Recently in Economics--Data Category

The Bureau of Labor Statistics of the U.S. Department of Labor today reported preliminary productivity data--as measured by output per hour of all persons--for the second quarter of 2009. The seasonally adjusted annual rates of productivity change in the second quarter were:

6.3 percent in the business sector and 6.4 percent in the nonfarm business sector.

Productivity gains in both sectors were the largest since the third quarter of 2003, and were due to hours worked declining faster than output.

Wow. I knew this was coming, but even so... Wow!

To begin with, gross domestic product excludes a great deal of production that has economic value. Neither volunteer work nor unpaid domestic services (housework, child rearing, do-it-yourself home improvement) make it into the accounts, and our standard of living, our general level of economic well-being, benefits mightily from both. Nor does it include the huge economic benefit that we get directly, outside of any market, from nature. A mundane example: If you let the sun dry your clothes, the service is free and doesn't show up in our domestic product; if you throw your laundry in the dryer, you burn fossil fuel, increase your carbon footprint, make the economy more unsustainable -- and give G.D.P. a bit of a bump.

...

This points to the larger, deeper flaw in using a measurement of national income as an indicator of economic well-being. In summing all economic activity in the economy, gross domestic product makes no distinction between items that are costs and items that are benefits. If you get into a fender-bender and have your car fixed, G.D.P. goes up.

A similarly counterintuitive result comes from other kinds of defensive and remedial spending, like health care, pollution abatement, flood control and costs associated with population growth and increasing urbanization -- including crime prevention, highway construction, water treatment and school expansion. Expenditures on all of these increase gross domestic product, although mostly what we aim to buy isn't an improved standard of living but the restoration or protection of the quality of life we already had.

Common sense tells us that if we want an accurate accounting of change in our level of economic well-being we need to subtract costs from benefits and count all costs, including those of ecosystem services when they are lost to development. These include storm and flood protection, water purification and delivery, maintenance of soil fertility, pollination of plants and regulation of our climate on a global and local scale. (One recent estimate puts the minimum market value of all such natural-capital services at $33 trillion per year.)

Nature has aesthetic and moral value as well; some of us experience awe, wonder and humility in our encounters with it. But we don't have to go so far as to include such subjective intangibles in order to fix the national income accounts. As stressed ecosystems worldwide disappear, it will get easier and easier to assign a nonsubjective valuation to them; and value them we must if we are to keep them at all. No civilization can survive their loss.

Given the fundamental problems with G.D.P. as a leading economic indicator, and our habit of taking it as a measurement of economic welfare, we should drop it altogether. We could keep the actual number, but rename it to make clearer what it represents; let's call it gross domestic transactions. Few people would mistake a measurement of gross transactions for a measurement of general welfare. And the renaming would create room for acceptance of a new measurement, one that more accurately signals changes in the level of economic well-being we enjoy.

Our use of total productivity as our main economic indicator isn't mandated by law, which is why it would be fairly easy for President Obama to convene a panel of economists and other experts to join the Bureau of Economic Analysis in creating a new, more accurate measure. Call it net economic welfare. On the benefit side would go such nonmarket goods as unpaid domestic work and ecosystem services; on the debit side would go defensive and remedial expenditures that don't improve our standard of living, along with the loss of ecosystem services, and the money we spend to try to replace them.

Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- decreased at an annual rate of 6.1 percent in the first quarter of 2009, (that is, from the fourth quarter to the first quarter), according to advance estimates released by the Bureau of Economic Analysis. In the fourth quarter, real GDP decreased 6.3 percent.

Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- decreased at an annual rate of 3.8 percent in the fourth quarter of 2008, (that is, from the third quarter to the fourth quarter), according to advance estimates released by the Bureau of Economic Analysis. In the third quarter, real GDP decreased 0.5 percent.

Almost all the overshoot in GDP relative to consensus was in the inventory component; final sales fell at a 5.1% rate, with consumption down 3.5% and [business spending] on equipment and software down a massive 27.8% (biggest drop in 50 years) both worse than we expected. Net trade was much better than we expected, adding a hard-to-fathom 0.1% to growth; the BEA must have assumed much better December numbers than us. The big mystery, though, is the $6.2B rise in inventories, which bears no resemblance the monthly numbers. It makes us more bearish for the first quarter because this rise has to reverse in some size. In short, we are not comforted. -Ian Shepherdson, High Frequency Economics

The inventory miss reflected a huge swing in the inventory valuation adjustment (or IVA). The fourth quarter IVA was +$211 billion vs -$97 billion in the third quarter -- a jump of more than $300 billion (or +11 percentage points of GDP at an annual rate). In the past 10 yrs, the next largest one-quarter swing in the IVA was $38 billion. The IVA is an adjustment used to translate the reported book value changes in business inventories to an economic value. We had expected to see a sizeable jump in IVA given the big drop in energy prices, but the actual outcome turned out to be several multiples of our model-based estimate, which relies on the historical relationship between the IVA, energy prices and other factors. -David Greenlaw, Morgan Stanley

Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 2.8 percent in the second quarter of 2008, (that is, from the first quarter to the second quarter), according to final estimates released by the Bureau of Economic Analysis. In the first quarter, real GDP increased 0.9 percent.

The GDP estimates released today are based on more complete source data than were available for the preliminary estimates issued last month. In the preliminary estimates, the increase in real GDP was 3.3 percent.

The unemployment rate rose from 5.7 to 6.1 percent in August, and non-farm payroll employment continued to trend down (-84,000), the Bureau of Labor Statistics of the U.S. Department of Labor reported today. In August, employment fell in manufacturing and employment services, while mining and health care continued to add jobs. Average hourly earnings rose by 7 cents, or 0.4 percent, over the month.

Series Id:           LNS14000000
Seasonal Adjusted
Series title:        (Seas) Unemployment Rate
Labor force status:  Unemployment rate
Type of data:        Percent
Age:                 16 years and over

Real GDP was up 3.3% in the 2nd quarter.  That's more than most expected.  Certainly not what you'd expect to see in a recession.  It should be noted that this is not a clean bill of health for the economy.  It would be premature to say that we're out of the woods.  However, if this is a recession, it would be a pretty unusual one.  As King Banaian put it a couple days ago in response to labor market news, "If it be recession, it be wimpy."  And so today's news further complicates the picture.

Just what I needed as I sit in contemplation as I prepare to write about the local economic outlook.

The Wall Street Journal's Real Time Economics blog makes the following observation:

But the forecasts of a shrinking economy may not be so far off the mark after all. Gross domestic income, which Fed officials have in the past highlighted as perhaps a better measure than GDP, advanced just 1.9% at an annual rate last quarter after contracting the two previous quarters. Thursday's report is the first to show first quarter GDI in the red.

...

GDP is a consumption-based measure, adding up consumer, business and other spending and investment as well as net exports. GDI is income-based, adding up things like personal income and corporate profits. GDI is included in quarterly GDP, but not in the first, or "advance," estimate, so Thursday's report was the first for second quarter GDI.

In theory, the two should equal each other, but they don't always. In recent quarters, net exports seem to be the main reason, since they flow directly into GDP but only indirectly into GDI. In addition, GDI more heavily reflects corporate profits than GDP does.

Before-tax corporate profits grew slightly in the second quarter after falling the previous two quarters. The difference between GDI and GDP is more than just academic.

In a Fed paper released last year, Fed economist Jeremy Nalewaik wrote that "real-time GDI has done a substantially better job recognizing the start of the last several recessions than has real-time GDP." Fed officials have even taken notice. According to the Fed's May 2007 meeting minutes, when economic data were giving mixed signals on the economy's underlying state, Fed officials "discussed how best to reconcile the slowdown in output growth over the past year with the relatively strong performance of the labor market."

"This apparent tension could partly reflect measurement issues; in particular, participants noted that the more-rapid gains in estimates of gross domestic income over this period might better capture the pace of activity than the modest advances in measured GDP," the minutes said.

Now that the two measures have flipped with GDI lagging, it seems likely that Fed officials will now take 3%-plus GDP growth with a big grain of salt.

True.  One other thing to consider is how much the weakening dollar is helping GDP by reducing the trade deficit.  Exports are growing rapidly while (real) imports are shrinking.  The real trade deficit (quarterly SAAR) is about a third less than it was a year ago.  That's pretty significant, and definitely accounts for some of the increase in GDP.

In fact, the contribution of net exports to real GDP growth last quarter was 3.1%.

Out of 3.3%.

While I still think that the Fed's next move will be to raise interest rates rather than lower them, I admit to being a little concerned that a rate hike too soon might strengthen the dollar before we're ready.

Mark Thoma has more.

My class was right... including about who the dissenters would be. (Though they actually predicted more dissent, I cautioned them that two was probably the most you'd see in the vote.) Not that this was a particularly hard call. On the surprise meter, today's move by the Fed--from the amount and direction of the change to the dissenters to the apparent shift in stance going forward--barely registers. Indeed, what is there to say that hasn't been said already?

For the record, here is the statement from the Fed:

The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 2 percent.

Recent information indicates that economic activity remains weak. Household and business spending has been subdued and labor markets have softened further. Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters.

Although readings on core inflation have improved somewhat, energy and other commodity prices have increased, and some indicators of inflation expectations have risen in recent months. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook remains high. It will be necessary to continue to monitor inflation developments carefully.

The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time and to mitigate risks to economic activity. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Gary H. Stern; and Kevin M. Warsh. Voting against were Richard W. Fisher and Charles I. Plosser, who preferred no change in the target for the federal funds rate at this meeting.

In a related action, the Board of Governors unanimously approved a 25-basis-point decrease in the discount rate to 2-1/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Cleveland, Atlanta, and San Francisco.

There are two very obvious differences between this statement and the last (in addition to a few more subtle variations of the wording that are also consistent with the overall shift but probably not worth obsessing over). Those two obvious differences are that what was

Recent information indicates that the outlook for economic activity has weakened further.

is now...

Recent information indicates that economic activity remains weak.

The interpretation being that we may have "hit bottom," to put it rather bluntly. The other is that the sentence in the last statement...

However, downside risks to growth remain.

... is simply gone. Hard to be more obvious than that.

The inflation paragraph is interesting. There is some acknowledgment of the improvement in the core numbers. Also, the sentence in the last statement,

Still, uncertainty about the inflation outlook has increased.

Is now...

Still, uncertainty about the inflation outlook remains high.

As with the statement about economic activity, the implication is that while there hasn't been much improvement in the level, the first derivative looks better. It's almost as if an academic economist had a hand in crafting it.

Barring any new developments, expect no change in June.

Now, over to the GDP report. James Hamilton's post on the subject is my pick of the day for excellent analysis of the report. To tell you the truth, the GDP figure was pretty close to what most of us were expecting. Most expectations that I saw were in the positive-but-under-1-percent range. Also, it is important to remember that it is subject to revision, so I wouldn't make any big deal out of it beating expectations by a small fraction of a percent. It's what we expected, and it is not particularly good. The difference in economic activity over a 6 month period between growth of 3.5% and growth of 0.6% is a couple hundred billion dollars. Far from pocket change, that amount of lost economic activity in 6 months is roughly comparable to the current annual federal budget deficit.

But is it a recession? No. Not yet, anyway. And though some forecasts show an improvement in the 2nd half of 2008, we're not out of the woods yet. The increase in inventories and the accompanying decline in real final sales is particularly worrisome going into the 2nd quarter. The recovery from this slowdown (if not recession) will take some time.

Here's a link to the new PDF version of the Beige Book. Here's the old html version.

The Wall Street Journal headline is "Beige Book Hints at Stagflation Amid Slow Growth, Prices Pressures"

I'm heading out the door, but I know what I'll be reading tonight.

The news isn't good. The PPI is on the rise. (MSNBC)

WASHINGTON - Battered by bad economic news, consumer confidence plunged while wholesale food, energy and medicine costs soared, pushing inflation up at the fastest pace in a quarter century.

The Labor Department said Tuesday that wholesale inflation jumped by 1 percent in January, more than double the increase that analysts had been expecting.

The next paragraph isn't about inflation, but isn't great either...

Meanwhile, the New York-based Conference Board reported that its confidence index fell to 75.0 in February, down from a revised January reading of 87.3. The drop was far below the 83 reading that analysts had forecast and put the index at its lowest level since February 2003, a period that reflected anxiety in the lead up to the Iraq war.

And on another note, I was revising my homework solutions for my principles of macro course this semester. I always ask students to find the most recent rate of inflation by the CPI (12 month % change). Last semester, the answer was 2.0% at the time I asked the question. The answer now? 4.4%. (4.3% not seasonally adjusted)

Uh oh.

But Martin Feldstein does say this in Wednesday's Wall St. Journal:

The dysfunctional character of the credit markets means that a Fed policy of reducing interest rates cannot be as effective in stimulating the economy as it has been in the past. Monetary policy may simply lack traction in the current credit environment.

As they say, read the whole thing.

Ouch.

Feb. 15 (Bloomberg) -- Confidence among U.S. consumers fell more than expected this month, reaching a 16-year low, as the labor market cooled and expectations about inflation rose.

The Reuters/University of Michigan preliminary index of consumer sentiment decreased to 69.6, the lowest since February 1992, from 78.4 in January.

UPDATE: FRED has not updated their series to reflect today's data, so I have drawn in where the new data point will be. The series has been noisy in the current (I'm still using present tense) expansion. The reader is left to draw his or her own conclusions.

GDP increased by a paltry 0.6% in the 4th quarter of 2007 according to the Bureau of Economic Analysis. But there are reasons to be guardedly optimistic. First, real final sales were up 1.9%. Residential investment may be in the tank but households continue to consume at a steady pace. Obviously the major reasons for the low GDP number were the decline in residential investment and the decline in inventories. The decline in inventories, however, is not all bad. This means that producers may have already been slowing production on the expectation of falling demand. If there are further drops in demand, the adjustment may be smaller and smoother. If a drop in consumption doesn't materialize, production will need to increase to build up the inventories again.

James Hamilton's take on the inventory picture is similar. King Banaian at SCSU Scholars is less optimistic. He notes that the inventory/sales ratio has been in decline for some time and that if this was planned that it doesn't imply a turnaround in the current quarter.

Perhaps not. Perhaps the support provided by the consumer will weaken (but that's what the stimulus is for, right?). This report doesn't give us those kind of answers. We now await the employment report, which, according to some, might be better than you think.

PGL directs us to Kevin Drum. They are both hot under the collar about this from the Washington Post.

New data from the Department of Commerce showed that consumer spending increased 1.1 percent in November compared with the month before on a seasonally adjusted basis -- more than analysts expected and a sign that consumers had not yet been discouraged by rising energy prices and a slumping real estate market.

Incomes also rose in November, by 0.4 percent, double the rate of increase in October, although that was more than offset by increased prices, the department reported. Discounting for inflation, disposable personal income -- the money left to spend after taxes -- fell 0.3 percent.

PGL suggests a shorter version.

Real consumer spending rose by 0.5 percent in November despite a 0.3 percent decline in disposable personal income. With consumption increasing despite the drop in income, personal savings declined.

Yep. Much better.

Drum comments:

What possible excuse can there be for leaving the initial impression that incomes rose in November? Real income is the only income that matters, and real income was down. That's the number that should get the attention.

Indeed. Mark my words. If inflation makes a resurgence in 2008, we are going to have to really be on the lookout for this sort of thing. Inflation makes it all too easy to point to rising nominal spending and miss the fact that real spending (or income) is barely moving.

UPDATE: It's not just the Washington Post. This article on MSNBC (which comes from the Associated Press) does the same thing. It's not any one writer. It's just the fact that these stories follow a formula the reflects the government press release.

That's the problem.

Nonfarm payrolls increased by 93,000 last month. The average for the last 5 months is approximately 99,000. We would certainly like it a little better if these numbers were a little higher. If we need somewhere around 125,000 jobs per month to keep up with population growth, then we are falling behind--albeit slowly, but falling behind nonetheless. What is interesting is that the gains have been reasonably consistent. In the last 5 months, three data points were in the 90,000s, just two outliers--one at 170,000 and one at 44,000. So it's as if the economy is trying to keep growing, but just isn't getting the traction it was getting in 2005 and 2006. We're stuck in neutral, unable to get back into the higher gear.

But at the same time, the labor force participation rate climbed a bit last month, back up to 66.1%--where it was in July. The employment to population ratio is at 63%--also the same as its July level. These numbers had dipped a bit in recent months, so this could be a good sign that there still is some strength remaining under the surface.

Of course employment is a lagging indicator. I wouldn't recommend trying to forecast when a recession will begin by looking at the last month's job growth. But given the preponderance of the evidence this number is not going to be enough to cause the Fed to stop cutting interest rates yet. Not until there's a clearer sign that we've finally let out the clutch and are safely in high gear again.

Productivity is up. (BLS press release)

The Bureau of Labor Statistics of the U.S. Department of Labor today reported revised productivity data—as measured by output per hour of all persons—for the third quarter of 2007. The seasonally adjusted annual rates of productivity growth in the third quarter were:

6.7 percent in the business sector and

6.3 percent in the nonfarm business sector.

In both sectors, changes in productivity are higher than the preliminary estimates published November 7, and represent the largest productivity gains since the third quarter of 2003. The upward revisions to productivity resulted from upward revisions to output—which grew 5.7 percent in both sectors—and small downward revisions to hours, which fell 1.0 percent in the business sector and 0.6 percent in the nonfarm business sector in the third quarter.

Also see the Wall St. Journal.

Does this change anything going into the FOMC meeting? In my estimation, no.

Final sales, especially for durable goods, appear to be stalling out. That's not a good sign. If we weren't waiting for the other shoe to drop on housing and the financial markets, this might be regarded as a decent GDP report. But consumption is likely to contract in the current quarter. The question is, how much?

Chairman Bernanke spoke last night. Here's the full text. Here's the part that made everyone take notice.

With respect to household spending, the data received over the past month have been on the soft side. The Committee will have considerable additional information on consumer purchases and sentiment to digest before its next meeting. I expect household income and spending to continue to grow, but the combination of higher gas prices, the weak housing market, tighter credit conditions, and declines in stock prices seem likely to create some headwinds for the consumer in the months ahead.

In the very short run (like, say, the next couple hours), no. Wall St. Journal story on GDP here. The stock market, quite predictably, rallied a bit. However, it has not moved anyone seriously off of their expectations of a 25 b.p. rate cut. So, if your immediate thought was that this might buy the Fed a way out, I have to say that I don't think it's any easier. In a perfect world, expectations might have been more balanced coming into today and then this data could have tipped the balance towards doing nothing. I might wish that was the world we live in, but it's not. Felix Salmon has more.

On the fundamental question of what the Fed should do--taking everything, including expectations, into account--I'm left with the opinion that while it would be a courageous statement of principle to do nothing (and part of me really wishes they could), I think it might be too risky given the somewhat fragile state of the market. I'm really holding my nose as I say that because I don't like the idea of the Fed being pushed into doing something. But in some sense you also have to play the hand you are dealt...or the hand you dealt yourself... or something.

Commenter Kevin writes:

I think Ben's Fed has really tried to stay away from any commitments about the path of future policy moves. So I think your suggestion that they say that this will be the last cut is a nonstarter. However, what I do expect would be more guidance about the conditions for any changes - which may include taking back the rate cuts (imagine that!).

First, a clarification. When I made reference to them saying that this would be the last cut, I was using some verbal shorthand at the end of a long post (in a three part series!) Of course they will not say it in so many words. They can "say" it in their assessment of the risks to growth and inflation. It's easy to come up with some wording that would say that they are going to have a "neutral bias" (though that language is itself somewhat passé). Whether one could make that language credible is another matter.

So then what about some guidance about the conditions for any changes? Not yet, not in any formal way. That could potentially end up being part of the new communication strategy that the Fed is discussing. But not yet. And they are certainly not going to say anything today about when these cuts are going to be taken back. Not a chance. Personally, I'd like to see that guidance too. I think one could make a credible case that if 4th quarter GDP growth is above X and if average monthly job growth stays above Y and if core PCE stays below Z, then they could raise the funds rate in January or March. But they certainly aren't going to tell us X, Y, and Z (or whatever other indicators would come into play). And I really don't think you're even going to get much of a hint yet. I think the best we can hope for is a strongly worded statement that growth is stronger than anticipated, that the housing problems have not yet spilled over into the broader economy, and that the magnitude of that spillover may be less than anticipated. Furthermore, firms are getting squeezed by higher input prices. While that has not yet passed through to final goods prices, the weaker dollar is going to put more pressure on firms to raise prices. (Except that the Fed will not talk about the weaker dollar, but you get the idea.) Make it so we expect that at least 25 basis points will be taken back if this strength continues. That way, if the 4th quarter ends up being only slightly weaker, they could still get by with holding steady in December and January.

It's almost time.

The decline was more than expected. (Reuters)

NEW YORK (Reuters) - Consumer confidence declined for the third month in a row in October to its lowest level in two years on growing concerns about weakening business conditions and the impact that could have on the job market.

The Conference Board said on Tuesday its index of consumer sentiment fell more than expected to 95.6 in October down from a revised 99.5 in September. The median forecast of economists polled by Reuters was for 99.0 in October.

From Bloomberg:

Oct. 25 (Bloomberg) -- Orders for American-made durable goods unexpectedly fell, led by a slump in military equipment that overshadowed increases in business investment.

Demand for cars, planes and other items made to last several years fell 1.7 percent in September, the Commerce Department said today in Washington. At the same time, orders for and sales of computers and machinery, a proxy for capital spending, advanced.

``Manufacturing will have slow-but-steady growth through the end of the year,'' said Adam York, an economist in Charlotte, North Carolina, at Wachovia Corp., which had forecast orders would decline in September. The drop in total orders was ``not quite as weak as the headline suggests.''

Record export demand will keep manufacturing growing, helping prevent the housing-market recession from sinking the broader economy, economists said. The gains in business investment prompted Morgan Stanley and Macroeconomic Advisers LLC, a St. Louis-based research group, to lift their estimates of third-quarter growth.

Macroeconomic Advisers, headed by former Federal Reserve Governor Lawrence Meyer, increased its calculation of growth last month to 3.3 percent, from 3.1 percent. Morgan Stanley adjusted its estimate to 3.5 percent, from 3.1 percent.

The falling dollar is keeping the export market going. The decline in military spending in September could be due to the end of the budget year or just the vagaries of war spending. That investment remains strong is quite impressive. For the rest of 2007 I think we're going to see very uneven performance as certain sectors struggle due to the decline in housing while others respond positively to strong global demand.

King Banaian made a good point along these lines a few days ago.

A local friend reported to me that someone spoke in a meeting of business leaders rather negatively about my writing on the local economy. Basically that I don't know what I'm talking about. Someone responded to him that at least sectorally there are problems stemming from housing. My friend reported that, afterwards, several people came up to him and the guy who spoke back to the critic saying "doesn't he know there are people really hurting out there?"

"Is your firm hurting?" I asked.

"No, we're fine," he replied. "But I know others who are in big trouble."

And so in today's environment, perhaps more than business managers are used to from past experience, sectoral recessions may not lead to overall declines. But when people see a recession in one sector it makes them think that everyone is suffering the same fate... except (perhaps) them.

That said, the size of the decline in housing reported yesterday had me saying, along with Brad DeLong, "GURK!"

The Philly Fed is upbeat.

Activity in the region’s manufacturing sector picked up in September, according to firms polled for this month’s Business Outlook Survey. Indexes for general activity, new orders, and shipments increased, reflecting continued underlying growth. Firms continued to report a rise in prices for inputs, but price increases for finished manufactured goods were not widespread. On balance, the forecast for growth over the next six months has not diminished appreciably, even though, according to responses to special questions this month, over one-quarter of the firms said they are scaling back employment and capital spending plans because of the recent deterioration in the construction industry and uncertainty in financial markets.

...

Respondents continue to report higher prices for inputs this month. The prices paid index increased eight points, after edging lower in the previous three months. Thirty percent of the firms reported higher input prices; 7 percent reported lower input prices.

Less than 10% of firms surveyed expected a substantial decline in employment or capital spending as a result of recent developments.

I think I just heard a bond price drop. The 10 year yield stands at 4.63% and climbing.

It's probably a good thing that the determination of a recession is not subject to a majority vote.

Via Reuters:

NEW YORK (Reuters) - Just over two-thirds of Americans believe the country is either already in recession or headed for one over the coming year, according to a new poll conducted jointly by The Wall Street Journal and NBC.

Nearly half the survey respondents, 46 percent, believed a recession was already under way.

The conviction comes despite a 3.4 percent rebound in economic growth during the second quarter, according to Commerce Department data released last week.

A recession is generally defined as two consecutive quarters of declines in gross domestic product.

Turning points in the economy are notoriously difficult to predict. In 2001, many Wall Street and government forecasters waited until growth had already turned negative before acknowledging a period of contraction.

Can we lose the definition of "two consecutive quarters of declines in GDP"? By that definition, we didn't have one in 2001. What we had was three quarters of negative growth, but they were every other quarter. One down, one up... one down, one up.... one down, one up. Definitely a recession, there's no question about that. But the standard textbook definition is obsolete.

Likewise, even though the most recent quarter posted growth above 3% doesn't mean that this is a trouble-free economy. Just about everyone acknowledges that growth for the rest of 2007 will be weaker, perhaps significantly weaker. If we have two quarters of growth around 1%, will it feel like a recession? Perhaps in many ways, yes. Would it meet the textbook definition? No.

This is not your father's economy, and the textbook definitions that worked in the '70s and '80s to explain the malaise of the time are not applicable now. We need to get out there and educate the next generation as to the subtleties of economic statistics, lest they become disillusioned that economists and the media are out of touch with their textbook definitions from the '70s.

At least we don't wear bell-bottoms.

After reading the latest GDP news, I went poking around the CBOT website to see how things were going on the futures market for fed funds. One thing caught my eye. Shortly before noon today, there was a posting of a trade of 500 Fed Binary Options for December 07. Specifically, they were call options with a strike price of 94750. The trade was completed at a price of 41 ($410 per contract). That is the only open interest on that contract so far.

Here's what this means. A long position in this contract receives $1000 per contract if the fed funds target is less than 5.25% (the prevailing rate today) on the day after the December 2007 FOMC meeting. Essentially, two parties were able to agree on a bet that effectively indicates a subjective probability of a rate cut by December at 41%.

In case you're interested, the latest prices for similar options maturing in August, September, and October are 9, 20, and 28 respectively.

The more traditional 30 day futures on fed funds were broadly higher as well, though yesterday's moves in light of the continued housing difficulties were larger. Today's GDP numbers seemed to reinforce yesterday's news. September contracts on the IEM have not started to move much yet. We'll keep in eye on that.

It will indeed be interesting to watch the binary options on the CBOT in the coming weeks. Keep it tuned right here for the coverage.

Click to enlarge the chart.

Real GDP grew at a rate of 3.4% in the 2nd quarter of 2007, according to the Bureau of Economic Analysis. The Wall Street Journal has an article as well as reaction on their economics blog. Behind the headline number, which sounds pretty good (most of us would regard 3 to 3.5 percent as being consistent with the growth of potential GDP), there are a couple of areas of concern. Foremost in the minds of many economists is the fact that personal consumption, which accounts for 70% of GDP only grew at a 1.3% rate. In the last 3 years, only the 4th quarter of 2005 was lower (1.2%). The weakness in the housing market likely accounts for some of the drop in the growth of consumption, which causes many to worry that soft consumption growth could continue for the rest of 2007.

Also, for the first time since 2003, imports decreased for the quarter. At a very basic level, imports can be an important indicator. In the 3rd quarter of 2000, imports began to fall and did not turn up again until the first quarter of 2002. The 2003 drop seemed to be a one off event that did not presage a recession. Hence, this drop does not immediately set the recession alarms ringing. However, if we had two consecutive quarters of imports falling, I would be much more concerned.

Government contributed 0.82% to GDP growth, which is on the high side of where it has been for the last few quarters.

The strength of the economy right now is clearly in the non-residential investment market. I see evidence of this anecdotally wherever I go as well. Spending on non-residential structures increased at a 22% rate--the highest in years. That pushed overall investment spending to its highest growth rate since the first quarter of 2006--even while the housing slump was putting downward pressure on the number. Neither the government spending, nor non-residential investment spending are likely to continue at this rate for an extended time. Unless there is a tremendous bounce-back in consumption, GDP growth for the rest of 2007 is likely to be below 3%, probably in the high 1's or low 2's.

I always find the chart at the top of this post useful. It shows the contributions of the various components of GDP to the overall growth rate. For the first time in a long time, every major component was on the plus side. That doesn't happen often, and some aspects of it do not bode well. My subjective probability for a rate cut by the end of 2007 just increased considerably. More on that later.

UPDATE: James Hamilton is thinking along the same lines. He also does a chart of the contributions to GDP. His includes residential investment as a category. His recession probability index is up to 26.2%, even with the relatively strong overall GDP number. All of this just goes to show that it's not just the overall number. You've got to look at the individual components. It's 3.4%, but it's a pretty ugly 3.4%.

If you liked this one, you'll enjoy the sequel.

Hat tip to Felix Salmon.

Here is the full report from the BEA. Real GDP increased at an annual rate of 1.3%. Most of us were expecting less than 2%, but few expected something this low.

The short version is that housing is the main negative component and consumer spending is the main positive component. In fact, consumer spending continues to defy the expectations of many, contributing 2.66% to the overall growth rate. Nonresidential investment contributes a small 0.21%. Residential investment subtracts almost a full percentage point (0.97%). As King (SCSU Scholars) points out, this is less than its impact in the 4th quarter--and I would add, the 3rd quarter. Inventories and net exports also shave a bit off the overall total.

To be sure, this number was a little lower than I expected, but not much. I was not looking for anything near the 2% that was the top of the range given by some analysts. While I don't think it's time to call recession yet, it does make me wonder how long consumption can hold up in the face of the declines in residential investment.

I concur with some of the voices in the blogosphere today. King Banaian also writes:

Worth noting: When this number is revised (and there will be two such revisions) the trade figure is the one that changes the most. So I expect this GDP estimate to be rather volatile to trade revisions.

Bill Conerly says, "No panic." Barry Ritholtz points out that the PCE deflator is up 3.4% (from a 1.0% drop in the 4th quarter). This is enough to get my attention and cause me to doubt that inflation is coming under control as quickly as we thought. No doubt the Fed will be concerned about this. Ritholtz says that this is why you aren't hearing any "rate cut" chants. Kash is more pessimistic, saying that this is a yucky report. I wouldn't go that far. But it is definitely concerning. I can't just shake this one off and forget about it.

(NY Times and WSJ articles.)

UPDATE: PGL isn't pleased with the long term prospects either.

UPDATE 2: James Hamilton has two posts that hit the mark. He sees the strength of consumer spending as evidence of consumption smoothing behavior in the face of a temporary drop in the other components of GDP. That's the story I'm going with for now.

Ok, this is one of the best animated graphs I've seen in a while. Play with it. You can change the variables on the axes. It was created by the Gapminder Foundation. I will definitely use this in my classes when I need to illustrate economic growth.

Hat Tip: Division of Labour

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

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.

This month's fedgazette from the Minneapolis Fed features poverty as its theme. There are a number of interesting articles that are worth your attention. In this post, I call your attention to one in particular on income mobility--the ability of individuals and households to move through the income distribution over time.

Income mobility is one of those things that we like to talk about and make claims about. We like to hear stories of "rags to riches", but how often does it really happen? It turns out that we understand relatively little about mobility from a statistical standpoint. Ronald Wirtz writes in the fedgazette article,

Bhashkar Mazumder, an economist at the Federal Reserve Bank of Chicago, has authored several mobility studies in recent years. He said, also via e-mail, that prevailing mobility research throws water on the common notion that U.S. income is highly mobile and more mobile than other countries. More recent studies, like his own, have used much richer longitudinal data that track income over longer periods of time, giving a more accurate reading of lifetime incomes in the United States. Research over the past decade and a half shows that “mobility is relatively low in the U.S. and lower than we thought,” said Mazumder.

...

Nathan Grawe has also done research on income mobility as an economics professor at Carleton College in Minnesota. In his estimation, the four best studies done to date on intergenerational mobility have both positive and negative findings, and most results were not statistically significant; in other words, the findings aren't particularly trustworthy. “All told,” Grawe said via e-mail, “I'd say we have no evidence of change.”

Part of the problem is that studies done before about 1990—which generally concluded that the United States had high mobility—are widely discredited today as faulty, mostly because they relied on very small windows of income data, often just a few years or less. In 1992, Solon published one of the first papers suggesting that U.S. mobility was not as high as everyone thought.

Mazumder's research comes to the same conclusion. But his most recent effort with Daniel Aaronson (also of the Chicago Fed) might have something of a silver lining. They found that current mobility might simply be returning to its historical trend line after experiencing an uptick in the 1970s. In other words, mobility might be worse compared to the 1970s, but it might well be in line with the country's historical average.

Obviously, a lack of longitudinal data going way back will remain a problem. Maybe in fifty years we'll be able to put the current period in historical perspective. Too long for some. You know what Keynes said about the long run. While the evidence here is conflicting and the conclusions not quite conclusive, the situation is better than that concerning the question of how much mobility is optimal.

The notion of perfect mobility—an equal chance for any outcome, regardless of where you start—has a hint of social and economic chaos, by virtue of the fact that it implies a lack of predictability in outcomes regardless of the very things that families and societies tend to value: effort, ability, education and other human capital investment, and parenting.

Economists believe incentives motivate behavior. Grawe, from Carleton College, noted that mobility research was often written “in ways which suggest more mobility is better.” But a society with no obvious determinants for income “would clearly have all sorts of incentive problems.”

For example, parents' attempts to offer certain advantages to their kids—reading to them, sending them to better schools, saving for college, transmitting certain values—might be for naught in a world where these things have no lasting economic effect. In a 2002 working paper on the notion of perfect mobility, sociologist Adam Swift of the University of Oxford wrote, “Even those that regard current mobility patterns as evidence of morally unacceptable unfairness should acknowledge that some mechanisms by which parents transmit advantage—or disadvantage—to their children are unobjectionable and would exist even in an altogether just society.”

In other words, there is no clear guidance at all on how much mobility is optimal or even what we mean by optimal mobility. One cannot escape the fact that mobility requires an appeal to long run incentives, but people do not always behave in accordance with those long run incentives. Hence, a divergence between opportunity and outcomes is assured. This is the world in which we live. And this is why the solution to the problem of income inequality is more difficult than many people realize.

3rd quarter real GDP grew at a 1.6% annualized growth rate. King asks how bad this really is and says that it's pretty bad, but not as bad as some will make it out to be. Brad DeLong says, "Gork!" Nouriel Roubini pats himself on the back for an excellent forecast. And he goes on to say:

What do these Q3 growth figures imply for Q4 and 2007 GDP growth? Expect today the usual spin with the soft-landing optimists – who were altogether wrong on Q2 growth and even more wrong on Q3 growth – having already started to spin the fairy tale of a Q4 rebound. This Q4 rebound has, so far, no base or data behind it: residential investment will be falling at a faster rate in Q4 than in Q3 given recent data on building permits and housing starts; non-residential investment that was, until now, growing very fast will sharply decelerate in Q4 and much more in 2007: see the lead story in the WSJ today referring to a McGraw Hill Construction study forecasting a rapid fall in construction spending in 2007 (including non residential construction and specifically stores and shopping centers), the first decline of construction spending since 1991.

No spin here. I do admit to being more optimistic than Roubini, but even so I am open to letting incoming data refine my position. I do not predict a 4th quarter rebound. Even if this is something approximating a soft landing, we're not out of the woods yet. Looking at the contributions of the different components of GDP to the overall growth rate, I cannot see any reason to expect anything much over 2% for the 4th quarter even under the best of circumstances. I would not be surprised with a number between 0.5 and 1.5%. Less than 0.5% would surprise me but not shock me. Residential investment will continue to be a drag on GDP, no argument there. However on the plus side, retail sales are continuing at a decent pace. Inventories are basically unchanged suggesting that firms still have some pricing power and consumers haven't yet let the housing slump get them down. Unless something suggests that the bottom is in the process of dropping out as we speak, I don't see 4th quarter GDP to be markedly worse than the 3rd.

Tim Duy makes the following observation:

Also, there is a reasonable chance that investment spending is held back by the delayed launch of Windows Vista. And note this from Bloomberg:

Norfolk Southern Corp., the fourth-largest U.S. railroad, boosted freight rates, helping third-quarter profit increase 38 percent. Sales rose 11 percent.

''Overall, we don't see any drastic slowing of the entire economy,'' Norfolk Southern Chief Executive Officer Charles ``Wick'' Moorman said in an interview. ``We think that pricing power will stay with us for a while.''

I pay attention to what the rail barons say – they generally have a good sense of economic activity.

Indeed. So while an actual prediction of a recession may be a bit premature, there are still many uncertainties that cloud the picture as we move from winter into spring. I will be paying close attention to the holiday spending figures. But interpret the early numbers with caution. The day after Thanksgiving isn't what it once was. Internet shopping peaks in mid-December. Some internet shoppers have already been at work (propping up 3rd quarter consumption?). This article on the subject is a year old, but probably still a good guide to what to expect.

The bottom line is that we are probably in for two or three quarters of below average growth. The 1995 soft landing was harder than what we have experienced so far--a fact that hasn't been mentioned much. By no means would I predict a reversal of the current trend and a return to 3+% growth yet. This report probably didn't surprise anyone at the Fed, nor would a slightly worse report in the 4th quarter. These figures support the position that pausing when they did was probably the right thing to do, but do not give any clarification about what is to come next (i.e. which will come first, a cut or an increase in rates). Staying the course still seems like the best option.

In closing, I point out a report that I have not seen getting a lot of play yet. From Bloomberg:

Oct. 27 (Bloomberg) -- An unexpected increase in auto production last quarter was a statistical fluke that will be reversed, making current U.S. economic growth even weaker, according to a former Commerce Department economist.

Last quarter's annualized 26 percent increase in motor vehicle production shocked Joe Carson, now director of economic research at AllianceBernstein LP in New York. Without the gain, the economy would have grown at an annual rate of 0.9 percent, not the 1.6 percent the Commerce Department reported today.

The reported increase in output came despite cutbacks announced by General Motors Corp., Ford Motor Co. and others. A drop in the wholesale price of SUVs and light trucks as the automakers cleared leftover 2006 models made production look stronger than it actually was, said Carson. The economic fallout from the auto-industry cutbacks will instead come this quarter, he said.

``Last quarter was weak even with the benefit of this mismatch and the fourth quarter will now also be weak because it's going the other way,'' Carson said. ``Whatever output you have this quarter, which will probably be down, will be discounted by a likely rebound in prices.''

Carson stressed that there wasn't an error in procedure requiring a correction from the government. It's the way the Commerce Department always computes the data and doesn't mean the statisticians committed any mistakes, he said.

Adjusting For Prices

The mismatch can be explained by looking at how the government adjusts the figures for price changes.

Commerce Department economists use wholesale light truck prices, from the Labor Department's producer price report, to eliminate the influence of inflation on investment and inventories for that category. A 5.5 percent drop in price of SUVs and other light trucks last quarter made output look stronger when adjusted for inflation, Carson said.

Declines in shipments of vehicles and parts from the Commerce Department's durable goods report over the last three months and in the Federal Reserve's output numbers in its industrial production figures, reinforce forecasts that the fourth-quarter growth numbers will show the auto cutbacks, Carson said.

Read the whole thing. Chain weighting looks at the percentage changes in constant dollar GDP for adjacent periods. So if firms cut prices to get rid of inventories, it would show up as higher growth in GDP from the production period to the sales period than if prices didn't fall. The size of the influence on overall GDP growth is larger than I would have thought, but I'll take their numbers at face value. How much it affects the 4th quarter depends on the slowdown in production. We shall see. But it's just one more thing to keep in mind going forward.

Via Reuters:

The Labor Department said a seasonally adjusted 299,000 workers filed new claims for state unemployment insurance benefits in the week ended October 14, down from 309,000 claims a week earlier.

Economists polled by Reuters were expecting a slight increase in jobless claims to 312,000 from an original reading of 308,000 in the week ended October 7.

Separately, the Conference Board released its index of leading economic indicators today. From their website:

The Conference Board announced today that the U.S. leading index increased 0.1 percent, the coincident index remained unchanged and the lagging index increased 0.2 percent in September.

and...

The leading index has fallen 1.0 percent below its most recent high reached in January. At the same time, real GDP growth slowed to a 2.6 percent (annual) rate in the second quarter, following a 5.6 percent gain in the first quarter. The behavior of the leading index so far suggests that economic growth should continue at the slow rate in the near term.

According to the Wall Street Journal, analysts had expected a 0.3% increase in the leading economic indicators. So once again the news is mixed. Overall, it appears that the economy is slowing a bit. Growth for the remainder of the year will probably remain below average, but there is no indication yet of a full-blown recession.

Taken as a whole, this week's data releases leave us pretty much where we started. If there were only a couple pieces of conflicting evidence, it would be more puzzling. The preponderance of conflicting signals reinforces what most of us have been thinking for a while. For the past few months, indeed most of this year, the economy has been slowly inching toward a critical point where either growth will slow (perhaps briefly turning negative) or resume at a more normal pace. That's a good argument for not doing anything to rock the boat at the moment.

UPDATE: On Tuesday, I admitted that the mixed bag of data makes it impossible for me to be Harry Truman's "one-armed economist". Today, James Hamilton also cannot avoid saying "on the other hand."

I'm wondering though whether "no change" might be the least likely outcome at this point. If we start to see some serious financial repercussions develop in housing, I'd look for a rate cut, and wouldn't worry in that event about commodity prices, since I would expect to see commodities fall sharply on news of a big downturn in economic activity. On the other hand, if instead we have seen the bottom for housing and the core inflation numbers remain this high, I'd look for the Fed to tighten further.

That is the direction the data has been pushing me as well. Unlike Kash, who seems more convinced than I that we've reached a peak (though he does leave some room for doubt), I see the upside and downside risks as roughly equal.

It might be that the upcoming 3rd quarter GDP data could be the news that gives us a clue as to which way this will break. It probably won't be the overall growth rate (which is likely to be positive but below everage), but the different subcategories of consumption and investment that will tell the story. At least until that point, I'm prepared to use both hands when explaining where the economy seems to be going, and what direction interest rates might take in 2007.

UPDATE 2: David Altig finds himself in general agreement and is almost ready to take the next step--but not quite.

But, for reasons I'll detail in a later post, I'm beginning to wonder about the reach of developments in [the housing] sector. I'm not quite ready to take the anti-Roubini bet with the degree of confidence that Nouriel himself puts on his recession call. But I'm getting there.

Absent any additional negative shocks, I would agree. I'm not quite ready to call it a soft landing yet, but I too am getting there.

A couple of dynamics seem to be at work in the CPI numbers released today. Obviously the fall in gas prices decreased the headline number which was down by 0.5%. That was no surprise. Yet the core rate continues to come in above the Fed's comfort zone. This months increase in the core was at 0.2%, the same as last months increase. Combined with previous increases, the core CPI has increased by 2.9% from a year ago.

Owners equivalent rent (OER) continues to push the core upward. This is due to two factors--the improvement in the rental market as housing slows, and the fall in energy prices since OER is computed net of utilities costs. See macroblog for an excellent discussion. Of course OER held the core low during the housing boom. (Ironic, isn't it?) If the rental market continues to improve and energy prices continue to fall, this effect could be with us well into 2007. Does the fact that the rise in the core can be partly explained by the rise in OER make it less troubling? Perhaps slightly, but be careful not to discount it too much. In the last couple years when OER was holding the core down, the core rate was already at the top end of the Fed's comfort zone. If the current rise in OER is the most important change to affect the core in recent months, then not much has changed. The core was rising at slightly more than a 2% rate for most of last year. If the current trend in OER continues, the core inflation rate could top out above 3%. If a simple back-of-the-envelope calculation suggests that after adjusting for OER's effect the core inflation rate has been up around 2.5% or higher for all of that time, that would still be too much for most.

In short, these numbers don't inspire me to call for a rate cut right now. However, there is an interesting question of whether the FOMC's assessment of risks has changed since the last meeting. Aside from the OER component of core inflation (which we can reasonably expect to rise a bit more--and which is somewhat more predictable), it does appear that the risk of additional inflation may have diminished. But the fact remains that the current level of inflation remains too high in the eyes of many. Facing this fact, will the Fed hold rates at this level for an extended period of time or begin raising them again? Given the suggest of "opportunistic disinflation" a decade ago, it is reasonable to expect that they might try that strategy again and hold steady for a while.

Today's CPI figures do not totally clear up the fog of uncertainties. They reinforce the fact that this is still a critical time for the economy. Given the "wait-and-see" stance of the Fed currently, I think it will take more than this to move them off of that position. Will core inflation rates on the wrong side of 3% be enough to effect a change in policy? We may find out.

(Archived BLS press release of today's CPI report)

Harry Truman wanted a one-armed economist. He didn't like our tendency to say, "on the other hand...".

These numbers make it hard to be one-armed. Let's turn it over to Reuters...

WASHINGTON (Reuters) - U.S. producer prices fell more than twice as much as expected last month on a record drop in gasoline prices, but core prices jumped amid a rebound in autos that may vex the Federal Reserve as it weighs inflation risks.

The Labor Department said on Tuesday that producer prices declined 1.3 percent in September, the steepest drop since April 2003. This came with a 22.2 percent fall in gasoline prices that broke the previous record of a 22.1 percent drop, set in March 1986.

It should be obvious that the decline in gas prices is responsible for most of the decrease. So we look at the core PPI. Brace yourself...

The core producer price index, which strips out volatile food and energy costs, advanced 0.6 percent after a 3.5 percent rebound in light motor truck prices, the largest increase since October 1985, following a 3.4 percent dip the previous month.

Passenger cars rose 2.8 percent -- the largest gain in 16 years -- after falling 2.6 percent in August.

Stripping out those sharp rises in truck and car prices, core producer prices would have risen 0.1 percent, a Labor Department official said.

So now the picture is either murkier or clearer depending on the importance you put on the core and various components of the core.

U.S. stock futures and Treasury bond prices lost ground on news of the advance in core prices, while the dollar was little changed.

"It's mostly a rebound in motor vehicle prices that exaggerated the jump in the core," said Mark Vitner, senior economist at Wachovia Securities in Charlotte, North Carolina.

"The trend is still one of moderation and with economic growth slowing, we should inflation moderating further later this year. This doesn't mean that we are not going to see a troubling number from time to time," he said.

Wall Street economists had expected the report, which comes a week ahead of a Federal Reserve meeting on interest rates, to show overall producer prices declining 0.6 percent last month while core prices were forecast to rise 0.2 percent.

So they didn't see the change in auto prices coming.

Financial markets believe the U.S. central bank will hold interest rates steady not just at its October 24-25 meeting, but through the end of the year. But the mixed signals from producer prices underline the tricky task facing policy-makers.

"I think the Fed will be confused on the number but I think the market is looking at the 0.6 (percent rise in core prices) and saying the Fed is less likely to cut," said Robert Macintosh, chief economist at Eaton Vance Management in Boston.

Wasn't the probability of a cut almost zero already? (Was that a Freudian slip revealing his wishful thinking?) This doesn't change much, and it is not going to "confuse" the Fed. The fact that gas prices dropped last month--something that all of us watched happen and so knew would be reflected in the data--certainly will not make them more likely to cut. Core PPI rose more than expected because of autos but without factoring in autos the increase was much more subdued. But when you look at the increase in the core over the last two months, you see that because of the drop in core prices (again due to autos) of -0.4% in August the total increase in the last two months is about +0.2%. That is certainly tolerable.

Far from making the Fed "confused", I think this is a reassurance that last months drop was the anomaly. The core PPI data hasn't changed dramatically since mid-summer. If anything, maybe it is a bit better. Steady as she goes. I can't see how this report is enough to swing the policy recommendation either way. So the stock market is probably overreacting a bit. They'll figure it out soon enough. They usually do. Of course there might be a little latent anxiety in the market in advance of the CPI data tomorrow. We shall see if the headline number and the core go off in opposite directions again. Given the fall in gas prices, I think it's a safe bet. The numbers will be mixed. What else is new?

The September PPI and CPI come out tomorrow and Wednesday, respectively. Housing starts and the MBI refinancing index also are released on Wednesday. Initial jobless claims and the Conference Board leading indicators come out on Thursday.

This is an important week for data out in front of the FOMC meeting taking place on October 24-25. Fed speak will quiet down as the data releases take center stage. St. Louis Fed President Poole indicates that he will be watching the data this week.

"If it looks like the numbers this week and other information suggest to us that the inflation rate is moving higher, or in danger of hanging here ... then I am certainly very much in the camp that would favor additional policy restraint," Poole said in answer to questions after a speech.

Via Reuters.

Subtitle: One nasty little shock away from recession (thank goodness)

First, look at Tim Duy's take at Economist's View. Solid analysis and a couple of great lines worth quoting.

Are Fed officials just clueless? Don't they see that the end is coming? I think not – I bet Fed officials are not working overtime to spin a negative story out of every number...

and

If you forced the Fed to choose between cutting rates and hiking rates, they would choose the latter. Luckily, they can choose to pause as well.

I agree. Talk of recession is everywhere. A data point that comes in with slower growth, but growth nonetheless (the ol' "increasing at a decreasing rate" as I like to tell my macro classes) leads some to put on sackcloth and ashes. One certainly has to look at the broader picture, as James Hamilton has done, for example.

Yes, the point is often made that the Fed's record at producing a soft landing is a bit weak, with the only real success being in the mid '90s. Some say that overtightening in the late '80s brought on the 1990-91 recession. I agree that it was certainly a contributing factor. But that makes them 1 for 3 in the last 20 years (2001 being the other negative result). But I'm not sure that I'd look at the scenarios of the 1970s or the early 1980s as being similar enough to that of the last 10 years to want to make the comparison. Could Chairman Volker have managed a soft landing instead of a recession with the lousy deck of cards that he was dealt? Bernanke isn't sitting on a royal flush, but by the same token this clearly isn't 1979.

Whether or not a recession occurs is probably going to be due less to Bernanke's skill or lack thereof than it will be due to whether or not some additional exogenous shock hits the U.S. or world economy. I don't think I'm alone in saying that despite my overall optimism, I am not at all squeamish about saying that we are one nasty little shock away from a recession.

And that brings us to the news of today. Here, CNN channels Reuters:

NEW YORK (Reuters) -- The Thai baht staged its largest one-day fall in three years Tuesday after Thai armed forces ousted the prime minister, sparking a broad decline in a number of Asian currencies.

...

Prime Minister Thaksin Shinawatra, who was in New York to speak at the United Nations, declared a "severe state of emergency" in a broadcast on Thai television.

Looking ahead, the market will watch to see whether the Thai crisis prompts investors to abandon other risky emerging market trades.

The dollar would be the main beneficiary in such a scenario, said Divyang Shah, strategist at IDEAGlobal in London, as it is "not only a high-yielder but is also an attractive safe haven."

But other market participants said solid economic fundamentals in Thailand and other emerging Asian markets make a mass rush for the door unlikely.

"There's been an immediate reaction and people will move to the sidelines to see how it all unfolds, but what we'll see will probably be a short-term disruption," said Upadhyaya.

...

Karl Jackson, president of the U.S.-Thailand Business Council, said the country has experienced a military coup 17 times since 1932.

"Basically before democracy came to the forefront, this was the their way of changing the government and it continues," said Jackson, who is also director of Southeast Asia studies at Johns Hopkins University.

"There might be a momentary glitch on the part of investors, but as in previous coups, investment and property rights won't be affected. If the coup is successful, I expect everything will be normal in the morning," he said.

Still, investors were watching the situation closely, since the Asian currency crisis in 1997 started with the devaluation of the Thai baht, then grew into an international economic slowdown.

Yes, it may be that everything will be normal in the morning--except perhaps for Mr. Shinawatra. In all likelihood this will not cause the sort of contagion that took place when the baht collapsed in 1997. But as I read the news coming out of the Asian markets tonight as their trading day comes to a close, I can't help but get the feeling that someone is looking over my shoulder and saying, "Made you look!"

Yes, indeed I looked. Because if there is trouble to be made for the U.S. economy, or the world economy for that matter, it will be made by that unexpected exogenous shock. The straw that broke the camel's back--a classic non-linearity. Maybe not today. Maybe not the baht, but it made me look.

For the last year, I've been cautiously optimistic that we could avoid a hard landing, and to this point it would seem that we have. However the tensions of the last year or two (rising interest rates, rising then falling housing markets, questions about the health of the labor market, etc.) are beginning to give even the optimistic among us a little cause to look over our shoulder once in a while.

Yet, this is something we may have to get used to every decade or so. We have not eliminated the business cycle, but we have tamed it a little. That is going to mean sailing close to the rocks now and then. As long as we keep inflation low and stable, there will be less need for major course corrections. A soft landing, while not assured, is then possible if you are fortunate. It's nerve-racking, but it's better than the boom-and-bust alternative that comes from chasing the Phillips curve too hard.

Thus it is all the more important for the Fed to stick it its inflation fighting guns. As Tim Duy said, given a choice between raising and lowering rates, they would probably raise. That would be my choice as well. But given the increased uncertainty about the effect of the housing slowdown and the lagged effect of past rate increases yet to be felt, keeping rates where they are at this point in time (with a bias toward tightening) is an even better idea. Keeping inflation low and stable is the best thing the Fed can do to ensure that we are one nasty little shock away from a recession more often than we are rushing headlong into one.

Time for another economic Rorschach test. Retail sales increased by 0.2% in August. Considerably lower than the 1.4% increase in July, but many forecasters were expecting a decline. How you interpret this says a lot about your outlook on the economy.

So let's look at how the media is treating the news...

Wall St. Journal:

U.S. retail sales unexpectedly increased during August after an early-summer surge even though gas-station sales fell and consumers slowed furniture purchases.

...

"Remember how we all thought that consumer spending would eventually tank, weighted down by high energy costs and the end of the housing boom?" asked Joel Naroff of Naroff Economic Advisors. "The rumors of the consumers' demise remain just that," the economist said, citing prices -- not a lack of demand -- as the reason for soft spending gains.

...

Stephen Stanley, chief economist at RBS Greenwich Capital, said that gasoline prices have fallen by nearly 50 cents per gallon since hitting their highs in early August. He said this should provide a big boon to consumer spending in coming months.

"Consumer spending is going to explode, probably in September, October and maybe November," he predicted.

Looks like they see the glass as half-full. Now to the NY TImes...

WASHINGTON (AP) -- Retail sales in August posted the weakest showing in two months as worried consumers curbed their spending habits.

How's that for an opener?

The Commerce Department reported that the nation's retailers saw a tiny 0.2 percent increase last month following a much bigger 1.4 percent rise in July. It was the weakest performance since sales had actually fallen by 0.5 percent in June.

...

The tiny 0.2 percent rise in retail sales in August was slightly better than analysts had been expecting. They were forecasting an outright decline in sales of around 0.2 percent.

Can someone buy them a thesaurus? Is using the word "tiny" twice in this story a bit of overkill?

...

While the sharp slowdown had raised concerns of a possible recession, economists have grown less concerned about that possibility because of a retreat in oil prices, which have declined significantly from their mid-July highs.

The decline in gasoline prices is expected to show up in stronger retail sales in coming months as consumers have more to spend on other items because they will be paying less to fill up their tanks.

Stephen Stanley, chief economist at RBS Greenwich Capital, said that gasoline prices have fallen by nearly 50 cents per gallon since hitting their highs in early August. He said this should provide a big boon to consumer spending in coming months.

''Consumer spending is going to explode, probably in September, October and maybe November,'' he predicted.

For the record, the WSJ story is by Jeff Bater. The Times took theirs from the AP. The Times starts out in a very depressing tone but then works in the same quote from Stanley. Two uses of the word "tiny" followed by a statement that economists are less worried about recession. Looks like they want to see the glass as half-empty but do not want to totally ignore the positive. I think they are hoping you will be so discouraged by the first paragraph that you'll just move on.

Finally we have CNNMoney.com...

Retail sales rose moderately in August versus forecasts for a decline, the government said Thursday, but the gain was tempered by a slowdown in auto sales.

To me this is the most reasonable and accurate opener of the three. Later in the article...

"I am puzzled by this report. There seems to be somewhat of a disconnect," said Scott Hoyt, economist with Economy.com, noting he expects the government will revise retail sales for September lower later this year.

"Whenever you've got a strange disconnect like this, you almost always have to anticipate it," Hoyt said.

Ian Shepherdson, chief economist with High Frequency Economics, seemed to agree.

"Overall, this report is softer than it looks,' Shepherdson said in a note. "The headline is flattered by an inexplicable increase in auto sales, which cannot be squared with the 6.3 percent drop in unit sales reported by the automakers. Expect a downward revision."

At the same time, the recent retreat in gas prices helped to divert consumers' dollars and lift sales of products in other discretionary categories.

Sales at gas stations fell 1 percent last month compared to a 1.6 percent gain the previous month.

Food and beverage sales rose 0.6 percent. Sales of sporting goods, books, music and movie DVDs increased 0.8 percent. General merchandise stores posted a 0.4 percent gain.

While the drop in gas prices is clearly a plus for consumer spending, Hoyt pointed out that energy costs, including gasoline, typically represent only about 7 to 8 percent of the household budget.

"It's easy to overdo the gas price effect," Hoyt said. "Housing has a more serious consequence on spending patterns because slowing housing activity has an adverse effect on household wealth and mortgage equity withdrawals. With a cooling housing market, consumers have less cash to pull from their homes to spend elsewhere like electronics and furniture."

This article did a really nice job of tying it all together. I'd say it's more of a glass half-empty story. Sorry to disappoint you. But it is quite reasoned and consistent.

What do you think about the contrast between Stanley in the Journal and Times articles and Hoyt in the CNNMoney article? Is consumer spending going to "explode" now that gas prices are coming down? Or does the fact that gasoline (and energy in general) make up a relatively small fraction of the total household budget mean that we should be careful about reading too much into that? Is this a case of a report that is so anomalous that we should expect a revision and discount it until seeing if that revision is made?

If you want to tackle these questions or if you have other sightings of half-full vs. half-empty thinking, post them to the comments.

In other news, initial jobless claims hit a seven week low. That makes me a bit more confident in thinking that the labor market still has a bit of life left in it.

UPDATE: Commenter "zinc" inspires me to look at the confidence interval for this estimate (something that I do not recall seeing anyone in the MSM or the blogosphere cite either). So, for the curious, here is a link to the Census Bureau news release. Go to the link for the complete tables and charts. Here is the summary:

The U.S. Census Bureau announced today that advance estimates of U.S. retail and food services sales for August, adjusted for seasonal variation and holiday and trading-day differences, but not for price changes, were $368.2 billion, an increase of 0.2 percent (±0.7%)* from the previous month and up 6.7 percent (±0.7%) from August 2005. Total sales for the June through August 2006 period were up 5.6 percent (±0.5%) from the same period a year ago. The June to July 2006 percent change was unrevised from +1.4 percent (± 0.3%).

Retail trade sales were up 0.2 percent (±0.7%)* from July and were 6.6 percent (±0.8%) above last year. Nonstore retailers were up 12.5 percent (±4.5%) from August 2005 and sales of gasoline stations were up 11.0 percent (±2.0%) from last year.

As they point out...

* The 90 percent confidence interval includes zero. The Census Bureau does not have sufficient statistical evidence to conclude that the actual change is different than zero.

In all of the excitement from the cheerleaders and the doom-and-gloom from the pessimists, I did not once see anyone mention the confidence intervals. (Correct me if I'm wrong and missed it somewhere.) As the MSM articles I cited make abundantly clear, the MSM certainly didn't take the time to worry about such things (nor did the analysts they quoted).

Now, that is not to say that the data is useless. The overall trend paints a better picture. One data point alone does not provide a lot of information. In fact this one really makes me wonder about whether and how much it will be revised. James Hamilton looks at the trend and comes to the same conclusion that I do... that this is much ado about nothing.

This is why we have blogs and why blogs have commenters.

To answer "zinc"'s other questions, these are nominal (not real) and the widely quoted 0.2% is monthly.

UPDATE 2: Mark Thoma has even more.

There are a couple of things worth noting here. First of all, I was not aware of this open access medical journal, PLoS. I figure that a few of you might not know of it either, so now you know.

Anyway, I tracked it down from this story on MSNBC.com. The article is on the vast differences in life expectancies across geographical areas of the country. The authors then break down the data into "eight Americas" based on income and race. Hawaii scores well, but the south does very poorly. Of course one can easily criticize this as leaving out many potential other explanatory variables. For example, If industrial pollutants reduce life expectancy of all races but are concentrated in counties of a certain racial makeup, that would be useful to know. (I confess to having no knowledge of whether this would be a significant issue, but an enterprising person with a map of chemical factories could find out in a hurry.) The authors do identify access to health care, even among low-income rural areas of the northern states (e.g. my old stompin' grounds), as being an important positive factor contributing to life expectancy. Food for thought.

For the curious, their life expectancy data is available.

Other articles in this issue of the on-line journal look interesting as well, including a study comparing outcomes in academic medicine (i.e. teaching hospitals) and non-academic medicine.

I commend this journal for making medical studies more accessible to researchers, including those in other fields who will benefit from easy access.

The FRED (Federal Reserve Economic Database) is a valuable resource for economists. Many of us bloggers go there first for data. I see many journal references to it as well. I've been using it since grad school, and it keeps getting better. A few days ago I noticed a new improvement. You can now graph two time series on the same graph. You can also plot any series in logs, percentage change annualized or year-on-year and more.

Nice!

Apropos of my last post which lauded the midwest economy, we have a new data point from the NAPM-Chicago business barometer. Via Reuters:

NEW YORK (Reuters) - Growth in business activity in the U.S. Midwest slowed slightly in August, a report showed on Thursday, but the data may signal the economy is in recession.

The National Association of Purchasing Management-Chicago business barometer slipped to 57.1 from 57.9 in July, for a 40th straight month of growth. Economists' median forecast had put the index at 57.0. A reading above 50 indicates expansion.

However, according to Kingsbury International, a partner of NAPM Chicago, which puts out The National Association of Purchasing Management-Chicago business barometer, "the U.S. economy could be in a recession at this time."

...

Although the NAPM Chicago index has shown expansion for 40 consecutive months, with an average reading of about 59, in the past three months the reading has been below that average.

"In four of the last five recessions, the slowing of the Chicago business barometer signaled a recession either one or two years later," Kingsbury International said in a report.

Let us first take note that 40 months of expansion with an average reading of 59 is a pretty good run. But I would hesitate to say that slipping to 57.1 might be an indication that we are already in a recession. In fact, if you look at the entire series, you will see several instances where the indicator his touched 50 without recession--most notably 1985, 1995-96, and 1998. Kingsbury International is saying that in four out of the last five recessions were preceded by decreases in the series. But there are at least 4 (depending on how long or large a decrease you want) cases where a decrease in the series produced no recession. The power of this test (probability of rejecting the null when it is false) is not good.

The economy is slowing, and we may be on the cusp of a recession--perhaps still with the opportunity for a soft landing. However, if a recession has already begun with the Chicago business barometer at 57 it would be the first time since 1973 that something like that has happened. I don't think that's likely.

One of the nice things about blogging is that you can go back and revisit ideas from the past because the blog archives all of those old words and pictures as if you wrote them yesterday. For a professor, this is nice because invariably you want to bring up things that you discussed in the past, but a new set of students needs to get up to speed. In economics, it is essential to have access to that background. This post is in that spirit--just in time for classes to start in a couple weeks. Just about exactly one year ago I wrote this post that looked at the core CPI inflation rate and payroll employment starting from the trough of the last two recessions. Go back and take a look.

Here are the corresponding charts updated to the lastest data (including the labor market data from Friday).

The payroll charts tell us what we already know, but put it into context with the previous recovery. With the exception of the last few months, job growth has hovered around the 150,000 per month widely recognized as necessary to keep up with the growth of the population. There has not been the kind of robust recovery of jobs that came along after the 1990-91 recession.

Note also that the point in the recovery from the 1990-91 recession that corresponds best to today is early 1995. The labor market did experience a bit of a slowdown in 1995, and the possibility of recession was openly discussed. At the same time, inflation, which had been high at the start of the recovery, was starting to come down. This was the beginning of one of the most successful non-recessionary disinflations that this country has seen in the modern era. And in Feburary 1995, the Fed raised rates one last time by 50 basis points to 6.0% where it would stay until July when rates began to fall slowly for the next couple years.

Remember, the 1994-95 episode was a success in terms of a soft landing--a cooling of GDP to a sustainable pace, fall in inflation, and no recession.

Is it any easier to predict what is coming on the basis of this information than it was last year? Not really. I do have to say one thing, however. The totality of the picture is less encouraging than it was a year ago. Martin Feldstein shows his concern in Monday's Wall St. Journal opinion pages.

The Fed governors and Reserve Bank presidents appear to believe this [soft landing] will happen. Their "central tendency" economic projections, summarized in the July Monetary Policy Report, state that the Fed's favored measure of inflation, the PCE price index excluding food and energy, will decline from the 2.9% rate in the most recent quarter to between 2% and 2.25% in 2007, presumably on its way to Ben Bernanke's "comfort zone" of 1% to 2% in 2008. They project this to occur with real GDP growing above 3% and the unemployment rate remaining under 5%. Indeed, not a single one of the 19 FOMC members projected growth of less than 2.5% in 2007 or an unemployment rate above 5.25%.

Although this optimistic outlook is possible, experience suggests that it is unlikely. A mild slowing of economic growth is generally not sufficient to reverse rising inflation. That generally requires a sustained period of excess capacity in product and labor markets, with GDP growth falling significantly or even turning negative.

The last recovery being an significant exception to that rule, but as we have discussed, that requires everything to go right, especially productivity. Feldstein continues...

The official estimates of productivity growth showed a gradual decline of productivity growth in the nonfarm business sector from 3.9% in 2003 to 3.4% in 2004 and 2.7% in 2005. The result of the slower productivity growth and rising compensation per hour (from a 4% rate in 2003 to 5.1% in 2005) caused the increase in unit labor costs to accelerate from 1.3% in 2003 to 2.1% in 2004 and 2.8% in 2005. Taking the new GDP estimates into account is likely to lower the calculated productivity growth rates and cause estimated unit labor costs to have risen faster than 3% in the most recent quarter. There is no reason to anticipate a favorable productivity surprise of the type that contained inflation in the 1990s.

...

While this risk provides a rationale for a pause at tomorrow's meeting, it would be wrong to focus just on this downside risk. The probability that inflation will rise above the FOMC forecast is at least as great. The unemployment rate of 4.8% still represents a tight labor market. Waiting for more data before deciding to raise rates is not costless. If the Fed does not act and core inflation continues to rise, expected inflation may rise further. Higher expected inflation would cause faster increases in wages and prices. If the core PCE inflation rate rises above 3% in 2007, it would take a very substantial slowdown and a large loss of GDP and employment to bring it back under 2%.

In assessing the current interest rate decision, the FOMC members should recall that during the Volcker and Greenspan years the Fed pushed the fed funds rate to 8% above the concurrent rate of CPI inflation in the early 1980s, to 4% in 1989 and to almost 3% in 2000. That measure of the real fed funds rate is now less than 1%.

The Federal Reserve has a difficult task ahead. It is understandable that it would like to achieve the soft landing of low inflation with continued solid growth. But that may not be possible. And if the Fed wants to convince the markets that inflation will be contained in the future, it must show that it is willing to take the risk of tightening too much.

Feldstein is entirely correct to point out the real fed funds rate is still a bit low. This is what I have railed about time and again. If it is not possible to have the soft landing as we did in the '90s, then this meeting is a test of inflation fighting resolve. One long term lesson this episode may provide future generations of policy makers is just how important productivity growth is for cushioning the economy in situations like this. Without productivity growth, and worse yet with further increases in oil prices, it forces the Fed to go further than it would have ideally wanted in order to get the real rate where it needs to be. I am sympathetic to the argument that they should have raised rates faster in the early going (2004) to head off the rise in inflation. But in light of the weak labor market data--a labor market that the above charts show just never got off the ground the way it did in the mid-'90s--I can't say that I would have done anything differently. To raise rates too quickly while productivity growth rates were falling might have choked off the recovery even sooner.

On that note, I conclude with this little blurb from the NY Times.

DO WE HEAR A PAUSE? The central economic news of the week will emerge from the meeting of the Federal Open Market Committee, which will decide whether to raise the benchmark short-term interest rate — now at 5.25 percent — yet another time. On the one hand, many economists predict that the Fed will leave things unchanged, which would be welcome news for investors, but then again, who knows? The dearth of one-handed economists is legendary. (Tuesday.)

Try as I might to be single-handed, I can't say for sure what the Fed will do. I can come up with a lot of reasons to raise them one more time. I do worry a bit about the 6 to 18 month picture for inflation if they pause now. I'd like the increase to be now and the pause to be for the remainder of the year. But the markets have made up their mind, and Bernanke may not want to stir them up too much. They could very well send a strongly worded statement that though they pause now an increase in October is the default option unless new data changes that stance. If such a statement comes off as credible, it would be an acceptable compromise. We shall see.

UPDATE: The September meeting escaped my mind. Change the above to read September or October.

UPDATE 2: It gets worse. Michael Mandel reports that productivity figures for 2004 and 2005 are likely to be revised downward.

UPDATE 3: Mandel was correct. Productivity was revised downward for the last couple years and the 2nd quarter of 2006 came in at 1.1 percent growth. The trend is downward. While Mandel tries to tell a positive story of the 10 year productivity growth rates, his chart shows exactly what is troubling in this situation. In the mid-'90s, the trend was reversing and going up making it easier to contain inflation. Today, the growth rate of productivity is falling.

Blogging has been light for a while so that I can work on some other projects. I do plan to resume a more typical posting schedule now. I've been thinking a lot about fiscal policy lately and will post some thoughts on that soon. Of course, we've got another month to go before the FOMC meets again. But I have to be honest. Nothing in the last few days worth of data has changed my opinion that another rate hike is more likely than not. See, for example, this post by David Altig on the PCE. The May employment report is probably the next data point of sufficient importance to potentially shift the prevailing winds. What about the recent report that GDP rose faster than we thought? Old news. Inventories were building up faster, and the revised number probably includes some effect from the hurricanes last fall. It doesn't do much to strengthen the case for a pause, but neither does it make me want to slam on the brakes.

Much more to talk about later in the week. In the meantime, have a great Memorial Day.

Real GDP was up 4.8% in the first quarter according to advance figures. (Full Press Release)

It appears that a couple of items that dragged down 4th quarter GDP were an aberration. I figured that the weak government purchase figures were nothing to worry about. However, I was a genuinely concerned about durables three months ago. Today's figures on durables make up what was lost in the 4th quarter, but taken together the last 6 months have been pretty bad for durables. If that continues through the rest of the year, it will be a drag on GDP.

Taken in context, today's report looks good mostly because the last one looked so bad. The average growth over the last 6 months is still in the 3 percent range. That's acceptable but not breaking any records. I think that Bernanke and the rest of the crew at the Fed are correct to expect GDP to slow just a little bit in coming quarters--maybe around 3% or the high 2's. I think it would have taken a number like 5.5 or 6% today to get me to argue that the rate increases should go on unabated. Bernanke wants to pause. I think we could use a pause in either June or August--data dependent of course.

Let us not forget about the GDP deflator and the PCE deflator which are included in today's report. Inflation as measured by the GDP deflator came in at 3.3%. The PCE deflator registered only a 2.0% increase--the lowest in over a year. So was the March CPI a one-off event? I'm still waiting on the April data before committing to an answer.

But putting it all together, I am comfortable now with a policy regime in which rates are expected to rise every 12 weeks instead of every 6 weeks. I do not want them to give any impression that a pause is a stop. Inflation is still at the top end of my comfort zone. But we also need to remember that we've got 2 or 3 rate increases in the pipeline that were not anticipated by the market when this process began. As the last few hikes start to take effect, we can probably afford to ease up a little.

Or as I like to say, take a little pressure of the brake pedal, but don't take your foot off of it.

UPDATE: See also Angry Bear, Brad DeLong, and Andrew Samwick.

Via Reuters:

After a two-day meeting, the Federal Open Market Committee, the Fed's policy arm, also left the door open for more rate increases in a bid to keep a vigorous economy from overheating, as growth in Europe and Japan appears to be picking up.

Earlier the Conference Board, a private research firm, said its measure of consumer sentiment jumped to 107.2 from an upwardly revised 102.7 in February, beating Wall Street forecasts of only a modest gain.

ABC News adds this:

The Conference Board said that its consumer index shot up 4.5 points to 107.2, the highest level since May 2002, when the reading was 110.3. Analysts had expected a reading of 102.

The latest measure was up from a revised 102.7 in February, which was down 4.1 points from January and broke a three-month rebound from last year's Gulf hurricanes.

Not bad. Generally I don't get too worked up by consumer confidence numbers one way or the other, but the way this one surprised Wall Street and the fact that it is almost a 4 year high is worth noting in passing.

Reuters has the headline of the day: Forecasters way off on growth estimates.

The Wall Street Journal has some responses from economists, including Angry Bear's Kash Mansouri

The only thing that kept GDP growth positive at all was a massive build-up in inventories -- the largest increase in inventories since early 2002. Apparently businesses were caught off guard by the slowdown in demand, and have not yet slowed their production accordingly. Presumably, they will. All in all, this is an extremely worrying report. I've been bearish about economic growth in 2006 for a little while now, and this has just confirmed my worst fears.

Indeed. Inventories contributed 1.45% on the plus side. Basically things shook out this way. Durables were way down, but nondurables and services are still strong. Fixed investment was pretty flat, some components up, some down. Exports didn't contribute much and imports continue to be a drag (see also, nondurables). Government spending, particularly defense spending is down. (Full press release)

So what is with defense spending? Isn't there a war on? Look closely. There was a surge in defense spending in the 3rd quarter followed by a drop in the 4th quarter. The fiscal year ends on Sept. 30.

I'm just sayin'.

So maybe that is just an artifact of budgeting and the timing of the fiscal year. I'm not sure that seasonal adjustments would catch all that, especially if the war causes a lot of unusual spending activity that isn't built into the adjustment process. So one has to think that defense spending and government spending in general will be back up in the first quarter of this year.

But what about durables? What about fixed investment? Is the buildup of inventories troubling? Remember, there was a big draw down of inventories in the 2nd quarter. Perhaps today's data represents part of that ebb-and-flow. If so, and if defense spending goes back to normal, the only really discouraging part of the report is the drop in durable goods. And there's no way to sugar coat that, especially given the announcement by Ford this week (oh, and this report just in concerning GM). If any weakness remains in the first quarter of 2006, that will probably be it.

If you're not too depressed already, go over and read James Hamilton's assessment. He has some links to others as well. King at SCSU Scholars says, "there's no way you can paint this as good news."

While I expect that there might be a small revision upward in the next month or two, I would also revise my 2006 growth estimate down a couple tenths. We're probably looking at the low 2% range, that is unless another shoe drops. Remember, the thing that gets you is the thing you didn't see coming.

There will undoubtedly be some reflection on what all this means for interest rates. The FOMC meeting is next week, and participants are observing the usual pre-meeting "blackout". I don't think it changes anything for Greenspan's last meeting, but after that...

I know we'll all be looking forward to macroblog's implied probability charts. (Link to this week's edition--before GDP data)

UPDATE: Altig's implied probability charts are up. The title of the post is "GDP Tanked...And Nobody Cared." I guess that should tell you that the market still has its chips down on another quarter point rate hike in March. At the moment, the likely candidate for a pause is the May meeting. There will be a lot to talk about between now and then.

4th quarter GDP figures come out in the morning. Talk is that it will be under 3% for the first time in almost 3 years. That might well be. I'd put my chips on the "under 3%", but I'd never go "all in" on advance quarterly GDP. In the latest Econoblog, Kash (of Angry Bear) explains why:

In October 2005 the Congressional Budget Office published "The CBO's Economic Forecasting Record," in which they took at look at the track record of both the CBO and "Blue Chip consensus" forecasts for various macroeconomic variables. Doing a quick check on the accuracy of the Blue Chip consensus forecast for GDP growth shows that, on average, the consensus forecast was off by 1% (in absolute value). Forecast errors were particularly large during large changes in GDP. In other words, economists are particularly bad at identifying turns in the business cycle.

Now, I'm not sure whether this average error of 1% is larger or smaller than I would have expected, compared to an average GDP growth rate of 3.1%. But I am quite sure that it's disappointing to see that a forecast that simply extrapolated last year's GDP growth into next year's GDP growth would have had a slightly smaller average error. In other words, the average of our best macroeconomic models does no better at predicting GDP growth than a person who simply always guesses that next year's GDP growth will be the same as this year's!

To me, that's a pretty bad testament to the state of the economics profession's understanding of the macro economy. Are economists leaving out important information? Is the importance of psychology and other inherently difficult-to-model factors making hay of our economic models? I'm not sure … but add it all up and I find myself regularly disappointed with our ability to make good macroeconomic forecasts.

Kash and James Hamilton (Econbrowser) bat it around a bit, and it's well worth the read--and timely given the upcoming release of the advance GDP data.

Hamilton relates an interesting anecdote:

I spoke recently with the manager of a fund with one of the best forecasting records of anybody in the business, and was very interested in his description of how they worked. At the research stage, they use all variety of sophisticated econometric techniques to look for relations in the data. But when it gets to the point of actually making the investment call, they throw out the econometric estimates of all the coefficients, and replace them with values that make sense from the point of view of an understanding of the basic forces that are operating, values that are hopefully consistent with the econometric estimates, but not identical. They are thus deliberately coming up with a statistical model that does a worse job of fitting the data than something else that is available, but hopefully is more robust about predicting what may come next in a world which, as we've both observed, is constantly changing. That's certainly consistent with my advice for any forecasters -- don't try to do too much with overfitting the data, but settle for a simple model that gets the broad brush correct.

Sound advice. Turning points, when they happen, can look like outliers. Overfitting the data is bound to cause you to miss the turning. There is much that we do not understand.

UPDATE: The folks at Davos aren't doing much better.

Industrial production is up 0.6%. Autos are still hurting but other areas are taking up the slack. Capacity utilization is at 80.7%, up from 80.3%. Not too bad. Capacity utilization is a full percent higher than it was last year and now just 0.3% below the 1972-2004 average. (WSJ Article)

This could, of course, be seen as inflationary. We'll get a look at that tomorrow with the December CPI and the Beige Book. Most are expecting the core CPI to increase by 0.2%. If it is rises more than that, it would fuel talk of interest rate increases extending into March. (Remember, January is all but a foregone conclusion.) The Beige Book will give us some additional insight into whether and where business are finding themselves able to pass along higher energy costs to their customers. It will be two very useful data points in one day.

Among other items on the calendar this week are initial jobless claims and housing starts on Thursday. Friday brings the Michigan survey of consumer sentiment.

Stay tuned.

Is 4.3% growth of real GDP just ok, or is it _______ (use whatever superlative you like)? One of my frequent commenters, spencer, writes in response to my earlier post that since WWII real GDP growth has exceeded 5% almost a third of the time. Against that record, today's news sounds quite average.

But of course the volatility of real GDP has declined significantly since WWII. Here's the picture:

The words "structural break" come to mind.

Chang-Jin Kim and Charles Nelson were thinking along those lines when they wrote their paper "Has the U.S. Economy Become More Stable? A Bayesian Approach Based on a Markov-Switching Model of the Business Cycle" in the 1999 Review of Economics and Statistics. Drawing on work done by fellow blogger James Hamilton (1989 Econometrica), they find a break at 1984Q1. (Links are to the appropriate papers on JSTOR for those who have access.)

Bottom line: If you want to grade the current economy on a curve, don't use the 1950s to construct the grading scale (or anything before 1984, for that matter).

Interestingly, David Tufte (VoluntaryXchange) constructs a grading scale for GDP based on post 1983 data. I would contend that "eyeball econometrics" should lead you to believe that the relevant data to use to construct your grading scale is somewhere between 1983 and 1985. Kim and Nelson's result happens to fall right smack in the middle of that range, so I'm ok with that.

So the next step is to look at a histogram of the data from 1984 onward. Here you go:

This does not include today's data release, but you can see where it would go. Grading on a curve, it's a solid "B". Tufte concurs. Tufte's scale using 1983 as a starting point indicates that the last quarter falls in at the 69th percentile. Using Kim and Nelson's 1984 break point makes things look a little better. The last quarter comes in at the 73rd percentile of GDP growth since 1984.

Of course, the structural break model is just that, a model. The variance of GDP may change more than once. We haven't even addressed what might be causing the change. In general, I'm reluctant to grade a time series on a "curve" like this if there is heteroskedasticity (changing variance) such as this.

That said, I am very sympathetic to the reason why you might want to make the comparison. Thus, I am quite happy to give this report a solid "B" as long as everyone understands that a nice long string of "B"s and "C"s without any "F"s is a pretty good achievement indeed. Stable, sustainable growth gets a "B" or a "C" on this scale, but stable and sustainable growth is exactly what we want.

UPDATE: See the comments for an addendum about per capita GDP.

UPDATE: David Tufte responds by calculating presidential GPAs. For fun, try to guess Clinton's and Bush's GPAs before clicking over!

From the Wall Street Journal:

The Commerce Department reported Wednesday that gross domestic product, the broadest measure of U.S. economic activity, grew at a seasonally adjusted annual rate of 4.3% in July through September. That was stronger than the 3.8% rate of growth seen in an earlier estimate of GDP issued a month ago, and was the best showing since an identical 4.3% gain in the first quarter of 2004.

Also,

Real final sales of domestic product, which is GDP less the change in private inventories, advanced at a 4.7% annual rate in the third quarter, above the originally estimated rate of 4.4% while below the second-quarter's 5.6% growth.

Read the report from the BEA.

Consumer and business spending was higher than originally estimated. The PCE and GDP deflator were revised down a tenth of a percent each (and that's including food and energy, in case you're interested).

Bloomberg also has the story. Here's a sampling:

``The economy is booming,'' said Mike Englund, chief economist at Action Economics LLC in Boulder, Colorado. Englund correctly forecast third-quarter growth. ``As much as people may have been concerned about gas prices, consumers took the hit and now gas prices are falling.''

and...

Manufacturing in the Chicago area expanded for a third straight month in November, the National Association of Purchasing Management-Chicago said today. The group's index, based on a survey of executives in the region, fell to 61.7 from October's 62.9. Readings higher than 50 signal growth and the November figure exceeded the 60.5 average for this year. A measure of orders backlogs was the highest since July 1994.

Hard to put a dismal face on that data.

Treasury Secretary John Snow heralded the GDP report as ``very good news for American workers and those looking for jobs,'' even as a recent poll showed many Americans still perceive the economy as weak. A survey released Nov. 28 by the Manchester, New Hampshire-based American Research Group found that 43 percent of those questioned said the economy was in a recession, while 44 percent said it wasn't.

OK. Believe me. Despite my usual attempts to be optimistic, I'm aware of all of the reasons to be pessimistic. The yield curve is flat and job growth has been sluggish, and so on. But 43% of people thinking the economy is in recession? Half of those surveyed who have an opinion at all? Seems a little high, don't you think?

If yesterday's news was "pretty good", today's news is "quite good," I would say.

UPDATE: James Hamilton (Econbrowser) notices improvement in the economy and says,

Putting it all together, what are this month's data telling us? Overall, the numbers are better than expected, so whatever your take on the economy was at the start of the month, you should be a little more optimistic about things now.

And he says it with "emoticons", so be sure to check it out.

UPDATE 2: General Glut is back! He laments the sorry state of personal savings in his post.

UPDATE 3: I said the report is "quite good," others say it's "perfect." Let's not get carried away.

Plenty of good headlines, but does the good news run deeper? From the NY Times:

Sales of new homes surged to a record in October, the government reported today, bucking recent reports of a slowdown in the roaring housing market.

New home sales jumped 13 percent last month, to an annual pace of 1.42 million, and selling prices increased modestly, the Commerce Department said. The report comes a day after the National Association of Realtors said existing home sales fell 2.7 percent last month and inventories rose to their highest levels in more than two years.

Calculated Risk, as always, has even more on the housing picture. Let's just say he is encouraged. Back to the Times article:

New home sales, which account for about 15 percent of the overall housing market, tend to increase and decrease more erratically from month to month than the far bigger base of existing home sales. Also, the Commerce Department records sales when contracts are signed, rather than when transactions are closed as the Realtors association does for existing home sales.

...

In other economic news, the Conference Board said that its consumer confidence index surged by 13.7 points, to 98.8, after falling for the previous two months. It credited an improving job outlook and falling gasoline prices, which at an average of $2.16 a gallon are below where they were before Hurricane Katrina struck New Orleans.

"While the index remains below its pre-Katrina levels, the shock of the hurricanes and subsequent leap in gas prices has begun wearing off just in time for the holiday season," Lynn Franco, the board's director of consumer research, said in a statement.

Good news, but hard to interpret. Katrina made mincemeat out of consumer confidence. It had to come up, but predicting how much and when is probably best left to a roll of the dice. Give me a couple more data points post-Katrina, then we'll talk.

American manufacturers, particularly aircraft makers, also appear to be in better spirits.

The Commerce Department said today that orders for durable goods - or products that last for more than three years - surged by 3.4 percent last month after falling by 2 percent in September. Economists had been expecting an increase of 1.6 percent, according to a survey by Bloomberg News.

Orders for defense aircraft and parts more than doubled to $7 billion in October, after falling by 2.7 percent in September. Commercial plane orders saw a dramatic 50.4 percent increase, to $11 billion, after dropping by 41.5 percent the month before. Some of the rise was related to the end of a machinists' strike, which hurt production at Boeing in September.

Excluding the transportation sector, however, orders rose just 0.3 percent, far slower than the 1 percent increase forecast by analysts. Orders excluding transportation dropped 0.2 percent in September, a figure the Commerce Department revised today from the 1 percent decline it had reported earlier.

So the slow 0.3% gain may not be as bad in light of the revision of the September data.

All in all, there's nothing that makes me jump up and down, but nothing to make me hang my head either.

UPDATE: Barry Ritholtz is not impressed by the new home sales data. To be fair, the article did point out that new home sales make up a smaller percentage of the real estate market and are notoriously variable. When looking for quotes to pull from the article, I wanted to make sure that I got that in. What the article did say was enough to make me a little skeptical (hence, my opening sentence). But Ritholtz really digs in. Go read what he has to say.

I was remiss in not commenting on this last week. From Everyone's Illusion (a blog with the rather hawkish tagline: "Inflation: Everyone's Illusion of Wealth") comes this news:

Aside from GM being downgraded two notches to B1 today (something for another time but needless to say this company will not be around much longer), there was other bad news for the auto industry. Total auto sales plummeted in October as the end of “employee discounts” cause consumers to stay home. Sales fell from 16.4million to 14.7million which was the weakest pace since mid 1998. There are two interesting consequences from this, first consumers are unwilling to accept any inflation in auto prices, and perhaps fears about core-CPI increases are a little overblown. Second real PCE is likely to be negative in October.

If real PCE falls in October it will be the third straight month of real PCE shrinkage. The last time this happened was the 1991 recession....

...

With demand falling, how much longer will the Fed increase rates. As I said earlier today 4.50% seems like a lock, but it looks like that will be an overshoot as opposed to neutral.

File this away. We might want to come back to it later.

James Hamilton (Econbrowser) has more.

And how bad is the bad news? Let's take the good news first. Via Reuters:

WASHINGTON (Reuters) - Business productivity surged in the third quarter, far outpacing Wall Street forecasts, and an unexpected decline in labor costs helped ease inflation worries.

Non-farm productivity, or worker output per hour, grew at a 4.1 percent annual rate from July to September and second-quarter gains were revised higher to 2.1 percent, the Labor Department said in a report on Thursday.

Wall Street had expected productivity to rise at a 2.5 percent pace after a previously estimated 1.8 percent second-quarter advance.

The gain in productivity "reinforces confidence that the underlying sustainable rate of increase in productivity is solidly 2.5 percent or more and that has been the premise of the Fed's willingness to raise rates in only a measured, moderate way," said Pierre Ellis, senior economist, Decision Economics in New York.

That's good news. If you look at the last few years of data, we've been averaging around 3 to 4% since the 2001 recession. This is on the high side of average, and that's a decent spot to be.

But there's more...

Unit labor costs -- a key profit pressure gauge -- also defied analyst expectations by declining at an annual rate of 0.5 percent in the third quarter.

Economists, which had forecast a 2 percent gain in unit labor costs, said the report could ease worries at the Federal Reserve about creeping inflation.

"Come the Fed meetings around April, May, June next year, this may have an impact," said Tim Mazanec, senior currency strategist at Investors Bank & Trust in Boston.

"If unit labor costs are not increasing as much as we initially expected, that would get the Fed to pause (rate hikes) sooner than expected," Mazanec said.

The Fed watches productivity data for signs of how companies cope with rising costs, including expensive energy. Rising productivity and low labor costs gives companies a chance to hold prices down.

So is this good news, bad news, or both? Both. The very slow growth of unit labor costs mentioned here is supporting evidence of the widely reported sluggish growth of real wages in this recovery. If you're new to the issue, start with this post by Brad DeLong. Back in June, DeLong said,

When real wages start rising faster than trend productivity growth, it's a sign that inflationary pressures are or are about to start building. It's a sign that--as long as the Fed wishes to maintain its credibility as the guardian of effective price stability--it isn't going to be able to let employment grow rapidly for much longer.

So if I were to cheer at receiving news of disappointing real wage performance, it would be because I thought it told me that the natural rate of unemployment was lower than I had thought, and that the economy had more room to boom than I had thought.

Of course, bond traders don't think that far: they cheer at falling real wages and rising unemployment because the Fed's response to them is to cut interest rates and so elevate bond prices, and they are long bonds.

My minor quibble with the semantics of that post is that in the present environment it's less about cutting interest rates and more about the timing of the peak. That is, does this news make it more likely that the Fed will pause or stop the rate hikes in January? March?

Well, in what can only be described as a fit of rationality, the bond market is (at 11:18CST) essentially unchanged, even down a bit. In other words, aside from a tiny little blip right after the report came out, the news probably didn't much change the bond market's assessment of where the Fed is going. I concur--at least for now. By that I mean that I don't think this one data point will change much. It will take a couple more before the Fed declares victory. Think spring.

In the meantime, wages continue to grow slowly, and lose ground quickly to rising (relative) prices in the energy, healthcare, and higher education markets. The Fed can't do much to fight rising relative prices, but they certainly don't want to accommodate them with easy money either. That would only compound our problems. The result is pretty much what we're getting--bad news with the good--a consequence of having more objectives than tools to attain those objectives.

UPDATE: It might not have been a "fit of rationality" in the bond market. They might have simply been responding to this. And of course you know when I say "fit of rationality" my tounge is firmly in my cheek! I find the small scale almost daily overreactions in the bond market amusing but mostly harmless.

Click here for the full news release from the BEA.

Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 3.8 percent in the third quarter of 2005, according to advance estimates released by the Bureau of Economic Analysis. In the second quarter, real GDP increased 3.3 percent.

...

The major contributors to the increase in real GDP in the third quarter were personal consumption expenditures (PCE), equipment and software, federal government spending, and residential fixed
investment. The contributions of these components were partly offset by a negative contribution from private inventory investment.

The acceleration in real GDP growth in the third quarter primarily reflected a smaller decrease in private inventory investment and accelerations in PCE and in federal government spending that were partly offset by decelerations in exports, in residential fixed investment, and in state and local government spending.

Final sales of computers contributed 0.11 percentage point to the third-quarter growth in real GDP after contributing 0.32 percentage point to the second-quarter growth. Motor vehicle output contributed 0.48 percentage point to the third-quarter growth in real GDP after subtracting 0.01 percentage point from the second-quarter growth.

The price index for gross domestic purchases, which measures prices paid by U.S. residents, increased 4.0 percent in the third quarter, compared with an increase of 3.3 percent in the second. Excluding food and energy prices, the price index for gross domestic purchases increased 2.2 percent in the third quarter, compared with an increase of 2.1 percent in the second.

...

Real personal consumption expenditures increased 3.9 percent in the third quarter, compared with an increase of 3.4 percent in the second. Durable goods purchases increased 10.8 percent, compared with an increase of 7.9 percent. Nondurable goods purchases increased 2.6 percent, compared with an increase of 3.6 percent. Services expenditures increased 3.2 percent, compared with an increase of 2.3 percent.

Real nonresidential fixed investment increased 6.2 percent in the third quarter, compared with an increase of 8.8 percent in the second. Nonresidential structures decreased 1.4 percent, in contrast to an increase of 2.7 percent. Equipment and software increased 8.9 percent, compared with an increase of 10.9 percent. Real residential fixed investment increased 4.8 percent, compared with an increase of 10.8 percent.

The NY Times has a story as well.

More later... off to class.

UPDATE: One of the stories related to 2nd quarter GDP was the strong growth in final sales. That number was buoyed by a drawing down of inventories. Well, real final sales of domestic product increased by 4.4% in the 3rd quarter, which isn't that bad either. The change in inventories subtracted about 0.55% from 3rd quarter growth. In other words, firms are still drawing down inventories as sales growth leads GDP growth. Consumer demand continues to be the economies strength (like we didn't know that already). Investment (nonresidential fixed) increased by less than in the 2nd quarter, and we know from many other sources that residential investment may be slowing. The net export sector was basically flat compared to the 2nd quarter, which is good when you consider how much net exports grew in the 2nd quarter. (We didn't give any of it back in the 3rd.)

All in all, not a bad report. This is the 10th quarter in a row where real GDP growth has exceeded 3%.

Inflation is starting to show up in the GDP deflator, however. The rate hikes are not over, not by a long shot.

UPDATE 2: David Tufte (voluntaryXchange) gives it a letter grade of "B". Mark Thoma (Economist's View) has more links. Kash (Angry Bear) also weighs in.

UPDATE 3: King Banaian (SCSU Scholars) mentions the slowing growth of personal income and expects that production will pick up in the next two quarters as rebuilding begins in earnest in the hurricane affected areas.

Kash at Angry Bear discusses the disconnect between the core and the headline numbers.

...individuals are finding that the purchasing power of their paychecks have been sharply eroded, as the price for the average bundle of goods that they buy has risen by nearly 5% over the past year. If workers can successfully demand higher nominal wages to compensate for this loss in purchasing power, then we might start to see nominal wages rising faster.... However, this depends crucially on the ability of workers to extract wage increases from their employers, which in turn depends largely on the strength of the labor market.

FYI, here's a 10 year series on year-on-year earnings growth from the BLS (not adjusted for inflation).

UPDATE: David Altig (macroblog) responds to Kash:

I don't have a lot to quarrel with in that assessment, but I think I would avoid phrases like "depends largely on the strength of the labor market." As we know, rising wages are not inflationary as long as unit labor costs are not rising -- that is, as long as higher wages are being driven by advances in labor productivity. A perfectly strong labor market is wholly consistent with perfectly stable prices.

I am away from my access to the dusty old FOMC transcripts at the moment, but my recollection from the record of the early 1970s was that Arthur Burns on several occasions pronounced that it was just not reasonable to expect inflation to persist because labor markets were so weak. History, I believe, revealed that as not such a good call. The reason it was not, in my opinion, is because it neglected the fact that inflation was, and still is, primarily a monetary phenomenon.

The issue really is not weak or strong labor markets. It does not take falling real wages to generate a decline in the inflation trend. What matters is the inflation psychology of the moment. The dreaded wage-price spiral can arise because workers and businesses alike believe that individual nominal wages and prices can be increased simply because all other wages and prices are changing. And they can come to those beliefs if they are convinced that the central bank will make it so. In this case rising wages are a symptom of the problem, not a cause.

He's entirely right that labor market slack, or lack thereof, is not the whole story. Productivity is critical as are inflation expectations and the perceived level of the central bank's commitment to inflation fighting. According to the BLS, productivity growth was 3.4% for 2004 (the lowest since the recession year of 2001). In the first two quarters of 2005, productivity growth was 3.2% and 1.8% respectively. I hope that this is a temporary setback and that we're not heading into an extended productivity slowdown reminiscent of the late 1970s. In just a few days (November 3) we'll get our first look at 3rd quarter productivity. In light of this discussion, I'm sure the usual suspects will be all over it, and I'll reserve additional comment or speculation on the future direction of productivity growth until then.

Labor market slack is still relevant to the matter at hand, but if a supply shock causes wage growth to exceed productivity growth, that would test the Fed's inflation fighting resolve--with or without slack. In fact, a central bank might even be more tempted to ease up on the price stability goal if there was slack. (I think that is Altig's point about Burns in the 1970s.)

It's too early to say if a process like this has begun. Such things are more apparent after the fact. However it is appropriate, I think, to have it on the radar at this point. And because it is on my radar, I'm really anticipating the November 3rd productivity release.

From the BLS:

The Consumer Price Index for All Urban Consumers (CPI-U) increased 1.2 percent in September, before seasonal adjustment, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. The September level of 198.8 (1982-84=100) was 4.7 percent higher than in September 2004.

Further down in the report we find that the SAAR of CPI-U inflation for the first 9 months of 2005 is 5.1%. These are some of the highest inflation readings in about 15 years.

And the NY Times chimes in...

The inflation figures were the first, and perhaps most closely followed, slate of economic reports released today that showed retail sales rising at a moderate pace after sliding in August, consumer confidence dropping for the third month in a row, and industrial production declining as the two hurricanes and a strike at Boeing idled assembly lines, oil rigs, chemical plants and refineries.

The Commerce Department reported that retail sales increased by 0.2 percent in September, slower than the 0.5 percent gain may economists had expected. Sales had fallen by 2.1 percent in August, as big discounts by Detroit's big three automakers wound down.

Retail sales in September were also depressed by the end of heavy discounting by the domestic automakers; excluding cars, sales rose 1.1 percent. But last month's sales figures were also skewed by a sharp increase in the dollar value of gasoline purchases as prices at the pump soared past $3 a gallon in many parts of the country. Excluding both cars and gasoline, retail sales rose by 0.6 percent last month.

Reuters reports on the consumer confidence numbers...

NEW YORK (Reuters) - U.S. consumer sentiment fell unexpectedly in early October to its lowest level in 13 years, as high gasoline prices and the fallout from hurricane damage continued to take their toll, a report showed on Friday.

The University of Michigan's preliminary October index of consumer sentiment fell to 75.4, according to sources who saw the subscription-only report. That was below a final September reading of 76.9 and much below Wall Street's median forecast of an increase to 80.0.

"We were anticipating that we could see a little bit of an improvement in October because the rebuilding after the hurricanes appears to have started and energy prices have stabilized, but it appears that it will take a little longer for consumers to feel better about things," said Gary Thayer, chief economist at A.G. Edwards and Sons in St. Louis, Missouri.

The survey's expectations component eased to 62.4 from 63.3, also defying Wall Street forecasts for an increase to 67.0. The early October expectations reading was the lowest since March 1992.

I doubt that rebuilding is making much of an impact yet. Gas prices are coming down in some areas (IN-FORUM article-registration required). If that is to help at all, it might start kicking in next month.

Oh, and in the bond market, the 10 year is down 5/32 pushing the yield to 4.48%.

Once again, the Fed is in a tough spot, but clearly all of the recent talk from Fed officials has been that they are worried about inflation and will pursue a course of action designed to contain inflation. All along the word has been that the policy would be data-dependent. My guess is that the inflation figures will weigh more heavily on their deliberations. The consumer confidence numbers will improve if energy prices stay contained and as the hurricanes fade from memory (or at least fade away from the forefront of national consciousness). I don't think that the Fed would weaken its stance on inflation based on the consumer confidence survey.

Months ago, I would have anticipated a pause in the rate hikes by years end. As inflation has ticked up over those months, I have been revising my priors every now and then. Another data-point and another revision in my probabilities. A pause in the rate hikes by the end of the year seems almost out of the question unless something out of the ordinary happens. Then it will depend on data from the next few months and perhaps on who is selected to replace Chairman Greenspan. As long as inflation is creeping up, the rate hikes will continue, perhaps into March before we get a break.

Not a hard landing yet, but we are experiencing some turbulence. We're leaning hard against the wind, but the wind is picking up. It's an uncomfortable situation, to say the least.

Via macroblog:

When weighted by their expenditure shares in the market basket used to construct the CPI, the majority of price increases were far less than the average increase. Over 50 percent of the weighted price gains were less than 3 percent (when annualized). Nearly twenty percent actually fell.

You might say that this is all fine and good, but you happen to actually purchase the average market basket, and the price of that went up by a full 1/2 percent in one month. In other words, your cost of living rose, and stripping out those prices that increased a lot does not make you feel one bit better.

Hey -- that's a good point, and one that moves us in the direction of discussing what monetary policy ought to be trying to accomplish. Should we be content with managing the rate of inflation going forward? If so, the core measures seem exactly the thing to be focused on, as they likely provide a more accurate picture of the inflation trend. But there is no guarantee that such a let-bygones-be-bygones approach will undo the effects of large one-off increases in some price or subset of prices, even in the medium term. In other words, there is no guarantee that focusing on core inflation will stabilize the cost-of-living over horizons that people may care about.

Monetary policy is a very blunt instrument for dealing with changes in relative prices, especially in the short run. In the long run, if higher energy prices (which raise the cost of production) are passed through to all goods, that blunt instrument can be useful.

The question can be restated, at what point in the short-to-medium run do you bring down the hammer?

Read the BLS press release here.

The two numbers everyone is looking for are the headline inflation rate (all urban consumers) and the core rate (excluding food and energy). The headline rate was the same as in July, up 0.5% for the month of August. Excluding food and energy, the CPI was up 0.1% in August, also the same increase as in July. In the previous 12 months, the headline rate is up 3.6%. Excluding food and energy takes it down to 2.1%.

Transportation was up 2.2% in August, due to higher fuel costs. Energy was up 5.0% in August and 20.2% in the last 12 months.

Reuters is reporting "Treasuries tick up on tamer-than expected core CPI"

NEW YORK, Sept 15 (Reuters) - U.S. Treasury debt prices ticked higher on Thursday on tamer-than-expected core consumer inflation data in August, suggesting that, at least before Hurricane Katrina, the Federal Reserve could still raise rates at a moderate pace.

But post-Katrina data showing a bigger-than-expected jump in weekly first-time jobless claims, also added to buying in the bond market.

The U.S. government said the core consumer price index, which excludes food and energy prices, ticked up 0.1 percent in August, compared with economists' expectations of a 0.2 percent increase and a July's 0.1 percent rise.

The government also said jobless claims rose to 398,000 in the week ended Sept. 10 -- above the 350,000 economists expected and the upwardly revised 327,000 in the prior week.

Tamer than expected, perhaps. But energy price increases are starting to be passed through. Transportation is hit first and most obviously. It will be interesting to see how the media reports on this. Just glancing around some news sites it appears that most are accentuating the "tamer than expected" story.

UPDATE: Econbrowser, macroblog, and The Big Picture continue the discussion.

Historical Statistics of the United States Colonial Times to 1970 is on the web.

What wonderful times in which we live.

I don't need to tell you that there's been a little dust-up recently concerning the health of the labor market. See Mark Thoma's latest post, for example. Economist (and non-economist) blogs are resounding with shouts of optimism and wails of pessimism.

I've been called a "bad news bear" and been accused of jumping up and down (as if with glee, I suppose). In truth, I tend towards being optimistic when it comes to the macroeconomy, but my tendency for optimism is always tempered by the data. In macroeconomics, data is paramount. But the data does not always speak with a clear voice. Macro data also has the disadvantage of being at a lower frequency than, say, financial data. So you get a bad payroll report and it wears on you for a month. Comes with the territory.

But if you get enough recent data to allow you to compare it to other time periods, things are a little better. Much of the recent debate has centered on economic growth, labor market recovery, and inflation compared to the recovery after the 1990-91 recession. I've tossed in my two cents. Today, I will let the data speak.

To begin with, I took HP filtered (log) real GDP and found the quarter of maximum deviation below trend. For the 1990-91 recession, that was the 4th quarter of 1991 (two quarters after the NBER recession end date). For the most recent recssion, it was the 1st quarter of 2003 (more than a year after the NBER recession date). I would attribute the difference to the fact that the transition both into and out of the most recent recession was more gradual than in 1990-91. Why? That is an open question.

Next, I plotted payroll job growth and core CPI inflation starting from that point of maximum deviation from trend real GDP (October 1991 and January 2003). Here's payroll employment growth:

To make things a little clearer, I took a 3 month moving average centered on the observation.

Oddly, there is a spike in payroll growth about a year and a half after the maximum negative deviation of real GDP from trend. It is pretty clear, however, that the current recovery has been consistently lagging the previous one. And unless things really pick up in a hurry, the cries of those who are more pessimistic are going to get louder. If the job market hums along at 200,000 new jobs per month, that will seem paltry compared to the job growth in 1994.

Please note, however, that the Fed waited longer after that maximum negative deviation of trend real GDP to pull the trigger on interest rates. Indeed, rates were still falling in 1992. All my students should know that this should have led to a faster recovery in 1991 and beyond. (Of course, the Fed's job in the last recession was complicated by the fact that interest rates got so low that we were worried that they might run out of ammunition.)

The fact that rates were still falling in 1992 and didn't start to rise until 1994 should have also meant that inflation would have started to bubble up a bit sooner. The next chart bears this out.

The data is the CPI excluding food and energy taken from FRED and last updated 7-14-2005. For clarity, I only show the 3 month moving average as you can see the trends more easily. After taking the moving average, I converted it to an annual rate for ease in interpretation.

This too, pretty much speaks for itself. Core inflation was very low at the start of 2003, but by the time the Fed started raising interst rates it had climbed. But we are still in a better position than in 1994-95. All in all, not too bad a job of sticking to the mandate of price stability.

On the dual mandates of price stability and full employment, the picture is mixed. Some would say the Fed should have a single mandate of price stability, but that's not the way their mandate reads at present. The real test will be to see if the steady growth we have seen (note: I use the word steady, not booming) will be sustained. If the timing of a soft patch is similar to the timing of the last one, it could still be in the future. I do believe that it can be avoided. It would appear to this observer that the Fed has made a real effort to avoid the mini-boom and mini-bust nature of the last recovery. Does no mini-boom mean no mini-bust? Time will tell.

But the pictures do help put it into perspective.

UPDATE: A misprint in the CPI graph was corrected. The first series starts in October 1991.

One more thing. Most comparisons of the labor market recovery to that after past recessions use the NBER recession end dates. The reason I chose not to use those dates (and use the date of maximum negative devation of real GDP from trend) was to try to allow for the fact that the last recession was more shallow and the below trend growth lasted longer. I was trying to see if the job recovery was delayed by a similar length of time. Not quite, but it might be useful to think about the reasons for the recession being shallow and the deviation from trend lasting longer as at least partially driving the "weak" labor market recovery.

Most of today's BLS news release was pretty lukewarm. The unemployment rate was unchanged. Payroll employment up just over 200,000--which is on the short side of being just enough to hold our own with population growth. The employment/population ratio was up 0.1% to 62.8% (which PGL notes as being a sign that things are slowly improving).

I noticed one thing that might have slipped by. Check out page 13 of the pdf version of the news release. (N.B. It's not archived yet, so this link will be current for only a month. I'll try to remember to update the link when it is archived.) Notice the breakdown of unemployment as a percent of the labor force. "Job losers and persons who completed temporary jobs" went down from 2.5% to 2.4%. "Reentrants" went up from 1.5% to 1.6%. "New entrants" and "job leavers" are unchanged. This is positive news. The unemployment rate was unchanged for the month but the makeup of the unemployed pool of workers changed. A larger number of the unemployed are reentrants to the work force and a smaller number are the job lowers and persons who completed temporary jobs. In fact, when you look at the seasonally adjusted numbers right above this on the page, you will see that this represents the smallest number of people who are unemployed but not on temporary layoff since September 2001 and has been consistently falling for about two years. The number of reentrants has been a little more stable, but is at the highest it has been since February 2005.

Also, the mean duration of unemployment is down 2 weeks since April (from 19.6 to 17.6 weeks). The median duration is down from 9.3 weeks to 9.0 weeks since March.

These facts do not come out in the headline numbers, but they are indications that things are still moving in the right direction, slowly but surely.

See also: Economist's View and Big Picture. I'm sure the list of those commenting on the numbers will grow.

The numbers are in. Real GDP was up 3.4% in the 2nd quarter. This is on the heels of 3.8% growth in the first quarter.

That's not stellar, but it's not bad either. It is well within the sustainable range and shouldn't fuel inflation fears all that much. But King at SCSU Scholars finds the news that others might miss.

The markets are soft today after the GDP report came in with 3.4% growth. But buried in the report itself is good news.

The real change in private inventories subtracted 2.32 percentage points from the second-quarter change in real GDP after adding 0.29 percentage point to the first-quarter change. Private businesses reduced inventories $6.4 billion in the second quarter, following increases of $58.2 billion in the first quarter and $50.1 billion in the fourth.

Real final sales of domestic product -- GDP less change in private inventories -- increased 5.8 percent in the second quarter, compared with an increase of 3.5 percent in the first.

As my dad would say, "in English, please?" It means that in real terms, businesses who had stockpiled lots of inventory over the previous six months sold it all off in the previous quarter. It seems unlikely that they would continue to disgorge inventories (already at the 1.3 benchmark as a ratio to sales), so production should pick up again in the next quarter. A 5.8% growth of final sales is the best since the second quarter of 2003.

This report also showed a turnaround in net exports, with imports decreasing 2% in the quarter. This and the Chinese repeg of the yuan might mark the end of that drain on GDP growth going forward.

Yep. The market may have yawned, but it really was pretty good news when you dig beyond the headline. PGL of Angry Bear saw it too... and he seems a little less bearish today.

As one that has been hoping for a reversal of the bad news that we saw for export and investment demand, however, I see some good news in these numbers. Export demand growth was reported at 12.6% per year and imports fell. Fixed investment growth was reported at 9.3% with both business fixed investment and residential investment reporting strong growth rates.

Final sales of domestic product grew at a 5.8% annualized rate with the difference between growth in sales and the growth in production coming from a “negative contribution from private inventory investment”. Could this news be a harbinger of an export and investment led recovery, which would might increase the employment to population ratio to 63% by year end? One can only hope!

It is, of course, too early to say if this is a "soft landing." That's a call that I think we might be able to make about a year from now with some air of certainty. But today's news is consistent with a soft landing scenario. Next week we'll get some more labor market numbers and we'll see if we're making any more progress on that e/p ratio.

Finally, I'll throw in this from CNN:

Manufacturing in the Midwest region continued to expand in July, according to the release of the Chicago PMI, shortly after the start of trading. The index rose to 63.5 from 53.6 in June, topping forecasts for a rise to 55.5.

UPDATE: Tim Duy and James Hamilton weigh in as well. Note also that this is the 9th straight quarter of greater than 3% real GDP growth. I was in 7th grade the last time that happened.

PGL (Angry Bear) and I brought it to you earlier. (UPDATE: I should have also mentioned James Hamilton, General Glut, and Brad DeLong. I've probably missed others.) Now, Paul Krugman chimes in.

Many seemingly authoritative figures, not all of them partisan shills, say that the American economy has fully recovered from the recession that began in 2001. They point to the unemployment rate, which has fallen from a peak of 6.3 percent in 2003 to 5 percent last month. That's not quite as low as the 4.2 percent unemployment rate in February 2001, when the recession began, but it's fairly low by historical standards.

For some reason, however, the public isn't feeling prosperous. Gallup tells us that only 3 percent of Americans describe the economy as "excellent," and only 33 percent describe it as "good."

Maybe people are just ungrateful. Maybe they've been misled by negative media reports. Maybe they're grumpy about their paychecks: adjusted for inflation, average weekly earnings have been flat for the past five years.

Or maybe the figures on unemployment are giving a false signal.

Economists who argue that there's something wrong with the unemployment numbers are buzzing about a new study by Katharine Bradbury, an economist at the Federal Reserve Bank of Boston, which suggests that millions of Americans who should be in the labor force aren't. "The addition of these hypothetical participants," she writes, "would raise the unemployment rate by one to three-plus percentage points."

Allow me to point you to Bradbury's paper. There's a little more worth reading than just what Krugman quotes. Go on... read it! Interesting charts as well.

Some observations after reading it.

1. Women's LFPR has been climbing steadily for many years but appears to have topped out. That makes comparisons with the past difficult and comparisons with men's LFPR more relevant. These comparisons are in the study as well, but not in the charts. The charts for the women could be misleading in light of this.

2. Both men and women 55+ have seen large gains in LFPR lately. They were effectively unscathed in the recent recession. Part of this is, as the study points out, due to a "pig in the python" effect of baby boomers hitting 55 and lowering the average age of the 55+ cohort, but I suspect there's more.

3. Men's LFPR appears to be in a long term decline. If that continues and if women's LFPR levels off, what are the implications?

4. The declines in LFPR across the board seemed to begin before the recession started. According to Bradbury's chart, the women's LFPR looks like it topped out in the late 1990s.

The study raises some interesting questions in addition to the ones that have already been asked. Though I'm less worried than PGL about this, I do agree that it bears watching.

PGL at Angry Bear recently commented on the lack of a rebound in the employment to population ratio (henceforth in this post: e/p) during the current recovery.

Fortunately, we saw some improvement in the labor market this month, which showed up in higher EP and LF ratios. I’m on record for praying for a return to the days of having employment being 64% of the adult population. Let’s suppose some forecaster tells us his macroeconomic model predicts a 4.5% unemployment rate by the end of 2006. I’m sure some Administration apologists will go giddy with glee, but I’m going to look at the details as to what the forecaster is saying about the labor force participation rate. If the forecast is for LF = 67% so EP = 64%, I’ll join in the glee. But if the forecast is for LF = 66% so EP = 63%, I’ll continue to argue we should hold to higher standards before we declare full employment.

Right now, total e/p is at 62.6%. It was around 64% before the recession (hence PGL's comment) and bottomed out around 62%. But let's go behind the total number and break it down as the BLS does. (All data is available on the BLS site.)

My series starts before the 1990-91 recession for some additional historical perspective. Some things should pop out at you. The decline in e/p for males 20 and over was similar in both cycles. In the '90s the ratio never quite made it back to its level before the 1990-91 recession. Hence, the trough was a little lower. The recovery does not seem altogether much worse than after the last recession, though it is a little early. The ratio didn't make it back up to 73% until nearly 1995 after the last recession. Demographics will start working against us on this series very soon as well if some baby boomers start to retire early. Whether the e/p ratio can attain the level at its last peak is a serious question, just as valid today as in 1995. Like PGL, I would like e/p to get back to something more akin to full employment, but I also think there should be research into what that level is for the demographics.

For women age 20 and over, the picture is not quite as bright, and it is a very different picture indeed. The e/p ratio fell only slightly in the last 1990-91 recession and then quickly returned to its former pace as women continued to enter the workforce during the '90s at a rapid pace. After falling nearly 2% in this recession, it has stabilized at just over 57%. For reference, this is about the level of early 1997. The speed with which the ratio will return to its previous level depends on what kind of continued gains in e/p women would be expected to see in a full employment economy and the elasticity of labor supply. Those, too, are interesting questions that could be pursued.

And so we come to the real story behind the story. Both sexes ages 16 to 19. Their e/p ratio practically fell off the chart in this recession and has not started to recover at all. The reasons for this are many, but the CBO (who I do not categorize as apologists for the administration) seems to have found one factor. Men and women ages 16 to 19 as well as those 20 to 24 are more likely to stay in school than even just a few years ago--enough to make a difference. This fact does not explain everything. Employment rates are lower even among non-students. This could be due to increased competition from unskilled immigrants, among other things, according to the CBO. The entire report, published in November of last year, is worth reading--too much to summarize effectively in a single post. But the comments are open to anyone who wants to read the report and talk about it.

While you're at the CBO, check out these titles which are apropos to the topic at hand.

Disability and Retirement: The Early Exit of Baby Boomers from the Labor Force

CBO Projections of the Labor Force

UPDATE: PGL responds at Angry Bear an in the comments to this post. A commenter at Angry Bear remarks that job prospects drive schooling. Hence, the increase in enrollment is not something to celebrate. True, there is a cyclical component that I think can be seen quite clearly in the more dramatic response in e/p in both of the last two recessions. As with the males over 20, the cyclical declines in the series are very similar in the two recessions. But what explains the fact that teenage e/p failed to reach its pre 1990 peak during the late 1990s? School enrollment seems a good place to start.

Another commenter here claims that minimum wage increases also contribute to what we are seeing here. It's hard to separate the effect of the recession and the coincident increase in the minimum wage in the early 1990s. However, the minimum wage increase in 1996 and 1997 where the chart does show a little weakness. There were two separate increases in the minimum wage, and the timing works well for one but not the other in the chart. Thus, I'm hesitant to pin an inordinate amount of significance to it, but I'm willing to accept it as a possibility, especially for late 1996 and early 1997 where it probably did have some effect on keeping teenage e/p from rising more rapidly.

The fact that students may stay in school longer when job prospects are poor does not invalidate my point that the e/p ratio may decline over time due to a combination of a long run trend towards more schooling and the demographics of an aging population.

UPDATE PART TWO: Bob Herbert laments "The Young and the Jobless."

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.