Archive for the ‘inflation’ Category

Dammit Janet, I love you!*

9 October 2013

I am very pleased with the president’s nomination of Janet Yellen to be the next Federal Reserve Chair. Ms. Yellen has impeccable credentials, the best economic forecasting record of any recent Fed official, and appears to take the regulator part of the Fed Chair job seriously.

This last part is important. Larry Summers, the original front-runner for the job, helped push through the key deregulation of the late Clinton years, has dismissed the idea that it contributed to the bubble or crash, and has basically never admitted a mistake in this area. Alan Greenspan was essentially hostile to financial regulation, and bears as much responsibility as anyone for the housing bubble of the 2000s. Ben Bernanke has acknowledged that the Fed failed as a regulator during the housing bubble, but he was a Fed governor for most of that bubble and Chair for the last two years of it. Economist Bill Black finds Bernanke to have been sorely lacking as a regulator. The Fed’s main regulatory task is to try to detect and reduce systemic risk, i.e., risky activities that threaten the larger financial system and economy. Granted, Yellen told the Financial Crisis Inquiry Commission in 2010 that she failed to see several of those risks (securitization, credit rating agencies, Special Investment Vehicles) when she was San Francisco Fed President in 2004-2010, but on the other hand she was among the first at the Fed to publicly call attention to the housing bubble

Granted, monetary policy, not financial regulation, is the main part of the job. I agree with those who have said she will probably be very similar to Bernanke as far as that goes, and I’d call that a good thing. The Fed needs to do what it can to pull us out of this Little Depression, and since interest rates cannot fall below zero, additional measures like buying long-term bonds and mortgage-backed securities (i.e., quantitative easing, or QE) make sense, as long as they work. Yellen is often stereotyped as a “dove” because in recent years she favored expansionary policy and did not state that inflation was an imminent risk, but those recent years were the Little Depression that began in 2008. When unemployment is not the nation’s biggest problem, Yellen is more concerned about inflation. Such as in the roaring 1990s, when Yellen was Clinton’s Chair of the Council of Economic Advisers and then a Fed governor. With unemployment down to its lowest levels in decades, Yellen was an inflation “hawk,” as Matthew O’Brien details.

Whether the Senate is capable of that much nuance as it considers her nomination remains to be seen. I expect she’ll win majority support, including a handful of Republicans, and that Republicans will resist the temptation to filibuster her nomination. The right-leaning American Enterprise Institute offers several reasons why an anti-Yellen filibuster would be a disaster. Then again, flirting with disaster seems to be the Congressional Republicans’ game plan of late.

PS Here is a recent (Nov 2012) interview with Janet Yellen.

* Title stolen from EconoMonitor, who of course got it from Rocky Horror:

No taper, no problem

18 September 2013

The Federal Open Market Committee concluded one of its most anticipated meetings in a long time with the expected decision to keep its federal funds rate target near zero (0 – 0.25%) and, less expectedly, not to “taper,” i.e., announce that it would gradually reduce its monthly purchases of mortgage-backed securities and longer-term Treasury bonds. Those purchases are otherwise known as “quantitative easing” (QE).

From various market surveys and betting sites, it appeared that about half the market was expecting a taper. Just why is hard to figure. Excessive asset purchases by the Fed can be inflationary, but excessive is in the eye of the beholder, and inflation has been under, not over, the Fed’s target of 2%. There is the argument that these new and unusual QE policies are damaging to investor confidence, but they’re not that new anymore, and the investors in the stock market seem remarkably undamaged — the S&P 500 has more than doubled since early 2009, i.e., since shortly after the first round of QE was implemented. Then there is the opposite argument that QE has created a “sugar high” in the stock market and maybe the housing market, too. This last argument has to be taken seriously, in view of how the 2000s housing bubble was stoked in part by the Fed’s easy-money policies circa 2004, when economic recovery was well underway.

But not too seriously. The S&P 500 is only about 15% higher now than it was mid-2007; adjusting for inflation, it’s hardly any higher at all (and the jury’s still out over whether stocks, as opposed to housing, were a bubble in 2007). Moreover, corporate profits are at record highs, so the fundamentals look rather good. Home prices are rising fast, but they’re still at 2004 levels, and monthly mortgage payments are cheaper than rents. A true speculative bubble is when people are obviously overpaying for assets, especially when they do so knowingly, with the plan of selling to a greater sucker later on. Is there evidence of that here?

The evidence about the general state of the economy is much stronger, and the evidence is that it’s still pretty weak. In particular, employment — the indicator that the Fed is supposed to focus on, along with inflation — is dismal. The employment-to-population ratio is still under 76%, or 4 points below where it was before the crisis. (The graph below, by the way, is of the “prime-age” population, 25-54 year-olds; if it included 16-24 year-olds, it would look even worse.)


For more on unemployment and tape:



19 March 2012

Rising gas prices are on everyone’s mind again, as the price of oil has risen some 25% (about $25 per barrel) in the past year and the price of gasoline inches ever closer to $4 per gallon. While 1970s-style stagflation appears unlikely — the price of oil quadrupled in 1973-75, so even another 25% or 50% increase seems comparatively small, and industry has become less oil-intensive since then — the implications for the overall economy are still not good.

Alarmists often exaggerate the importance of oil prices on the economy — the bar for ridiculousness was set last week by Donald Trump, who said the 2008 financial crisis wasn’t about the banks but high gas prices — but here in today’s inbox is Nouriel Roubini, as credentialed a Cassandra as you could ever ask for, saying:

‘Today’s fragile global economy faces many risks: the risk of another flare-up of the eurozone crisis; the risk of a worse-than-expected slowdown in China; and the risk that economic recovery in the United States will fizzle (yet again). But no risk is more serious than that posed by a further spike in oil prices.

Roubini does not blame the 2008 crisis on oil, but he does say that the previous three world recessions were touched off by geopolitical shocks in the Middle East — the Arab oil embargo and 1973-75, the Iranian revolution and 1979-82, and Saddam Hussein’s invasion of Kuwait and 1990-91. He links the current rise in oil prices to fears that Israel will attack Iran, which may be developing nukes but definitely has lots of oil. He says oil supplies are currently plentiful and world demand remains weak, reflecting the weak economy, but that the fear factor is driving the increase. Some players along the supply chain may be hoarding oil in anticipation of higher prices caused by a disruption of Iran’s oil production. Many investors are buying futures contracts for oil at ever-higher prices, which will tend to raise the demand for oil now (since oil now and oil later are substitutes). The NYT has a fuller analysis.

Just how much of a drag on the economy would a spike in oil and gas prices be? First, just a small increase would put the price of gas over $4 a gallon, which would seem like a psychologically important “nominal anchor” (i.e., not many would notice if gas goes from $3.96 to $3.98, but if it goes from $3.98 to $4.00, alarm bells will sound). This would likely be a blow to consumer confidence, especially now that winter is ending and longer car trips are feasible. The price of gas is probably the most closely watched economic variable, more so than GDP or inflation or unemployment or even the Dow Jones average, so this negative effect could be large. Throw in the reduction in consumers’ real income and the increase in business costs, and how big a hurt does this put on real GDP? Jared Bernstein says the rules of thumb “say a $10 increase in a barrel of oil translates into about a quarter more per gallon at the pump, and, if it sticks, could shave 0.2% off of GDP growth.” Yet unlike Roubini he puts oil #2 on his list of threats to the recovery. #1 is fiscal drag, i.e., continuing government spending cuts in our already demand-starved economy. (Europe is his #3.)

So we might have already lost 0.2% in GDP growth, and the projected additional 20-25% increase in oil prices if Israel attacks Iran would mean about another 0.3%. Not enough to derail recovery, but enough to make it noticeably more anemic than it is already.

Is inflation on target? (corrected)

5 August 2011

The new BLS unemployment numbers (9.1% unemployment rate, 16.1% comprehensive unemployment rate, 117,000 new jobs created) are the talk of the morning. I don’t have much to add to it, but I’ll echo the oft-made point that job growth needs to be twice as fast for the next several years for unemployment to fall to normal levels. I’ll also note that the numbers are a bit better than those of a year ago, but a bit worse than those of March, when unemployment was 8.8%. So although the numbers are better than expected, they’re still underwhelming and we still might be in a double-dip recession.

Instead I want to focus on the other big economic variable. Inflation has been so low over the past few years — in the range of 1-2% — that Ben Bernanke and others have seemed more worried about deflation than inflation. At the same time, some Fed critics have charged that the Fed’s actions to backstop dodgy financial asset markets and flood the banks with new reserves will lead to a massive inflation after the slump is over or a stagflation (stagnant economy with high inflation) even sooner. Some numbers to remember: Inflation has averaged 3% a year over the past century, and close to that over the past few decades. The Fed’s unofficial target for inflation is 2%. What do the markets expect for the years to come?

A good way to answer that question is to compare the well-reported interest rates on regular Treasury bonds with the interest rates on “TIPS” — Treasury Inflation-Protected Securities. The payments on a TIPS bond are adjusted for whatever inflation occurs over the bond’s lifespan.  The inflation adjustment is trickier than I’d originally thought — instead of simply adding the inflation rate to the interest rate that arose from the bond’s auction, the interest rate stays the same but the bond’s principal rises, and the interest payments are based on the original interest rate times the new principal. (Ex.: Imagine a 1-year, $1000-face-value TIPS bond that sells at par, i.e., for $1000 and therefore has an interest rate of 0%. If inflation is 3% over the next year, then the principal rises 3% to $1030. The interest is still $0, but the overall yield on the bond is 3% ($30/$1000). That’s a simplified example. It’s more complicated if the interest rate isn’t 0%.) Because the arithmetic can get complicated, it’s easier to look up the “breakeven” rate, which is the inflation rate implied by the different on TIPS and ordinary T-bonds.

(Add to that a conceptual complication: Because the TIPS bond is less risky, since it’s indexed for inflation, it should be in somewhat greater demand than the regular T-bond. So, other things equal, it should command a higher price and pay a lower interest rate. With that in mind, the difference between the interest rates on regular T-bonds and TIPS bonds is roughly the expected inflation rate plus an inflation-risk premium, which reflects people’s uncertainty about future inflation.)

Comparing the interest rates for 5-year bonds last week (when this was originally posted), the  T-bonds paid 1.12% and the TIPS paid -0.67%. The implied inflation rate (1.80%, if my spreadsheet math is correct) is actually very close to the difference in the interest rates on the two bonds (1.79%). Apparently the market is expecting the Fed to be just shy of its 2% target over the next 5 years.

Looking at the 10-year bonds, the T-bonds paid 2.47% and the TIPS paid 0.24%. The 2.03-percentage-point difference is again a close approximation of the breakeven rate; my spreadsheet math yields an expected inflation rate of 2.22%, or slightly over the Fed’s target. Together the two breakeven rates imply that the market is expecting inflation to average about 2.6% in years 6 through 10. These numbers provide no guide to where they think that inflation is going to come from (recovery? shortages of gas or food? QE5?), but the weakness in the stock market suggests they’re not expecting a recovery anytime soon. It may just be that their flight to safety has gone into overdrive, and TIPS are in exceptionally heavy demand because they are even less risky than regular T-bonds. So possibly they’re expecting inflation rates of about 1% through 2016 and 2% in 2016-2021, with the remainder being a risk premium.

In sum, the Fed does seem to be hitting its inflation target, more or less, but that’s about all. Bondholders appear willing to lock in near-zero or negative real returns over the next five or ten years, just so they can hold a safe asset. Which suggests they’re scared shitless.

Fed up with Bernanke?

31 July 2011

Greg Mankiw has a good column in today’s NYT in defense of embattled Fed Chair Ben Bernanke. How embattled is Bernanke? Mankiw notes an (admittedly unscientific) online CNBC poll from June, in which the question was “Do you have confidence in the way Ben Bernanke is handling the economy?” 95% of respondents answered no.

Mankiw says the Fed has done basically all it can to combat the Little Depression (unfortunately “all it can” is not enough), while steering clear of high inflation. The core inflation rate in recent years has been just 2%, widely believed to the Fed’s unofficial target inflation rate. Mankiw suggests making that 2% target official, but otherwise sees no obvious room for improvement in Bernanke’s performance.

I tend to agree that Bernanke’s Fed has done about all that monetary policy can do here, but Scott Sumner, one of the more interesting monetary thinkers I’ve come across lately, says the Fed actually has a lot more ammunition in its arsenal and compares the situation to the early 1930s, when the Fed increased the monetary base but needed to do a lot more to stem the massive tide of bank failures and monetary collapse. Unfortunately, I’ve yet to find the specifics of his argument, but I’ll share them with you when I do.

Sumner, by the way, loves the idea of a 2% inflation target and even suggests that Mankiw be appointed to the Fed’s Board of Governors. Maybe Mitt Romney (to whom Mankiw is an adviser) can do that next year.

Why is the Fed still paying interest on reserves?

12 November 2010

Matt Yglesias, channeling Scott Sumner and Louis Woodhill, makes a good case that the interest rate on bank reserves, which was 0% up until just a couple years ago, should be lowered from its current 0.25%.  He suggests lowering it to 0.15%; I’d go lower, to 0.10% if going back to zero is out of the question.

Paying interest on reserves made some sense back in 2008 when the Fed was flooding the system with reserves in order to prevent a deflationary catastrophe.  The fear then was that when the economy picked up, banks would start loaning those reserves out and unleash a huge inflation; to prevent that, the Fed put an interest rate on reserves that could be raised whenever it became necessary to “soak up” those reserves.  But nothing like that is happening now — instead we have a banking system with about $1 trillion in reserves that they’re not loaning out, and the amount is likely to grow as the Fed makes its monthly $75 billion purchases of longer-term bonds under QE2.  The string the Fed is pushing on ought to move a little more if the interest rate on reserves were closer to zero.  0.25% might not sound like much, but it’s more than the federal funds rate on any given day and more than the short-term Treasury bill rate.  If banks could only earn 0.10% on reserves, I think they’d be more likely to loan them out, i.e., monetary policy would be more likely to work.

When the recovery finally shifts into high gear (and it could be sooner than most of us think, considering all the “green shoots” among leading indicators at present) and banks start loaning out those reserves, then the Fed can raise the interest rate on reserves.  But keeping it this high now gives preemption a bad name.

The next Federal Reserve Chairwoman

8 August 2009

. . . would of course be the first Federal Reserve Chairwoman.  But the word on the street is that San Francisco Federal Reserve Bank President Janet Yellen is said to be on the very short list of possible Fed Chair nominees, along with Larry Summers and a Ben Bernanke re-appointment.

Yellen is an intriguing possibility.  Hands-on experience as S.F. Fed president (including a seat right now on the Federal Open Market Committee, the Fed’s policy-making group), stints on the Fed Board of Governors and as chair of the Council of Economic Advisers during the Clinton Administration, longtime tenured economics professor at Berkeley. I’ve read a few of her papers on macro theory and policy, and she writes unusually well for an economist.  (Her review article on efficiency-wage theories of unemployment was probably the clearest thing I read in my entire first year of grad school.) And for what it’s worth, she’ll have good advice at the breakfast table: she’s married to economics Nobel laureate George Akerlof. (Democrats are big on the whole “two for the price of one” concept, no?)


Printing money?

10 June 2009

Trivia question:  How much money has the Federal Reserve printed in its entire ninety-five-year history?

Answer:  $0.  The Bureau of Engraving and Printing, part of the federal government’s Department of the Treasury, prints all the money.  And none of those bills become “money” (i.e., part of the money supply, M1 or M2) until they’re held by the public anyway.

Am I being pedantic?  After all, those dollar bills are “Federal Reserve Notes” and are delivered to the twelve Federal Reserve Banks upon request.   I don’t think it’s pedantic, though, as there’s a world of difference between printing money and dropping it from a helicopter (as described in countless economics classrooms and which would be very inflationary) and how those bills actually do hit the street (generally not covered in econ classes, an omission that has always mystified me*, and which is not so inflationary).

Anyway, what brought on this post is the constant chatter in the media and the blogosphere about how the government or the Fed is printing money.   (Of course this chatter is most pronounced on the right.  The three minutes I heard of Limbaugh’s show this year were devoted to some witless sarcasm about we should all be allowed to print counterfeit money because the government is already doing it.  Har de har.)


The phantom inflation menace, and a credit crunch update

30 May 2009

Krugman has it right here, in yesterday’s NYT. I’d been planning a post on the recent spate of fear-mongering about the deficit, and Krugman covers a lot of the same ground.  One of the arguments against deficits is that they may lead to high inflation down the road, if the government leans on the central bank to “inflate away the debt” (i.e., jack up the price level so as to reduce the real burden of the national debt), but Krugman notes that there are precious few such examples in recent (post-WWII) history.  He concludes:

‘. . . it’s hard to escape the sense that the current inflation fear-mongering is partly political, coming largely from economists who had no problem with deficits caused by tax cuts but suddenly became fiscal scolds when the government started spending money to rescue the economy. And their goal seems to be to bully the Obama administration into abandoning those rescue efforts.

‘Needless to say, the president should not let himself be bullied. The economy is still in deep trouble and needs continuing help.

‘Yes, we have a long-run budget problem, and we need to start laying the groundwork for a long-run solution. But when it comes to inflation, the only thing we have to fear is inflation fear itself.’