William J. Polley: December 2006 Archives

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December 28, 2006

David Warsh takes on Duncan Foley

In Economic Principals, Warsh reviews Duncan Foley's new book, Adam's Fallacy: A Guide to Economic Theology. (hat tip to Mark Thoma):

Foley dwells entirely on what economists have managed to make so far of The Wealth of Nations, and gives short shrift to Smith's other book, The Theory of Moral Sentiments, and to the relationship of the one to the other.

He wouldn't be the first. Nor, I fear, the last.

As they say, read the whole thing. Also, Mark Thoma links to these Brad DeLong posts which include a rejoinder from Foley.

Posted by William Polley at 09:04 PM | Comments (0) | TrackBack

December 27, 2006

No-WIN situation

PGL at Angry Bear picks up on my comments from last night, as I hoped someone would. He quotes extensively from the 10 point WIN proposal and notes that Ford also called for capital gains tax cuts and investment tax credits. So allow me to call attention to point number nine:

Number nine: Federal taxes and spending. To support programs, to increase production and share inflation-produced hardships, we need additional tax revenues.

I am aware that any proposal for new taxes just 4 weeks before a national election is, to put it mildly, considered politically unwise. And I am frank to say that I have been earnestly advised to wait and talk about taxes anytime after November 5. But I do say in sincerity that I will not play politics with America's future.

Our present inflation to a considerable degree comes from many years of enacting expensive programs without raising enough revenues to pay for them. The truth is that 19 out of the 25 years I had the honor and the privilege to serve in this Chamber, the Federal Government ended up with Federal deficits. That is not a very good batting average.

By now, almost everybody--almost everybody else, I should say--has stated my position on Federal gasoline taxes. This time I will do it myself. I am not-emphasizing not--asking you for any increase in gas taxes.

I am--I am asking you to approve a 1-year temporary tax surcharge of 5 percent on corporate and upper-level individual incomes. This would generally exclude from the surcharge those families with gross incomes below $15,000 a year. The estimated $5 billion in extra revenue to be raised by this inflation-fighting tax should pay for the new programs I have recommended in this message.

Ford was not a Pigouvian--that much is certain. However, one can see that his understanding of fiscal policy was probably more nuanced than that of many presidents due to his experience in the House. In point number five, he asked for spending to help provide public service employment during the time of recession (you might think he sounds like a quaint New Dealer at this point). But he realizes that this together with the investment tax credits would balloon the deficit if there wasn't some kind of offsetting tax increase. This is the point that I wanted to make earlier, and I thank PGL for the comment that gave me an excuse to refine the point.

This point number nine in the WIN proposal was, however, the only place I could find reference to Ford calling for tax increases, which is why in yesterdays post I was careful to state that he called for tax cuts as well. But, like PGL, I found this to be a rather curious thing. As PGL points out, Ford also calls for monetary restraint and lower interest rates as well. There were some contradictions there. After reading the whole proposal, I get the feeling that he was trying to be revenue neutral (increasing some taxes and decreasing others) while stimulating economic growth and reducing inflation. The cynic in me wonders why he didn't ask for a pony as well, since this was already an impossible list.

But the better part of me wants to cut him some slack. This was two months after taking office in a most undesirable way and one month after making a tough decision that cost him politically. Why not lay it all out on the line? WIN was an impossible dream. Anyone who thought it would whip inflation and bring back prosperity before the 1975 State of the Union Address was not being honest with himself. But Ford did start the ball rolling on some important initiatives that included tax reform and regulatory reform. And the WIN speech was where some of those ideas were rolled out. As usual, Gerald Ford was thinking beyond the next political cycle. Such thinking tends not to get one re-elected, but we could use a bit more of it. The biggest problem with WIN, as I see it, was that it was bound to fail as a short-run solution even though certain aspects of it would have carried long-term benefits. That is a familiar problem in political economy.

As the months wore on, it was the tax cuts that took center stage in Ford's economic policy, but his was not a policy of tax cuts for the wealthy alone. He vetoed a bill that didn't include enough tax relief for the middle class and that didn't include spending cuts.

PGL concludes:

By the time Gerald Ford made this speech, the unemployment rate had increased from 4.9% to 5.9%. By May 1975, the unemployment rate reached 9% and still at 7.7% when voters went to the polls to decide between Gerald Ford and Jimmy Carter. My problem with the WIN program was less its details and more with the fact that this President seemed to ignore the fact that we were on the verge of a rather significant recession.

Check that. By NBER dating, the economy had already been in recession for just short of a year when he made this speech and was only 5 months away from pulling out of it. The labor market is a lagging indicator, so while the unemployment rate was still high, it was trending downward as Carter took office. He was a victim of poor timing in that regard. That is, unless you are going to tell me that the continuation of that trend and a decline of 1% in the unemployment rate in Jimmy Carter's first 12 months in office was due to Carter's economic policies. If so, I would respectfully disagree. Remember also that Ford had to work with a heavily Democratic congress. The wheels turned slowly. The divided government, while perhaps slowing the recovery, also kept either side from pushing the pendulum too far to either side and led to a slow but sustained recovery until the oil crisis reared its head again in Carter's term.

President Ford was dealt a really bad hand. He restored a measure of respect to the office and kept a bad economy from deteriorating any further. He used the power of the veto pen to stand up for fiscal responsibility. He put the nation's interests ahead of his own more than once. He did all this with civility and grace that is becoming ever more rare. He is not the sort of person we tend to elect, but he was there when his country called. He leaves a meaningful legacy to American politics.

UPDATE: Macroblog has more discussion of WIN. David Altig writes:

Seen through contemporary eyes, it is clear that the President Ford's speech hopelessly entangled shocks to relative prices with ongoing inflation of monetary origins.

Indeed. It was, to be blunt, a rather confused attempt to set out inflation's cause and cure. It was a political attack on a monetary problem. It's more about taxes, spending, and conservation. Altig continues:

Are there are any kind words to be found about all of this? More thoughts to follow.

I have tried to find kind words. However, I want to be clear that my kind words are more about what Ford's longer term objectives may have been, and what some of the WIN proposals, and indeed Ford's proposals more generally, were designed to do. I still think that WIN was misleading advertising and a set-up for failure in the short-term. But it was better than Nixon's price controls. Are those the kindest words? I look forward to hearing David's additional thoughts.

UPDATE: Altig does have some nice words to say. James Hamilton, on the other hand, is less charitable. Hamilton says:

And, despite the clever arguments that Dave brings up in the WIN button's favor, I think one great disservice of that campaign was to cultivate the misperception that inflation is somehow the responsibility of ordinary U.S. citizens. In my view, maintaining the purchasing power of a dollar is instead exclusively the responsibility of the people who control how many dollars get printed.

In the long run, yes. In the short run, other things do affect measured inflation, and WIN tried to affect some of these. I still think that it was ill-advised and a set up for failure because it created expectations that could never be fulfilled in the short run (because of politics and policy lags) or the long run (because of Hamilton's argument). Though you must admit that Ford was between a rock and a hard place on this, and although the buttons may have been overkill, some of the policies were worth a shot.

Posted by William Polley at 01:59 PM | Comments (5) | TrackBack

Icing the kicker

For all you football fans out there, Skip Sauer describes a recent study of field goal attempts that shows that icing the kicker (i.e. when the defense takes a time out before a field goal being attempted under pressure) may actually work. He would like to see the study repeated with more data.

Posted by William Polley at 12:10 PM | Comments (0) | TrackBack

December 26, 2006

Gerald R. Ford Jr. 1913-2006

President Gerald R. Ford Jr. has passed away at the age of 93. In the course of his life, he faced tough choices on a number of occasions. The one that immediately comes to mind would put him in the history books forever, and played a role in ending his political career. One that you may not know about was right after he graduated from the University of Michigan with a degree in economics. He was offered a chance to play professional football (the Packers and the Lions both wanted him) but chose instead to take a job at Yale as an assistant football and boxing coach and the chance to attend law school there. (He did not begin taking classes at Yale until three years later.) While it is true that professional football in the '30s is a world away from today's NFL, it still was a matter of turning down something that many people would have jumped at in favor of a chance at something bigger.

Then in 1942, before he can even get his law career off the ground, he answers his country's call and volunteers for duty in the U.S. Navy. This came even as he had been staunchly opposed to American involvement in the war in the '30s at Yale. He served honorably, and upon his discharge he returned to Michigan where he quickly became involved in the local political scene.

President Ford never sought the highest office in the land. He was, as television reporters are discussing this evening, a "man of the House." It was his work in the House of Representatives that he made his name as "a moderate in domestic affairs, a conservative in fiscal affairs, and a dyed-in-the-wool internationalist in foreign affairs." (Notice the touch of irony in his referring to himself as a "dyed-in-the-wool" internationalist when he had been an isolationist at Yale.) His leadership in that role led to his selection by President Johnson to the Warren Commission on the Assassination of President Kennedy. Through the '60s and early '70s, he was a big name in the Republican party with the likes of Goldwater, Dirksen, Reagan, and Nixon. When Spiro Agnew resigned as vice-president, Nixon needed to nominate a replacement. Most of all, he needed someone who could pass muster with congress quickly. Ford rose to the top of the list of big names--most of whom would have faced more congressional opposition. Upon Nixon's resignation a few months later, Ford became the first president in U.S. history who had not been elected to either the office of president or vice-president.

It was at this moment that he had his greatest choice to make. He chose to pardon his predecessor. This was a risky move. Some would say that it cost him the election in 1976, and this is likely true. But thirty years on it is widely regarded as the right decision, and one which has caused his stature in the pantheon of presidents to increase with the passage of time. It has been that passage of time that has allowed the world to see now what he saw clearly then--that prolonging the Watergate scandal would not have been in the best interest of the country. In a very real sense, American politics has still not recovered from Watergate. How much worse would it be if investigations, trials, and appeals would have dragged on into the '80s. President Ford said it best when he pronounced, "It could go on and on and on, or someone must write the end to it. I have concluded that only I can do that, and if I can, I must."

This accidental president then set about the task of governing a nation whose faith in its leaders had been shattered, whose involvement in a foreign conflict was ending badly, and whose domestic economy was plagued with problems. As would later state when he accepted his party's nomination in 1976, "To me, the Presidency and the Vice-Presidency were not prizes to be won, but a duty to be done." This wasn't false modesty, but true humility--one of President Ford's defining characteristics.

One of his early tasks was to fight inflation. In October 1974, only two months after taking office, Ford presented a 10 point plan to, as he put it, "Whip Inflation Now (WIN)." Looking back on the proposal, we see that he got some things right, but of course it wasn't until the Federal Reserve got serious about things that inflation really started to come under control. Ford wanted to remove acreage restrictions on farming, improve enforcement of antitrust laws, and improve energy conservation. He rejected price controls (a welcome departure from Nixon's policies) and even called for increased taxes (though he later called for tax cuts). All of these were steps in the right direction for a number of reasons (many of which not having to do with inflation) but it wasn't great strategy. Asking people to walk to work and waste less food was not going to cut it when M2 money stock was growing at double-digit rates. Economically speaking, it wasn't a shining moment.

The most unfortunate aspect of this episode was that it set Ford up for failure on the domestic economic front. The economy was beginning to suffer a productivity slowdown, the extent and severity of which was unknown to anyone at the time. Capital markets were still reeling from the collapse of Bretton Woods, and the table was being set for something that would come to be known years later as the S&L crisis. Creating an expectation in the public that inflation could be brought under control in a matter of months and that this would solve the country's problems was wishful thinking at best. That said, it is hard to find fault with his effort to increase tax revenue while getting federal spending under control. Likewise, he made strides towards deregulation that would be continued by his successors. And even as the public ridiculed "WIN", inflation did come down from double-digit levels, although this was due more to a stabilization of world oil prices rather than the specific "WIN" suggestions.

President Ford's term in office was short, and there was little time to effect large scale change. But he set a tone with his presidency. His term, short though it may have been, was the antithesis of the Nixon administration. President Ford was open to the press. He may have vetoed many bills, but he knew the art of compromise. He held to the principles that guided him through a quarter-century in the House of Representatives. His pardon of Nixon was not the only way in which he put the nation's interests ahead of his own.

The more you study President Ford, the more you get a picture of a man who had a long-run vision. This manifested itself early in his drive to get into Yale Law School. Such people tend to be more successful in congress than in the White House. He would have been an unlikely candidate anyway. Reagan would have been a more likely candidate in 1976 had Nixon remained in office. By conventional standards, he was not a successful president. But he walked into a very unconventional situation. Nixon had done much to damage the office as well as the political process--the damage lingers to this day. Ford stepped in as a moderate transition to what was to follow, and in so doing he played an invaluable part in putting the country back on track. History's opinion of him is likely to continue to rise in the coming years.

I should also point out that President Ford was another in a quickly disappearing set of leaders and intellectuals who could be strong in their beliefs and partisan loyalties without resorting to the kind of dirty politics that led to Nixon's downfall and continue to crop up today. It is particularly fitting to note this in a year that has also seen the passing of John Kenneth Galbraith and Milton Friedman. All three of them embodied a sort of genteel aspect of American political discourse that, while not dead, is becoming harder to find. For President Ford's part, this attitude was developed through his years as a minority leader. As he explained upon receiving John F. Kennedy Profile in Courage Award,

I have always believed that most people are mostly good, most of the time. I have never mistaken moderation for weakness, nor civility for surrender. As far as I'm concerned, there are no enemies in politics--just temporary opponents who might vote with you on the next Roll Call.

I want to believe that it is still possible to live by this maxim. There would be no more fitting tribute to President Ford than to try to uphold it.

Ford Memorial Website
Ford Presidential Library
Ford Biography at the White House website

Posted by William Polley at 11:08 PM | Comments (3) | TrackBack

Confirming what I knew all along...

Being messy is a good thing. (NY Times)

An anti-anticlutter movement is afoot, one that says yes to mess and urges you to embrace your disorder. Studies are piling up that show that messy desks are the vivid signatures of people with creative, limber minds (who reap higher salaries than those with neat “office landscapes”) and that messy closet owners are probably better parents and nicer and cooler than their tidier counterparts. It’s a movement that confirms what you have known, deep down, all along: really neat people are not avatars of the good life; they are humorless and inflexible prigs, and have way too much time on their hands.

...

In the semiotics of mess, desks may be the richest texts. Messy-desk research borrows from cognitive ergonomics, a field of study dealing with how a work environment supports productivity. Consider that desks, our work landscapes, are stand-ins for our brains, and so the piles we array on them are “cognitive artifacts,” or data cues, of our thoughts as we work.

Isn't that the truth? Do you know people who say about their messy desk/office, "I know where everything is."? Are you one of them? I am. My office and desk are full of "cognitive artifacts" that remind me what is where, which ones are important, and when I might need them. It's nice to have a name for them, and I intend to use the term next time someone asks how I can find anything in my piles. They're just my cognitive artifacts.

H/T to Katie Newmark

Posted by William Polley at 04:05 PM | Comments (0) | TrackBack

December 24, 2006

Merry Christmas

Thanks to all my loyal readers. Take a couple days of rest. We'll have some fun this coming week with predictions for next year and a look back. In the meantime, Merry Christmas!

Bill

Posted by William Polley at 08:25 PM | Comments (1) | TrackBack

December 12, 2006

A nifty little tool

Political Calculations has a tool to calculate the annualized percentage change in the S&P 500 with or without dividend reinvestment and, if you like, adjusted for inflation. Very nice.

Hat tip: Newmark's Door

Posted by William Polley at 11:25 AM | Comments (1) | TrackBack

December 11, 2006

Chinese open market operations

Kash points us to an interesting tidbit in the Wall Street Journal:

SHANGHAI -- China's central bank said it plans to absorb about $20 billion in cash in its latest effort to keep its economy from overheating. The move is meant to rein in lending without raising interest rates and to reduce liquidity in the country's financial system.

The People's Bank of China said Friday it plans to sell banks about 160 billion yuan, or $20.45 billion, of one-year bills in the yuan money markets today. The bills will yield 2.7961%. By placing the debt instruments with commercial banks, Beijing is reducing the amount of money banks have available to lend.

Kash's take:

...a bond issue of this size indicates that the financial pressure may be building on the PBOC to use the next obvious tool that would reduce the amount of yuan floating around in the Chinese economy: to allow the yuan to appreciate faster against the US dollar.

I agree with Kash. In the past, the Chinese were able to conduct operations like this behind the wall of capital controls. The capital controls allowed them to fix their exchange rate AND pursue independent monetary policy goals. Without capital controls (i.e. with a convertible currency), fixing your exchange rate to the dollar means subordinating your monetary policy to the U.S.. While that wall of capital controls has not entirely crumbled, it has been breached. For example, there was this announcement in July 2005 which was followed by a revaluation just a few days later. Unless these massive currency flows (caused by China's rapidly growing export sector) are sterilized, inflation is sure to follow. Higher interest rates are one possible approach, but given the fragility of the banking sector, it is not a particularly welcome prospect. Currency appreciation (or even revaluation) is another. Most likely, they will need both.

As always, the trick is to pull this off without causing a speculative run. Since the yuan is moving against the dollar, and the rate of appreciation appears to be picking up, they probably see things as moving more-or-less on course.

If they decide to move faster, it will be to try to quell their own inflation threat, not to respond to certain U.S. senators.

UPDATE: It is worth remembering that Secretary Paulson and Chairman Bernanke will be visiting China in a couple days. I'm guessing that these developments will be on the agenda at some point.

Posted by William Polley at 04:35 PM | Comments (0) | TrackBack

Forecasting the Fed is only as easy as forecasting inflation

That is to say, it's easy over very short time horizons and almost impossible over longer horizons. In Monday's Wall Street Journal, E.S. Browning continues the chronicle of the widening disconnect between the Fed and the market.

The Fed is expected to leave target interest rates unchanged, fueling hopes that it will start cutting rates some time next year, which would be good news for stocks and bonds.

But worries are spreading that, longer-term, investor hopes for interest rates may have gotten a little out of hand. If so, stocks and bonds both could be in for some rough waters in the coming months.

Later in the article, his interview subject expresses thoughts that should be familiar to any reader of this blog.

"Inflation is the key here," says Ethan Harris, chief U.S. economist at Lehman Brothers. "Inflation is the enemy of all markets. If you get serious inflation, if the Fed's fears materialize, then you will have the Fed hiking instead of cutting, pushing growth weaker. That is a lousy environment for both" the stock and bond markets.

Mr. Harris isn't forecasting a resurgence in inflation. He thinks it could remain more or less steady.

But, like the Fed, he doesn't think that is a sure thing, and he thinks investors could be making a mistake to assume that inflation is dying....

Sorry. No "one armed economists" here. On the one hand inflation could be under control. On the other hand the battle may not yet be over.

Some people find a certain irony in all this.

Now, Mr. [Jim] Bianco [of Bianco Research in Chicago] notes, "the guy that is holding the Fed back from easing is Helicopter Ben. We got him all wrong, at least for his first 10 months" in office.

It is really hard not to say, "I told you so."

Anyway, while we sit here and think about the implications of what the Fed may or may not do, Ed Prescott reminds us in a Wall Street Journal op-ed today that it may not matter all that much. The op-ed is titled "Five Macroeconomic Myths" and is sure to provoke a response from people who, for example, think that the national debt is too large (it's #4 on his list). Read the whole thing. Here's part of myth #1 that monetary policy causes booms and busts.

Between 1975 and 1980, the inflation-corrected federal funds rate was low; at the same time, output trended upward until late 1978. So far, things look somewhat promising for the mythmakers. But looking closer at the data we see that output began its downward trend in late 1979 while monetary policy was still easy through most of 1980. Also, output continued its decline through 1982, when it began to climb at a time when monetary policy remained tight.

These facts do not square with conventional wisdom. Our obsession with monetary policy in the conduct of the real economy is misplaced.

Where monetary policy's effect on output is concerned, expectations matter. That is a fact which is not lost on Mr. Bernanke, especially these days.

Posted by William Polley at 01:16 AM | Comments (0) | TrackBack

December 08, 2006

Economy adds 132,000 jobs in November

From the Wall Street Journal:

WASHINGTON -- U.S. payroll growth accelerated during November, suggesting the economy isn't slowing too much, and worker wages grew slightly less than expected.

Nonfarm payrolls increased by 132,000 jobs, after rising by a revised 79,000 in October, the Labor Department said Friday. The jobless rate inched up as expected to 4.5% from 4.4%.

Wall Street expected payrolls to grow by only 110,000 jobs last month. Another surprise came with average hourly earnings, up by just 0.2% to $16.94 instead of the expected 0.3% increase.

Blog roundup:

Angry Bear reminds us that the employment to population ratio hasn't changed much. Big Picture is waiting for the inevitable revisions. Calculated Risk thinks that construction job losses will start spilling over into the retail sector soon. General Glut compares this November to the last couple of Novembers and is unimpressed. Global Trader's Diary points out that the dollar isn't impressed either. Greg Mankiw touts wage growth. James Hamilton calls it "solid."

All in all, it's a little better than I expected, but it doesn't change much in the way of my thoughts on the likely path of Fed policy. Employment is still not a good early warning indicator. (On that note, macroblog has good news to report on some leading employment indicators.) In the last cycle, the peak employment was in February 2001 when the Fed had already begun to cut rates. Still, the figure is encouraging. The broader economy continues to steam ahead even as housing and autos falter. It has kept up longer than some people thought it would, and I don't think it has run out of legs quite yet. Time will tell, and people will be watching the December and January numbers very closely.

Posted by William Polley at 03:48 PM | Comments (1) | TrackBack

December 07, 2006

Gauging productivity

New York Fed economists James Kahn and Robert Rich have a new model for estimating productivity growth in "real time." Real time in this case still implies a year or two lag. However since productivity growth is notoriously volatile, there will always be the possibility that a change in trend will remain hidden for several quarters. The results do look promising. They suggest that we are still in a high productivity growth regime. A big tip of the hat goes to Mark Thoma for the pointer. I'm posting the link in light of my comments yesterday in which I worried aloud that slower productivity growth could make it harder for the Fed to fight inflation [cf. the recent argument that an undetected productivity slowdown caused the Fed to follow a more expansionary policy than they should have in the 1970s]. Chalk this up as evidence that it may be premature to announce the end of this period of high productivity growth that began (or rather, resumed) in the 1990s. I certainly do hope they are correct.

Tracking Productivity in Real Time, by James A. Kahn and Robert W. Rich

UPDATE: Bill Conerly points to a post of his from about a month ago where he said this:

What we see in last quarter's data is the weak GDP growth more than an underlying trend of weak productivity. In fact, long-term trends are the only way to really see what's happening in productivity. Unfortunately, it's hard to catch the first signs of a change in trend productivity. However, the actual data are consistent with the same old underlying trend productivity growth, plus a weak quarter of GDP. That's a judgment call, not hard science, but I feel very comfortable with this call.

Posted by William Polley at 03:31 PM | Comments (0) | TrackBack

Meanwhile in Europe...

The ECB has raised their key interest rate from 3.25% to 3.5%.

Posted by William Polley at 11:31 AM | Comments (0) | TrackBack

Memories of Iowa City

Listening to the Collegium Tubum play on the Old Capitol steps is one of my fond memories of Iowa City at this time of year. If only I didn't have some obligations that will keep me on campus tomorrow, I would make the drive.

University of Iowa News Release

UI Collegium Tubum Returns To Old Capitol Steps Dec. 8

The University of Iowa Collegium Tubum - also known as the UI Tuba-Euphonium Ensemble - will return to the original home of its popular annual outdoor performance of holiday music at 12:30 p.m. Friday, Dec. 8, on the front steps of the Old Capitol on the UI Pentacrest.

During the recent renovation of the Old Capitol, completed last spring, the tubas assembled on the steps of Macbride Hall for the annual concert.

John Manning, tuba professor at the UI School of Music and director of the group, commented: "For the first since 2001, Holiday Tubas will return to the steps of the Old Capitol. Playing on the Old Capitol steps is such a long-held tradition that last May, the Collegium Tubum was invited to play at the rededication ceremony. A special piece entitled 'Old Capitol Fanfare' was composed by tuba student Karl Zelle and premiered on May 6, 2006.

"Now we will return to the Old Capitol steps to play holiday favorites such as 'You're a Mean One, Mr. Grinch', 'Jingle Bell Rock' and 'Frosty the Snowman.' Please come and bring the kids!"

Since it is outside, the concert will naturally be free, and Manning promises that, as always, it will take place regardless of weather. In Iowa, that is of course a significant promise: The concert has often been played amid snow flurries, and in some past years frigid temperatures have forced the group to perform in tag-team fashion, with members periodically retreating indoors to un-freeze their valves.

To heighten the festive spirit of the event, ensemble members customarily decorate their instruments, and some wear costumes of their own.

Manning is a founding member of the award-winning Yamaha performing ensemble, the Atlantic Brass Quintet, with whom he has toured across the United States and around the world, including performances at the White House, Tanglewood, the Santa Fe Chamber Music Festival and June in Buffalo. An active freelance musician, he has performed with the Boston Symphony, the Empire Brass and the Boston Pops Esplanade Orchestra. He joined the UI faculty in 2004. More information: http://www.uiowa.edu/~music/bios/BRASSmanning.htm

Posted by William Polley at 11:24 AM | Comments (1) | TrackBack

More forecasts of rate cuts in 2007

This time, it comes from Ed Leamer, who is worth listening to: (Reuters)

SAN FRANCISCO (Reuters) - The U.S. economy will expand at a weak pace next year, setting the stage for lower interest rates, according to a UCLA Anderson Forecast report released on Thursday.

The forecasting unit's latest report projected quarterly real gross domestic product growth no higher than 2.7 percent next year, reflecting the weak housing market.

...

As a result, the Federal Reserve will cut interest rates to stimulate business, said Edward Leamer, director of the UCLA Anderson Forecast.

"We think the Fed will shift from an inflation concern to a sluggishness concern so that we'll get some rate cuts," Leamer said, adding that he sees the Federal Funds rate falling to 4.5 percent by the fourth quarter of next year.

...

Manufacturing has already shed so many jobs it is in no position to produce the kind of massive layoffs that paired with a housing downturn would trigger recession, Leamer added.

"We've trimmed it to the bone," Leamer said, referring to factory work. "It's already lean and mean."

Additionally, the economy will avoid recession because credit is abundant and consumers will continue spending at a moderate pace, Leamer said.

Interesting. Their prediction of moderate growth (2.7%) is certainly less than average, but equally certainly not indicative of a recession. It is quite similar to the GDP growth in 1995 (a "soft landing" year). And while there were two rate cuts in 1995 (and one more in early 1996), those cuts were to bring the funds rate down to 5.25%. Ironically, that's where we are now. So, while I'm not ready to predict three rate cuts in 2007 to bring the funds rate down to 4.5%, I would say that the UCLA forecast is in the ballpark.

Given all that has transpired in recent days, I would regard a rate cut in the first six months of 2007 to be more likely than a rate increase in that same time frame. That said, I continue to hold to the view that a rate cut at this time would slow the return of core inflation to its comfort zone. The fact that productivity is not growing as fast as it was in the first half of the year and that Mr. Bernanke has suggested that potential output growth may be slowing only serve to reinforce that view. Unlike 1995 and 1996 when productivity was rising rather than falling, the Fed will not have the luxury of cutting rates while inflation trends down.

The part of me that wants to give a prediction that is right is turning to the view that there will be at least one rate cut in 2007.

The Cassandra in me is having a tough time with that.

UPDATE: Calculated Risk quotes the LA Times version of the story, which includes Leamer quotes such as:

"If you are a builder or a broker, it will feel like a deep depression," he said. "But the rest of us will hardly notice."

and...

His conclusion: "The models say 'recession'; the mind says 'no way.' I'm going with the mind."

UPDATE 2: Leamer isn't alone. At least some people's models agree with his mind.

NEW YORK (Reuters) - The economy will likely pick up in 2007 after output growth slows rapidly in late 2006, according to a survey conducted by the Philadelphia Federal Reserve Bank released on Thursday.

Economic growth for 2008, released for the first time in the survey, was forecast at 3.0 percent.

Economists lowered their forecasts for U.S. growth in the first half of 2007 to 2.8 percent from 3.0 percent when the previous survey was taken six months ago. They forecast growth at 3.1 percent for the second half of 2007.

Posted by William Polley at 09:56 AM | Comments (0) | TrackBack

December 06, 2006

Would it help to print it in big, block letters?

Yesterday I wrote of the growing disconnect between the Fed and the financial markets:

Is it just me or are the markets trying like mad to find an argument for lower rates sooner? I think this would be a little frustrating for the Fed, which would like to bolster its inflation fighting credentials.

Now comes Greg Ip, writing in the Wall Street Journal:

WASHINGTON -- Federal Reserve officials -- unlike bond investors -- think the economy is a lot sounder today than at the end of 2000 and in early 2001, when the Fed abruptly reversed course and began a string of interest-rate cuts.

Yet Fed Chairman Ben Bernanke's effort to convey the message that today's conditions are different is hampered by the Fed's lack of candor back in 2000.

Fed officials, who have universally voiced concerns about inflation, are expected to keep short-term interest rates steady at 5.25% at their policy meeting next Tuesday. But bond markets have priced in a small chance of a rate cut next week and three one-quarter percentage-point cuts over the next 12 months.

Markets anticipate those cuts in part because they see parallels to 2000. A technology-stock and investment bust began to unfold in the summer of that year, yet in November the Fed still said its principal concern was inflation, not economic growth. Seven weeks later, with stock prices tumbling and businesses canceling investment plans, the Fed made the first of 13 interest-rate cuts.

Like stock prices then, housing prices today are turning down after a long run-up. But there is little sign the decline has spilled over into the rest of the economy. Stock prices are up, not down. Officials acknowledge recent data have been weak, especially for manufacturing and commercial construction, and they are expected to closely scrutinize the November jobs report, to be released Friday.

The weak data, however, haven't been corroborated by anecdotal evidence from the Fed's extensive business contacts. The Fed's recent "beige book" roundup of regional business conditions found "moderate growth" and "tight" labor markets.

In the comments to my post yesterday, spencer writes that he is more optimistic for lower inflation and interest rates and asks why he shouldn't be.

To which I would respond that I am also more optimistic for lower inflation than I was a month ago. That is, I am finding it easier to buy the story that the Fed has been giving us for the past few months that core inflation should be expected to moderate in 2007. Make no mistake, it is still above my comfort zone (and that of many of the FOMC members), but if the pressures that have been keeping it there are receding, I agree that the best thing to do is hold interest rates where they are now and allow the core inflation rate to fall back into the comfort zone and reassess things in a few months. Let bygones be bygones, as former Fed governor Laurence Meyer would say.

But I'm also still inclined to view today's short term rates as being pretty close to neutral--certainly more neutral than the 6.5% in place when the calendar turned from 2000 to 2001. The current rate is even a bit lower than it was in the 1995 "soft landing". The real interest rate was actually negative as recently as late as 2005--hard to argue that policy has been overly tight in recent months. The same cannot be said of 2000.

Most importantly, a rate cut here would not help long term inflation expectations. The longer that the core inflation rate remains out of the Fed's comfort zone, the more risky this becomes.

It's just hard to see a rate cut now (or in early 2007) as a risk that the Fed would want to take unless there was a pretty solid body of evidence pointing to a serious slowdown--more serious than most models are predicting. If it turns out that the forecast is wrong, then they will act. However I don't see them changing their course based on the bond market's comparison of 2006 to 2000. Indeed, I think it would damage their credibility to change course on that basis. Returning to the Wall Street Journal article, Ip interviews Edward Gramlich:

In late 2000, the Fed's business contacts were getting worried, and the stock market was crumpling as profit warnings proliferated. "Everything was pointing up and, all of a sudden, everything started pointing down," recalls Edward Gramlich, a Fed governor at the time. Today, "the key thing is whether the weakness in housing -- and now autos -- feeds over into consumption at large, and as I understand it, it really hasn't."

Trouble is, the bond market doesn't appear to share Gramlich's confidence that, as they say, this time it's different. And that has got to be frustrating for the folks at 20th and Constitution.

David Altig (macroblog) reads Ip's article as well.

Ip includes this comment:

"They're paid to worry about inflation, which means that until the slowdown is obvious and undeniable, they will stick to their forecasts," Ian Shepherdson, chief U.S. economist at High Frequency Economics, said in a report last week, citing the similarity to late 2000.

Altig responds:

... I'm not inclined to protest too much. I'll leave it to the sociologists and cognitive psychologists to figure out if being "paid to worry about inflation" somehow systematically biases the forecasts of policymakers. But just for the sake of argument, let's say it is so. Taking the long view, the not-so-arguable success of U.S. monetary policy over the past 25 years, and the memory that it wasn't always so, let me ask this: Would you really have it any other way?

No. And I wouldn't want to squander that success by allowing inflation expectations to creep up any further.

One more time over to Ip:

Transcripts of the Fed's November 2000 meeting offer grist for the skeptics. Fed officials at the time saw ample reason to shift from their assessment that higher inflation represented a greater risk to the economy than did weaker growth, to a view that the two risks were balanced. "The balance of risks has shifted quite noticeably," then-Vice Chairman Roger Ferguson said.

Mr. Kohn, then a staff adviser, said a balanced assessment of risks might well be merited, but could turn stock and bond markets frothy again. Then-Chairman Alan Greenspan agreed: "Were we to go to balance today we would almost surely end up tomorrow with financial conditions that would be too easy."

...

More so than Mr. Greenspan, Mr. Bernanke thinks it is dangerous for the Fed to slant its words to elicit a particular market reaction. Indeed, he was burned in April when markets misinterpreted his hints about a pause in interest-rate increases as complacency about inflation. That suggests he means his recent warnings on inflation to be taken at face value.

And so the problem boils down to this... Bernanke would probably rather not have to choose his words in such a way as to keep the bulls fenced in. But would you want to bet any amount of your paycheck that a more balanced assessment of risks would be interpreted correctly by the market? Ip is miles ahead of the bond market in understanding and interpreting Bernanke. That's great if you are a newspaper reader--not so great if you're a policymaker.

The Fed simply must continue to improve its communication strategy. This latest situation is the "measured pace" episode dressed up in different clothing. A change in language now will likely be interpreted as an announcement of a future policy change. That is not an ideal state of affairs, and I must say that I'm a bit more of an advocate of inflation targeting than I was when I got up this morning.

Posted by William Polley at 11:26 PM | Comments (0) | TrackBack

December 05, 2006

Is inflation whipped?

Maybe. (NY Times)

The Labor Department said that unit labor costs, a measure of what workers earn that takes into account their productivity, rose 2.3 percent in the third quarter, falling short of the preliminary estimate of 3.8 percent issued last month. Worker productivity increased 0.2 percent in the third quarter, more than the government’s first calculation of no change but far less than the productivity gains during the first half of the year.

Strong productivity is needed to help offset growing labor costs so they do not feed into inflation. In that sense, some economists noted that the 0.2 increase in productivity growth was troublesome.

A decline in productivity growth would mean somewhat tighter monetary policy would be warranted, all other things being equal. Let's go to Bernanke's speech from last week:

That said, longer-run trends in the growth of productivity are very difficult to predict. During the first half of the decade, productivity in the nonfarm business sector increased at an unusually high average annual rate of about 3 percent. However, according to current estimates, productivity growth slowed in the second quarter of this year and came to a halt in the third quarter. Moreover, the strength of recent hiring raises the possibility of subpar productivity growth in the fourth quarter as well. When all is said and done, however, I expect that the latest numbers will turn out to have been a reflection of the typical volatility in the data and some cyclical response to the slowing in economic activity, not a signal of a sea change in the longer-run outlook for productivity growth.

Even if productivity growth is sustained at a reasonably good rate, the slower expansion of the labor force will imply some moderation in the rate of growth of potential output over the next few years. In the very near term, that slower growth in the labor force needs to be taken into consideration when assessing the sustainability of given rates of expansion in economic activity. In the medium term, because the factors that affect potential output and thus aggregate supply also tend to affect aggregate demand, slower growth of potential output does not necessarily mean that inflation will be higher or that monetary policy will have to be tighter. Rather, the implications for monetary policy of a possible slowing in the growth of potential output depend on the extent to which such a slowing alters the balance of supply and demand in the economy. For example, as we saw in the second half of the 1990s, changes in expected productivity growth and potential output can significantly affect aggregate demand through their influences on income expectations and asset prices. The problem for policymakers is to identify, in real time, any changes in the prospective growth rate of potential output and to anticipate the accompanying effects on the balance of supply and demand.

Is it just me or are the markets trying like mad to find an argument for lower rates sooner? I think this would be a little frustrating for the Fed, which would like to bolster its inflation fighting credentials. Will next week's statement be more hawkish? Or will they admit that the slowing economy may necessitate easing? How would the latter be interpreted?

Posted by William Polley at 04:33 PM | Comments (3) | TrackBack

William J. Polley

Comments and observations on economics and whatever else catches my eye