Relevant and even prescient commentary on news, politics and the economy.

Investment and Interest Rates

In a recent post, I noted that actual non-residential fixed capital investment doesn’t show the pattern one would expect based on optimizing models at all. Ugh that sentence was convoluted and so is the post it describes. In fact, the puzzling pattern is really very simple. Non residential fixed capital investment (nrfinv) is high when interest rates are high.


This graph Shows an extremely high ratio of nrfinv to GDP in the late 70s and early 80s, exactly when nominal interest rates were highest. It also shows high investment in the late 90s during the dot com bubble/boom and in the early 20th century at the same time as the even more dramatically high levels of residential investment. In particular, the correlation of nrfinv/gdp and Moody’s index of Baa rated corporate bonds (ibaa) is extremely high 0.77 over the whole sample of available data. Over the period 1947-1995 it is an amazing 0.916.

This correlation is strange for two reasons. First the sign is surprising. Other things equal, one would expect high interest rates to cause low investment. note the brick red curve in the graph is the Federal Funds rate — a policy instrument. Second the interest rates are nominal. Sooner or later, I will try to understand what was going on.

Another question is: why did I just learn about this pattern ? In 1995 the correlation using all available data was over 90%. Why wasn’t this noted even as a puzzling fact ? I can answer this question. I have been playing with nrfinv/gdp and ibaa off and on for months. I have noted positive coefficients on interest rates. I have thought that they have the wrong sign and must be spurious. I am not as respectful of conventional models as most macroeconomists, but I do reflexively avert my eyes from some summary statistics which are too ugly to contemplate.

Here is another version of the graph a couple of FRED commands away from which shows the strange pattern more clearly.


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Adair Turner understands better than Paul Krugman

After watching the new video with Adair Turner from a talk he gave at the Bristol Festival of Economics in November 2014, it is clear he understands the economic situation better than Paul Krugman.

While Krugman tries to understand if inequality even leads to more financial instability (link), Turner knows that it does and the mechanisms by which it does. Turner then gives recommendations on how to lean against the economic forces creating inequality. The mechanisms work around real estate financing. In the video, Turner explains how to control lending practices for real estate.

While Krugman pushes for more accommodative monetary policy and fiscal policy, Turner recommends less accommodative policy and much more fiscal type policies that enter the income stream directly, including some form of helicopter drop. Helicopter drop options, as Turner says, are tax cuts, more welfare expenditures or infrastructure spending. Turner does not like QE accommodation because the money did not enter the income stream directly.

While Krugman recommends strong accommodative monetary policy if there is fiscal austerity, Turner does not support such strong accommodative policy. He sees it as exacerbating the causes of our economic problems. Turner sees that accommodative monetary policy needs to be unraveled and replaced with policies that allow money to directly enter the income stream within the general population. In essence, Krugman puts too much faith in monetary policy, while Turner does not.

In all, Adair Turner is ahead of Krugman in understanding macroeconomic problems and their solutions.

An essential moment in the video is Turner’s answer after the 1:01:00 point, where he explains his view of appropriate monetary policy.

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Real price of oil.

Thought people would find this of interest.

real oil



This is not updated from September being the last observation.

In 1999 when this bottomed West Texas Intermediate was under $12/bbl

and gasoline was under $1/ gal.

oil share

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Eleven richest Americans have all received government subsidies

A new report by Good Jobs First shows how the very wealthy in America have benefited from government subsidies as one element in building their fortunes. According to the study, the 11 richest Americans, and 23 of the 25 richest, all have significant ownership in companies that have received at least $1 million in investment incentives.

The study compares the most recent Forbes 400 ranking of wealthiest Americans with the Good Jobs First Subsidy Tracker database. Not only do Bill Gates, Warren Buffett, Larry Ellison, the Koch Brothers, the Waltons, Michael Bloomberg, and Mark Zuckerberg own companies that have received millions or even billions in taxpayer funds, 99 of the 258 companies connected with the Forbes 400 have such subsidies.

As I argued theoretically in Competing for Capital, the new report points out that subsidies for investment increase inequality as average taxpayers subsidize wealthy corporate owners. Location incentives directly put money into their pockets, which then has to be offset by higher taxes on others, reduced government services, or higher levels of government debt. Moreover, as the study notes, despite the huge amount of these subsidies given in the name of economic development, there has not been enough payback to raise real wages even back to their 1970s peak. In other words, if economic development has created so many new jobs, why haven’t wages risen?

Of course, subsidies don’t account for the biggest part of inequality. Read Thomas Piketty for the big picture on the subject. But the new report shows that large numbers of America’s wealthiest (or not so wealthy, like Mitt Romney) have benefited handily from government subsidies.

Cross-posted from Middle Class Political Economist.

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Current Edge of Adair Turner’s Thinking

This video was published on Youtube a week ago and has only had 27 views. The video is of a talk Adair Turner gave in November at the Bristol Festival of Economics. It reflects his current insights.

He gives explanations for 4 big patterns developing in the global economy.

  1. Increased Inequality
  2. Rising ratio of wealth to income
  3. Rising leverage (rising debt to GDP)
  4. Falling interest rates over decades

His ideas are good. For example, one main idea is that the increased values of real estate are making our economies unstable. Most leverage is created for real estate and not capital investment. Confidence in property values then goes through intensely more volatile cycles.

His explanations of falling interest rates is based on… ex-ante savings being more than ex-ante investment plans. He explains why investment needs are going down. The result is lower interest rates which make it easier for people to compete for real estate ownership, which brings him back to his main point.

He does make mention that in the past 3 years, monetary policy should have dropped money from helicopters instead of what it did. Helicopter drops of money is actually fiscal policy. I agree with his “radical” view as he calls it, because using the IS-LM model, I see the same idea… that we should have had less monetary policy and more fiscal type policies. (Link to my post)


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30 minutes to Fed Statement

The markets wait for the Fed’s statement in 30 minutes. Some thoughts beyond low inflation and an active labor market…

  • Fed must give forward guidance to normalizing the Fed rate.
  • Yet, any sense of disciplining the markets will be met with lower stock values.
  • The markets need discipline which is part of the normal process of a normalized Fed rate.
  • Yet, the markets and the Fed have fallen into a pattern of slack discipline.
  • Will the Fed give a sense of discipline during the Christmas shopping season? They have to be careful, because capital income is a big consumer at the moment.

Update: Dow quickly jumped 100 points on Fed statement keeping tone of considerable time in the new wording of “patient”.

“…the Committee judges that it can be patient in beginning to normalize the stance of monetary policy. ”

“This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.

“When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.” From Fed statement via WSJ.

No sense of discipline in the statement.

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Monetary Reflections… more to come in 2015

I reflected in a post last week that we should have had less accommodative monetary policy and more fiscal policy since the crisis… Thoughts on Investment, IS-LM & Effective Demand.

Today Paul Krugman also had what appears to be a moment of reflection upon monetary perspectives… The Limits of Purely Monetary Policies. He recognizes the limitations of monetary policy after the crisis in that they cannot just produce inflation when they want to.

He recognizes the need for more fiscal policy… He mentions the idea of just giving money to households, but that is really fiscal policy.

“But, asks Evans-Pritchard, what if the central bank simply gives households money? Well, that is, as he notes, really fiscal policy — it’s a massive transfer program rather than a conventional monetary operation.”

Putting money into the hands or people is a good fiscal idea that would have moved the IS curve to the right, which would have given the Fed rate a better chance to lift-off earlier, and thus normalize better. We could have generated more “grassroots” inflation pressures. My view is that the best way to put money in the hands of people is to raise labor share of income, but firms do not have an incentive to do that. Nor does labor have the power to negotiate that.

I foresee that 2015 will be the year for massive reflections and soul-searching about monetary policies. The Fed says that it is planning to lift-off the Fed rate, but others do not think that can happen (I am one) because they are behind the curve and there is too much global weakness.

2015 will surely be an interesting year…

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Peso Problems, Ruble Problems, Euro Problems and all Bhat

The Ruble is collapsing. This will do dramatic damage to the Russian economy, because many Russian firms have dollar denominated debts. This is a familiar story. Something similar happened in East Asian countries in 1997 and Russia in 1998. There is no good policy response, because defense of the Ruble based on extremely high interest rates (last I heard 17%) will also cause extreme distress.

I think that it is in Russia’s interests to impose capital controls, which will amount to allowing and forcing Russian firms to default but leave foreign creditors with no legal recourse. Imposing capital controls worked rather well for Malaysia in 1997 and Russia in 1998.

In this post, my interest is in why creditors lent dollars given the fact that Russian debtors would default if the Ruble depreciated. As used by economists, the phrase “peso problem” doesn’t just refer to the Peso. It is the argument that sample averages in available data can be very misleading indicators of expected values if there are rare large events. The example was devaluation of the Mexican Peso. This was back in olden days, when Mexican borrowers borrowed in Pesos and the Peso was pegged to the dollar. Peso interest rates were, nonetheless, higher producing what appeared to be a riskless profit opportunity. Then the Peso devalued. Milton Friedman is given credit for arguing, before the devaluation, that the apparent riskless profit opportunity was no such thing.

The bottom line is that rare extreme events can make it seem that riskless profits have been earned. I use “the bottom line” literally to refer to the profit or loss stated in a profit and loss statement.

It has been argued that people who manage other people’s money, have excellent reason to seek out (or if necessary create) peso problems. Until the extreme event occurs, there are high returns and low measured variance of returns (that is low sample variance in the sample of stuff that has already happened). Such a pattern is highly rewarded. If disaster comes later, it is too late to claw back bonuses. Bankers allegedly sometimes say “IBGYBG” that is “I’ll be gone, you’ll be gone.”

Dollar denominated loans to firms with revenues denominated in another currency are a way to recreate the Peso problem without pegged exchange rates. The knowledge that there is a risk of widespread default implies high interest rates on such loans. The fact that widespread default hasn’t occured implies high performance compared to ex post measured risk. Big bonuses.

Another example is a larger than optimal currency area, that is, the Euro block. The introduction of the Euro caused a huge increase in the flow of loans from Germany to Spain. The Peseta could not realign compared to the Deutschemark. But there could be widespread insolvency instead.

Default is often (typically ?) worse for creditors than devaluation. But fear of possible default in the distant future has not prevented massive foolish lending.
I think this could be the usual problem that people who manage other people’s money who are rewarded based on short run performance have strong incentives to push risk into the lower tail of the distribution. Rare huge disasters aren’t costly enough to them.

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Waiting & Watching… What response to Russia?

These are tense moments… At 1 am in the morning, Russia made a dramatic announcement to raise its base interest rate from 10.5% to 17%. Their ruble was falling fast yesterday. There is capital flight out of Russia. So the rate rise was meant to attract money back into their country. They even raised their deposit rates to 16%. They want money to stay in their banking system.

Since the announcement, the Ruble has stabilized against the dollar.


I tweeted last night that it is almost tempting to invest in Russian bonds. How many investors will actually put their money into Russia now?

US stocks started lower in the morning, then returned to yesterday’s close. The Dow sits at 17,200, where I believe it is in a stable orbit. Yesterday I expected the Dow to stay around that level for a while. And it is still there as of this moment, but the market is waiting and watching what response their will be from the financial authorities.

Update: Stocks are beginning to rise 30 minutes after publishing the above. Is the opinion forming that the Fed will not be able to raise the Fed rate? How would US companies benefit from the troubles in Russia and emerging markets? Is money flowing into the US markets? Would US stocks absorb funds first, then back down afterward?

Update: Ruble is rising since post above written about an hour ago.

ruble 2

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