doesn't help.

Unfortunately, it is easier (for both sides) to politicize the trust fund than it is to discuss the generational contract. It's inevitable (for reasons that economists on both sides understand quite well, I think), but it's very unfortunate just the same.

It's Monday. You know what that means!

Notice that the probability of a pause in rate hikes in July has taken a turn. We'll have to watch and see where that goes.

Apparently seats in law school classes were up for sale at NYU. I highly recommend that you read the entire article. If you're a professor you might be simultaneously intrigued, amused, and slightly disturbed (depending on your sensibilities towards the efficiency/equity tradeoff) all at the same time.

If you understand the Coase Theorem--and I mean really understand it at a deeper level than the econ 101 version--you'll know why I think this part is the best. The author of the article does understand the Coase Theorem.

[Vice Dean Barry] Adler, who was also Wilson's first-year contracts professor, would not cede the economic argument. He acknowledged that banning cash transactions might lead to inefficiencies—say, if Wilson had found a student holding a spot in Neuborne's evidence class who would have been happier with a less popular evidence class and a $200 dinner at Il Mulino, the old-world Italian restaurant down the street from N.Y.U. But the law school was also concerned with the distribution of wealth among its students. As Adler correctly observed, legal rules affect not only how resources are allocated, but who winds up spending how much. By barring the sale of classes, the law school aimed to avoid putting pressure on better-off students to buy the classes they wanted, and, even more importantly, pressure on poorer students to sell their valuable seats. "There's nothing inconsistent with Coase's Theorem there," Adler insisted.

The opportunity for empirical research was not lost on law and economics professors. Oren Bar-Gill, who teaches a behavioral law and economics class at N.Y.U., was quick to point out flaws in the putative free market for class spots. "In a Coasean world, one would think it makes sense to allow trading cash for classes, because both parties are better off," he explained. "But you also have to take into account the ex ante effects of the rule." Specifically, Bar-Gill feared that students would initially bid in the lottery not for the classes they wanted but for the classes most likely to fetch a high price on Coase's List. Then "bright but not so rich students" would avoid N.Y.U., knowing that many spots in the best classes would eventually be sold to their wealthier peers. Or, Bar-Gill mused, poor entrepreneurs might choose N.Y.U. over its competitors precisely because they could expect to earn pocket money by selling their class picks. As a result, many students would end up not getting the classes they wanted, and N.Y.U. would end up losing the students it wanted.

As the class-selling episode drew to a close, different people drew different morals from the story. Adler announced that the school was "looking at ways" to make a waiting list possible. Neuborne claimed that he was "furious about the practice." He said, "It cuts me out of the profit. If any student wants favorable treatment from me, the student must deal directly with me in a cash transaction."

I wonder what Coase would say about all this?

By the way, the web site Legal Affairs, whence comes this article, looks interesting enough to bookmark.

Hat tip: Newmark's Door

...on the list of top paying college majors in the class of 2005.

Kash at Angry Bear doesn't know why, but he thinks we should care about it.

I have no good explanation for this seemingly bizarre (dare I say irrational?) behavior. Financial markets do overreact sometimes, and at times they go through unexpectedly large swings as a result of new information that was actually unsurprising, such as the release of the FOMCs minutes last week, or the FOMCs statement in March. I think that such movements are often hard to explain if you believe in the perfect rationality of investors (rational overshooting models notwithstanding).

Should we care? It's tempting to dismiss this new collection of bearish stories as no more than hype, or the most recent "flavor of the month" in ever-fickle investor sentiment. So I'd like to say no, we don't need to care. Except for this one inconvenient, insurmountable fact: developments in financial markets, such as interest rates and asset prices, can have strong and lasting effects on the real economy.

He's right about the reason we should care. And it's nice that someone else thinks that the FOMC's statement and minutes were "unsurprising." In light of all that, I would have expected the 10 year to stabilize around its mid-March level (around 4.5%). We're below that now. It could be just overshooting, or it could be earnings worries. We probably won't know for sure for a few weeks.

In the meantime, watch and wait. But don't ignore it.

This CNN article has more on the story.

UPDATE: Another CNN piece interviews former Fed Governor Laurence Meyer. He doesn't think the sky is falling.

UPDATE: Paul Krugman thinks we're already having a mild case of stagflation.

Nouriel Roubini agrees.

Now remember, I still lean to the "soft landing" side of things, though I acknowledge that our current position is not without risk. Raising the level of pressure on China to revalue the yuan increases the risk.

Remember also, that I have said that China will not do anything until it is their time to do so. So it may not surprise you that I think that the talk from Washington is just that. Talk. And talk, as Roubini also says, is cheap. This is the kind of talk that could weaken our credibility if people really sat down and realized that it will likely have no effect on China and, as far as I can tell, is only really intended for domestic consumption.

You see, Brad Setser's comment in this post (the Peoria comment) is right on. I think this probably is a case of a position being taken (on the exchange rate issue) to look like we're doing something to close the trade deficit. There would be a small upside to a revaluation, but the downside is much, much worse for both China and the U.S. if the revaluation is too much, too soon (see Roubini's quote about not biting the hand that feeds you).

And China isn't going to do anything that is not in it's best interest anyway.

A few years ago, it might have been 2002, I was asked when I thought China would begin to relax their exchange controls in a meaningful way and begin to float. At that time, I answered somewhere between 2008 and 2012, and that it would be gradual, perhaps taking that entire range of years to complete. Funny thing is that today I'm less sure. I don't think I have the confidence to give a range like that now. If pressed, my answer would probably be about the same, but with less confidence. There would be something to be said for beginning before the Olympics, but that's really going out on a limb.

Bottom line is that there are still plenty of reasons for China to go slowly, even though we all know where they (and we) want to be in the long run--when they are ready.

And most of the things that need to happen for China to be ready are beyond our control--certainly beyond what we can change with mere words. All other things equal, too much talk could come back to bite us later, regardless of whether China responds to it or not.

Alas, it continues, (Reuters)

BEIJING (Reuters) - U.S. pressure to free up the yuan will be counter-productive to China's planned currency reforms, despite a growing domestic sense of urgency for making such changes, the official China Daily said on Monday.

"Pressurizing China will be futile, if not even complicating the situation," the newspaper said in a commentary. "Worse, it will distract the United States from attending to the domestic causes of its problems."

UPDATE: Dan Drezner has an interesting take.

Brad Setser comments on the Treasury's report on international capital flows for February.

Punch line:

In other words, after a bit of foreign interest in the US equity market in January, old patterns reasserted themselves in February. The US financed itself exclusively by the sale of long-term debt securities.

In an update to his post, Setser takes note of China. In particular, there is evidence from the flow data that China is buying large quantites of long term debt from us, but that is not showing up in the stock data, or for that matter, in the central bank data.

I agree with his bottom line:

Bottom line: there is no perfect measure of even the direct impact of foreign central banks on the US market.

Though I was a little disappointed in the lack of interest in equities, I can't say that anything in there surprised me too much aside from the abovementioned discrepancy concerning China. Given recent declines in the stock market and the recovery of the bond market, I would expect this pattern to continue at least through the April data and perhaps beyond.

Read the comments on Brad's post too. There is a mention of the latest attempt by the administration to get the Chinese to start floating the yuan. In response, Brad says,

... I suspect the intended audience is more "peoria" than "beijing,"...

Thanks for the Peoria reference, Brad! Anyway, this Peorian thinks that Beijing will do what it will on their own terms and in their own time.

It's April 15. Have you filed your taxes yet?

When I was in college, the local Dairy Queen ice cream stand would give away free chocolate sundaes from 10pm to midnight on April 15. You see, it was just a couple blocks from the post office (and the college). But the event became a college tradition (even though none of us actually waited until the 15th to file our taxes).

The line was longer at the Dairy Queen than at the post office. Much longer. And much happier!

I hope they still do it. If you're in Moorhead, Minnesota tonight, have a sundae for me.

UPDATE: The free sundae tradition continues!

Via Roubini's Global Macro, comes this article from EUobserver.

A top German economist has warned of serious economic consequences if there is a No to the EU Constitution in the 29 May referendum in France.

The chief economist at Deutsche Bank, Norbert Walter, told FT Deutschland that a French No might cause a currency crisis in the new member states.

"There could be speculative attacks on currencies of the new EU member states", Mr Walter said. "These countries would then have to raise their interest rates. It could cause enormous exchange rate fluctuations", he warned.

Here's more from the Telegraph.

Do a Google news search for "france eu constitution" and you'll see that the world is talking about this.

The U.S., alas, is not.

UPDATE: macroblog noticed a similar story in the Financial Times.

International Economic Trends Supplement from the St. Louis Fed.

If you were ever frustrated by the IET's format that lists all the variables for each country individually (making it hard to compare a single variable across countries), you will be frustrated no more.

Check it out.

This is the second in what I am planning as a series of installments on the similarities (and differences) between this point in the recovery and the corresponding point in the last cycle, about 1994/95. Astute readers will remember that the Fed commenced with an extended period of interest rate hikes beginning in February 1994 and continuing for a little over a year and ending with what was widely regarded as a "soft landing." We seem to be in the middle of that sort of situation again. The end of the story (the softness of the landing) has yet to be written.

The graph above shows the major currency index immediately before and during the tightening period. Now, I've been thinking about this topic for a while and have long suspected that there are similarities (though I do intend to point out differences as well) between this cycle and the last. I was expecting the two series to be similar, but I wasn't expecting this close of a match. It looks like the only real difference was a steeper depreciation of the dollar in the months leading up to the start of the rate increases. One could perhaps say that this suggests that the Fed started tightening a little late, at least where the dollar is concerned. However, I don't subscribe to that. The Fed's credibility has increased considerably since 1994 and the fact that the dollar appears to have responded in like manner once the tightening began is, I think, evidence that the policy is working. In 1995, the dollar bottomed out about 15 months after the start of the rate hikes. In the current context, that would correspond to about the first of October of this year.

To be sure, there is no guarantee that the current cycle will proceed along the same lines. Indeed, a multitude of factors, foreign and domestic, could push things off course. Let's not forget that there were currency interventions in the 1994-95 period, though it is not entirely clear that all of them were effectual.

So let's just say this is interesting. I will, of course, update the chart as necessary.

A quote from the minutes:

They also noted that the language had not precluded a notable increase in medium- and longer-term interest rates over the intermeeting period as markets extended the expected gradual increase in policy rates.

On the release of the minutes, the 10 year yield shed about 8 basis points almost immediately.

So what does all this mean? In a way, it looks like it's back to business as usual, but perhaps with a bit more clarity as we go forward to the next meeting. But let's go back to March 23, when I said:

If you haven't guessed by now, the thing that still puzzles me the most about Tuesday's events is why the bond market reacted so suddenly, so negatively to news that was not really news. What motivated traders to hold on to the 10-year until 2:15pm EST yesterday? If "measured" isn't that significant, and if the Fed is committed to keeping inflation at bay, and if we all knew that price pressures are building based on previous information, why did they wait for the statement to move?

Truth be told, the bond market did make it back to where it was right before the meeting within a few days. At the close today, the 10 year yield is down to the level of early March, around 4.35%. The 10 year, at least, has gained back all of what was lost on March 22nd and then some (which adds to the irony of my opening comment). I feel vindicated. I think I was right to be puzzled.

In the end, I think that the release of the minutes today did a lot of good. It brings some clarity to the situation. Some of the FOMC members were concerned, as the minutes confirm, about the continued use of the term "measured pace." But given the latest employment data and the general economic picture right now, those words might be with us for another few weeks--or at least until they can come up with something better.

At the close of the market today, the market feels like inflation really is contained, but some pressures are there. And if employment costs start to rise or other price pressures emerge, the Fed will act quickly, perhaps even with a 50 b.p. hike--but only if necessary. No need to dump those bonds yet.

And so, at the end of the day, 10 year yields are at the levels they were in early March, well ahead of the last FOMC meeting. The yield curve is flattening again.

Greenspan's "conundrum" is back. This story isn't over yet.

Along those lines, here's a CNN article that suggests the bond market might be in denial.

Thoughts?

The minutes of the March meeting are out. As is often the case, the really good stuff is towards the end. Here are some highlights.

Meeting participants commented in particular detail on the inflation situation. They noted with some concern the recent elevated readings on inflation in prices of core personal consumption expenditures, the producer price index, and indicators of prices at earlier stages of production, as well as the sizable further increase in energy prices. Nonetheless, many participants stated that they expected total inflation to diminish and any rise in core consumer inflation to be limited. One source of upward pressure on inflation had been the rise in energy prices, and it seemed reasonable to expect that these prices would level out or even decline mildly, as built into futures prices. Unit labor costs were still being held down by moderate wage growth and rising productivity. Indeed, a few saw a distinct possibility of further positive productivity surprises, representing a downside risk to the inflation outlook. Moreover, the markup of prices over costs in nonfarm businesses remained quite high, and firms would likely be pressed by competition to absorb a portion of any step-up in the growth of unit labor costs, at least if that acceleration were limited in extent and duration. In addition, prices of many non-energy commodities had risen in recent weeks, but such inputs constituted a relatively small fraction of overall business costs, and, partly for that reason, in the past commodity prices had demonstrated little predictive content for broad inflation rates. While short-term inflation expectations had risen somewhat, longer-term inflation expectations remained well contained. And lastly, monetary policy would be aimed at preserving price stability.

Still, many participants indicated that their uncertainty about the intensity of inflation pressures had risen in response to recent developments and that, in particular, the distribution of possible inflation outcomes was now tilted a little to the upside. Although monthly statistical releases could be quite volatile, the recent data showing consumer inflation a little above previous expectations were of concern. Also, anecdotal indications of price increases were becoming more common across a number of industries. Some business executives reportedly believed that, with aggregate demand expanding robustly and the lower foreign exchange value of the dollar putting upward pressure on import prices, a degree of "pricing power" had returned. Moreover, the recent rebound in spot crude oil prices, and especially the substantial advance in prices of crude oil futures contracts for delivery well into the future, suggested that a significant unwinding of higher energy costs might not be in prospect. Several participants indicated that, in current circumstances, they viewed an upside surprise to inflation as potentially more harmful than an equivalent downside surprise, partly because such an outcome could well impart additional upward momentum to inflation expectations.

This passage is interesting...

... Although the required amount of cumulative tightening may have increased, members noted that an accelerated pace of policy tightening did not appear necessary at this time, as a degree of economic slack apparently remained, productivity growth would probably continue to damp increases in unit labor costs and prices, and inflation would most likely continue to be contained. In these circumstances, Committee members judged that the measured removal of policy accommodation was appropriate for now.

... Regarding the risks to sustainable growth and price stability, members discussed a proposal to make the Committee's assessment explicitly conditional on an assumption of appropriate monetary policy so as to underscore that maintaining balanced risks would require policy action. It was noted that the Committee's assessment of balanced risks over the past nine months--a period in which monetary policy had been steadily tightened--necessarily had to be interpreted as based implicitly on an assumption that policy accommodation would be removed. A number of members believed that formulaic language by its nature was too rigid to reflect evolving economic circumstances in a satisfactory manner, especially when developments were subtle or complex, and some of these members believed that the risk assessment should be discontinued. All the members ultimately approved making the risk assessment in the policy announcement following this meeting explicitly conditional on appropriate policy.

And finally, the part I was really waiting for...

Members also focused on the issue of whether to reiterate the judgment expressed in the Committee's recent statements that ". . . policy accommodation can be removed at a pace that is likely to be measured." Some expressed the view that such language could constrain future policy inappropriately; while these concerns were not new, they were now felt to be more pressing, as the odds that the Committee might need to step up the pace of policy firming were thought to have increased. Members noted, however, that the existing "measured pace" language was clearly conditional on the economy evolving in a way that promised a gradual return to high levels of resource utilization and on inflation remaining low, and thus believed that the wording did not rule out either picking up the pace of firming or pausing in the process of removing policy accommodation should circumstances warrant. They also noted that the language had not precluded a notable increase in medium- and longer-term interest rates over the intermeeting period as markets extended the expected gradual increase in policy rates. Some discomfort was expressed with language that related so explicitly to the likely trajectory of future policy action. But it was also averred that the Committee should, to the extent possible, provide information that would help the public anticipate the probable course of monetary policy; providing such information would tend to increase the effectiveness of monetary policy. More generally, members recognized that the Committee's statement would need to evolve over time. (Emphasis mine.)

"Measured pace" does not mean 1/4 point increments. I think that much is clear. And I don't need to tell you that I'm glad about that. I was beginning to hate those words because I too think they are too constraining. I think the market misinterpreted them for a while, but we should be past that by now.

I have to go teach. More later.

Ben Bernanke is speaking in St. Louis on Thursday at the annual Homer Jones lecture.

If only it were on Friday. On the bright side, I'm sure the text of the speech will be posted on the internet.

Trade numbers for the U.S. will be released in a few hours.

As most people would expect, China has a trade surplus. (From Bloomberg via the NY Times)

China's trade surplus widened in March as manufacturers shipped more clothes, electronics and machinery to the United States and Europe.

The surplus reached $5.7 billion, up from $4.4 billion in February and rebounding from a $630 million deficit in March 2004. Exports rose 33 percent from a year earlier, to $60.9 billion, after gaining 37 percent in the first two months of the year, the official Xinhua news agency said yesterday.

and...

China's imports increased 19 percent, to $55.1 billion in March, after rising 8.3 percent in the first two months of the year. Growth has slowed from 37 percent last year amid a government clampdown on industrial expansion.

And also from Bloomberg,

April 12 (Bloomberg) -- The U.S. trade deficit probably widened in February to $59 billion, the second-largest on record, because of rising imports from China and other countries, economists said before a government report today.

The projected shortfall in goods and services trade, based on the median estimate of 67 economists surveyed by Bloomberg News, compares with $58.3 billion in January. That was second only to November's $59.4 billion gap.

No two ways about it. That's big.

A rise in oil prices and U.S. consumer demand for foreign- made goods including clothing and electronics probably boosted the value of imports during the month. A weaker dollar, which made U.S. exports less expensive, didn't help overcome slowing economic growth in Europe and most of Asia, economists said.

Here's your headline.

"Domestic demand has shown no signs of a slowdown, while foreign demand appears to have slipped recently," said Dean Maki, chief U.S. economist at Barclays Capital in New York.

The Commerce Department is scheduled to release the trade data at 8:30 a.m. in Washington. Deficit estimates in the Bloomberg survey ranged from $56 billion to $62.5 billion.

Oh, and don't forget this...

The Treasury Department is also scheduled to issue its estimate of the government's budget deficit for March. The report, due at 2:00 p.m. in Washington, is forecast to show the gap narrowed to $69.8 billion last month compared with $72.7 billion in March 2004, according to the median estimate.

Did I tell you that it's going to be quite a day for economic news?

Investors may also get a glimpse of how concerned Federal Reserve policy makers are about inflation when minutes from the central bank's March 22 meeting are also released at 2:00 p.m. in Washington. In raising the target interest rate a quarter percentage point to 2.75 percent last month, the Fed said pricing pressures had increased.

The transcripts would be, I am sure, much more interesting, but we have to wait 5 years for those.

Buckle your seat belts. It could be an interesting day.

UPDATE: Trade numbers are in.

The U.S. Census Bureau and the U.S. Bureau of Economic Analysis, through the Department of Commerce, announced today that total February exports of $100.5 billion and imports of $161.5 billion resulted in a goods and services deficit of $61.0 billion, $2.5 billion more than the $58.5 billion in January, revised. February exports were $0.1 billion more than January exports of $100.4 billion. February imports were $2.6 billion more than January imports of $158.9 billion.

That's on the high side of what was expected. It's also more than 2% higher than the monthly record set in November. Since these are in current dollars, this should be compared to growth of GDP in current dollars, which is around 6% annually. If the monthly trade deficit continues to grow by 2% every three months, it will continue to outpace GDP growth.

Calculated Risk has more on the relation of trade to oil prices and a prediction that will probably turn out to be correct.

UPDATE: Brad Setser weighs in.

Roubini's new site is at http://www.rgemonitor.com. Bookmark it and check it often.

If you are a student of macro or international economics at any level, you will probably find useful information for your research at Roubini's site.

As an aside, there is an incredible amount of high quality economic scholarship and commentary available for free on the internet today. Roubini's www.rgemonitor.com is one very good example, and he has links to so many others. Economics should appeal to any student wanting to understand what is going on in the world. With the amount of statistical data, academic papers, and discussion available to those of us who teach this stuff, economics classrooms can be much more lively and interesting than the stereotype.

In case you need a quick intro to this topic, Brad Setser wrote about the Korean situation here and here.

On to today's news. The plot thickens.

From Reuters:

SEOUL (Reuters) - South Korea's central bank will not seek to diversify currencies in its massive foreign exchange reserves away from the dollar because that would push the won higher, Yonhap news agency quoted the bank's chief as saying on Sunday.

Park Seung, Governor of the Bank of Korea, was also quoted as saying while visiting Japan that the won's rise was too fast and should not gain further.

He said he planned to discuss issues related to the foreign exchange reserves when he meets his Japanese and Chinese counterparts in Seoul on May 27, according to Yonhap.

"The exchange rate should not go down further," Park was quoted as telling reporters in Okinawa, where the Inter-American Development Bank (IADB) was holding its annual conference.

"The policy of seeking diversification in foreign reserves can push the exchange rate down further."

A currency dealer in Seoul said Park's remarks represented a dilemma facing South Korean foreign exchange authorities -- that they cannot afford to expand foreign reserves further amid domestic criticism about the costs of carrying reserves.

"I don't think it really means they are abandoning the diversification effort but the central bank wants to show the determination of authorities to slow the won's rise," said Park Yong-il, senior FX trader at DBS Bank branch in Seoul.

It's a dilemma, alright, as the first link to Setser's page (the more recent one) indicates. The words Scylla and Charybdis come to mind.

The article continues with a short but informative blurb on the reserve situation.

South Korea, Asia's third-largest economy, held reserves of $205.45 billion at the end of March, the fourth-largest holdings in the world. The reserves rose 26 percent over a year before, or some $42 billion, which dealers said mostly came from the central bank's direct intervention in the local currency market.

The rising cost of accumulating and holding reserves has emerged as a headache for Asia's central banks, which together hold more than $2.45 trillion of such assets.

The won has risen only about 2 percent so far this year against the dollar but it followed a 15 percent gain in 2004. Its rise was also in contrast to a drop of about 5 percent in Japan's yen against the dollar this year.

As a result, the won's value against the yen rose 7 percent this year to its highest level since the 1997-1998 Asian financial crisis.

Make no mistake, Korea does not want us to experience the hard landing scenario, and their ability to navigate these waters matters for how hard our landing is. Despite the fact that it looks less likely that Korea would massively sell off our debt, I can't exactly say that I'm flush with optimism over this news.

One study thinks so.

Fifty-three percent of adult e-mail users in the United States now say they trust e-mail less because of spam, down from 62 percent a year ago and about the same as a June 2003 Pew survey.

Pew also found that 22 percent of e-mail users say they are spending less time on e-mail because of spam, down from 29 percent last year. In 2003, it was 25 percent.

No confidence intervals, so I don't know just how much of a difference this really indicates. Obviously they think it's significant.

"This shows some level of tolerance that people are manifesting," said Deborah Fallows, a senior research fellow at Pew and the study's author. "Maybe it's they're getting used to it. Maybe it's like other annoying things in life - air pollution, traffic - they are just learning to live with it."

And then there's this,

Pornographic spam is on the decline, replaced by fraudulent "phishing" scams aimed at stealing bank passwords and other sensitive information, the study finds.

Maybe people just started ignoring the pornographic spam. Since the providers only get revenue if the spam actually gets results (cliking on the links, visiting their site, etc.), the best way to discourage them is to just ignore them. The cost of spamming is not zero, but it is low. So I'm a little surprised that they are giving up. (Surprised, but certainly happy.)

The "phishing" is a different thing altogether. These are attempts to defraud people and should be dealt with as such.

You've heard it a million times, but it bears repeating. Don't ever give out your passwords or account numbers in response to an e-mail. No reputable company will ever ask for them that way.

Unfortunately, the potential profit (or plunder) for phishing spammers might be better than it is for the pornography spammers. They might prove harder to get rid of. But if we all just ignore them... maybe. Just hit "delete".

Dave Altig knows what we want. He says that he'll be posting charts showing the implied probability of various outcomes for the fed funds rate as a regular feature every Monday.

Concerning today's charts, he says

The clear message in the latest data is the return of the "measured pace" expectations following the weaker than expected March employment report.

If "measured pace" means 25 basis points per meeting, that is.

Keep those charts coming!

Via Reuters:

Speaking in Washington, [Philadelphia Fed President Anthony] Santomero said policy-makers can move in a "slow and cautious manner" but cannot afford to get "behind the curve."

"We think he meant this in a more general sense, but the market may be reading it as a comment that is reflective of current circumstances," said Alan Ruskin, research director at 4CAST Ltd.

In the past week the bond market has largely discounted potential for the Fed to boost the pace of its interest rate increases.

Rate futures price a 25 basis point increase at the May 3 Federal Open Market Committee meeting, but chances of a 50 basis point hike are just 13 percent.

Santomero told reporters after the speech that the data "is consistent with inflation being reasonably well-contained," but that anecdotes suggest increased price pressure. "I think inflation is worth watching," he added.

So, we can be "slow and cautious" but can't "get behind the curve." Data suggests that inflation is "reasonably well contained," but it's also "worth watching."

This is interesting. I think most people are expecting the Fed to have to get more aggressive sometime, but we don't know when. Words like these seem to increase the uncertainty. This is the new way to "jawbone" long term rates up, and it appears to be working.

Like inflation itself, this development is also worth watching.

UPDATE: St. Louis Fed President William Poole is less ambiguous.

"The upward thrust to the economy appears quite substantial and the risk of higher inflation over the next six months or so seems clearly greater than the risk that inflation will fall below a desirable range," said Federal Reserve Bank of St. Louis President William Poole.

He continues,

"I think the FOMC (Federal Open Market Committee) could improve clarity, especially when policy direction changes, by agreeing in advance on stock phrases to describe different situations," he said.

I think what Poole is trying to say is that "measured pace" is too brief, uninformative, and ambiguous. We can do better at describing a set of contingent paths the Fed might take. He elaborates in his speech.

Why, you lock in a low fixed rate if you are a borrower, of course!

The Treasury would like to do the same thing. Series EE savings bonds will have fixed 20 year rates. Read it here.

Coming at a time when interest rates are near historic lows, this is not a development likely to help savers. It's more likely to doom Mom, Pop, and the typical newborn or bar mitzvah boy recipient to years of sub-market returns.

If, as analysts expect, interest rates continue to move up for months or years, this could make Series EE bonds so unattractive as to spell disaster for the program, suggested Jack Quinn, of http://savingsbonds.com, a non-government affiliated Web site that analyzes savings bonds.

"Maybe they are trying to gut this program," he said.

Ouch.

Never thought I'd write a post with that title. Let's face it. Curling not as big as, say, the NBA. In case you don't know what it is, it's a sport in which players throw (slide, really) heavy rocks on a sheet of ice with the goal of getting the most rocks near the center and knocking the opposing team's rocks farther away.

If you want to know more about the sport, check this site.

If you want to see the blog about curling, check this out. One of the co-bloggers is The Eclectic Econoclast, aka John Palmer, an economist at the University of Western Ontario. Palmer also blogs at The Sports Economist.

I've never tried curling, but I think it would be fun. Must be the Minnesotan in me.

Another reason why I think Brian Greene is one of the best ambassadors of physics is in today's NY Times.

Increase in the price of a substitute ==> Increase in demand

Driving in your own car and taking mass transit are substitutes. The rising price of gas has cause the price of driving yourself to increase. Therefore, the demand for mass transit increases.

It's happening in St. Louis.

I've taken the Metro in St. Louis quite a few times. It is clean, fast, on time (in my experience anyway) and efficient.

Hat tip: Division of Labour, who adds that the Metro should consider increasing fares to offset their own higher fuel costs.

True, it might be a good idea, especially if fuel costs are likely to remain high. (Alas, that might be the case--too soon for me to commit to a prediction on that.)

Economics works. Use it.

The Federal Reserve reports that the tightening of monetary policy may be starting to have some effect. However, rates are still quite low on new car loans. Revolving credit continues to outpace nonrevolving credit as it did for the latter part of 2004, and by quite a healthy margin (or unhealthy margin, depending on your point of view).

The numbers are here for those interested.

From Reuters:

"World-class regulation, by itself, may not be sufficient and, indeed, might even worsen the potential for systemic risk if market participants inferred from such regulation that the government would be more likely to back GSE debt in the event of financial stress," Greenspan said.

But he proposed a solution. "We at the Federal Reserve believe this dilemma would be resolved by placing limits on the GSEs' portfolios of assets, perhaps as a share of single-family home mortgages outstanding or some other variation of such a ratio," the Fed chief said.

In a related story,

WASHINGTON (Reuters) - U.S. regulators on Wednesday outlined a fresh series of accounting missteps at mortgage finance giant Fannie Mae in a further blow to the already reeling company.

"OFHEO's (The Office of Federal Housing Enterprise Oversight) special examination of Fannie Mae has revealed a number of significant new accounting problems at the enterprise," OFHEO Director Armando Falcon said in remarks prepared for delivery to a House Financial Services Committee panel.

As with previous accounting problems his agency uncovered, the new concerns reflect Fannie Mae's "tendency toward overly aggressive interpretation" of accounting rules, and in some instances, "willful disregard" of standards, Falcon said.

UPDATE: Kash at Angry Bear voices concern. Can't say I disagree.

If so, don't forget your passport. Same goes for Mexico.

I can see this being a bit of an inconvenience for residents along the Canadian border who occasionally trek up to Winnipeg to shop. American shopping centers within driving distance of Canada might likewise be concerned that requiring Canadians to have passports will cut into their business somehow. I fully expect some griping, but in the end, most folks will probably jump through the required hoops. Signs of the times.

UPDATE: Boy, that was fast.

But some business leaders in the Fargo-Moorhead area worry that the new travel restrictions may keep Canadian visitors from crossing the border to spend money at local motels, restaurants, gas stations and retail stores.

"The harder it is for our Canadian visitors to come down, the more likely it is they won't," said David Martin, president of the Chamber of Commerce of Fargo Moorhead.

"Not everybody has passports,"Martin said. "There's some expense and process involved.

"For the casual traveler - the visitors that support our hotels and restaurants - it might not be worth the hassle," he said.

Don't despair though.

For residents living along the U.S.-Canadian border, Homeland Security officials may consider offering some sort of "localized border crossing card" in lieu of passports, he said.

But unless they exempt the city of Winnipeg (whence cometh all those shoppers), the folks in Fargo won't be happy.

This headline is more clever than what you usually get from Reuters.

"Treasuries Stalled, Lacking Data Fuel"

Of course the headline writer could just have a sense of irony in that the market just hasn't figured out which way the spike in oil prices will turn bond prices. Oil...fuel.... get it?

An early spike in crude oil above $58 a barrel was considered to have mixed implications for bonds.

On the one hand, rising energy prices can act as a tax on the consumer and a drag on the economy and thus could be considered a positive for bonds. The rise in oil was also pressuring equities, which could make bonds look more attractive in comparison.

On the other hand, a further sustained increase in energy prices could feed through to inflation, a major threat to debt that pays a fixed rate of interest.

I will ignore any jokes about one-armed economists.

UPDATE: I almost forgot to clip this quote for you, from the same article...

Indeed, the current week is almost barren of meaningful data. As if to fill the gulf, Fed Chairman Alan Greenspan appears no less than three times this week, starting on Tuesday with a speech on energy.

That'll give us something to talk about.

I'm feeling much better today, resuming a somewhat normal schedule. (Thanks for the well wishes, Mark!)

Here's a link from Kash at Angry Bear showing that personal savings continues to disappoint. This is a difference between 1995 and 2005. Kash thinks it makes the soft landing scenario less likely. On the margin, yes, I agree that it does, but not because low savings rates are inherently bad, but because of the other things that tend to accompany low savings.

Check out this from the archives of December 2004, and I'll have some more on this later.

This excellent speech by Ben Bernanke should be read by every macroeconomics student. I think it is good that Fed governors actually get out there in the public and make speeches like this once in a while.

Here's a sample.

The person in the street might tell you that the Fed "controls interest rates." That statement is not literally accurate. In fact, the Fed has little or no direct influence over the interest rates that matter most for the economy, such as mortgage rates, corporate bond rates, or the rates on Treasury securities. Instead, the Fed affects these key rates, as well as the prices of financial assets such as stocks, only indirectly.

Thanks to macroblog for the link.

He lived his life boldly and without fear. We should all be so blessed.

Click the image to enlarge it and make it a lot clearer. I'm still trying to perfect the art of blogging charts. I need to create a good template and use it.

I wanted to post this earlier, but I've been under the weather for a few days, hence no posts for the last couple days.

Anyway, I am going to do a series of occasional posts for the next few weeks on the similarity of the fed funds easing/tightening cycles in the early 1990s and the early 2000s. The rise at the end of the chart (blue line) takes us into early 1995--the last real tightening that produced not a recession, but a "soft landing." In fact, I think the term "soft landing" was first applied to Fed tightening in the 1994-95 episode. As you can see here, the dollar was also at a low point in 1995. Yet, 1995 was the beginning of a pretty good number of years. As I recall, there was also a bit of a movement to fix Social Security that started about that time. What else is the same, and what has changed since 1995.

In no way do I mean to suggest that past performance is suggestive of future results. Please don't take that away from this observation. It is just that, an observation. I do, however, think there are some striking similarities as well as differences. I should also point out that the heady days of the mid-1990s in which money flowed like crazy into emerging markets led to the Asian financial crisis in 1998. I should also point out that in late 1994, the Mexican peso collapsed, causing much alarm.

No, 1994 and 1995 weren't perfect. But they were years in which a number of forces came together for better or for worse to shape the last half of the decade. Whether the reason things worked out the way they did was because we were good or because we were lucky is still up for discussion. But the last half of this decade could similarly depend on the decisions we make this year.

Expect occasional posts on this from time to time. Reader comments and observations are welcome.

But now I must get some rest.